Assessing Financial Feasibility

Determining financial feasibility will help you understand the viability of your project. For a project to be considered viable, the cost of building and operating it must be less than or equal to the income and other funding you anticipate the project to generate or receive. Similar to your assessment of your internal capacity, an initial analysis of financial feasibility will help you determine what you have available and what gaps you need to fill.

To get a baseline understanding of what gaps exist, you may only need to complete “back of the envelope” calculations. These calculations can inform the development model that you select as well as the funding sources you decide to pursue. These estimated calculations are not perfect, but they provide quick insight into anticipated cash flow and needs. The simple way to complete a BOE calculation is to estimate expected project income relative to estimated project costs. There are a few online calculators that can help you with this process:

• Grounded Solutions calculator captures more varied building types.

• Urban Institute calculator is limited to rental buildings that are either 50 units or 100 units.

Once you have done some basic financial feasibility, you will want to model the project in a pro forma.

Financial Modeling and Funding

Before we work to secure funding, you must understand what funding is needed and what operating income might be realized. To understand the budget needs, you should conduct a financial feasibility analysis of your project. Even if you are engaging a consultant to help with securing funding, it is important that multiple members of your development team understand the different components of the financial model so you can use the information most effectively.

You will learn the components of a pro forma workbook to test and analyze the impact of changes to your development model or addition of different funding sources on your project’s financial feasibility. Ultimately, you will use the pro forma to demonstrate to funders that your project is worthy of their investment.

Many affordable housing projects need to engage a consultant or technical assistance provider to perform a full financial analysis to demonstrate that a project is a sound investment. Engaging an expert to perform a financial analysis is another opportunity to learn from an experienced partner and build capacity for financial analysis in-house. All development partners should also be involved in the financial feasibility assessment process to ensure they understand and are able to communicate the results.

Estimates and Financial Feasibility

In the pre-development stage, you will not know for certain how much things will cost or how much funding you will be able to secure. As a result, this analysis will be based on a series of estimates and assumptions about your development model, information from your Project Team, plus data collected for the market analysis.

Types of estimates you will need to analyze financial feasibility:

• Cost of land, labor, and materials for acquisition, site work, and construction (AKA “hard costs”)

• Other costs not related to labor and materials, like fees and insurance (AKA “soft costs”)

• Anticipated income from the project (residential and commercial rents collected; income from parking, laundry, or service fees; rental assistance) on an annual basis

• Anticipated vacancy rate

• Operating expenses (taxes, insurance costs, utilities that are not paid by tenants, repair and maintenance costs, and other administrative or management costs)

• Operating and replacement reserve budgets, in case there are shortfalls or larger items (like HVAC) need replacement during your building’s lifespan

• Debt service or other financing costs

There are four primary ways we use this information to analyze and summarize the project’s financial needs. The follow components together are often referred to as a “pro forma.”

• A Development Budget, where you detail the costs of building your project and getting it ready for people to live in.

• A Sources and Uses statement, where you summarize the funding, you have relative to the development costs they will cover.

• Operating Income and Expenses, which helps calculate rental income and debt service

• A pro forma schedule of income and expenses, where you estimate how your project costs and revenues will accrue over time.

Many refer to all these components as a “pro forma” together because they are typically found within the same workbook and the pro forma forecasting spreadsheet is typically populated with values from the other sheets and can be useful in doing base calculations. We have a sample pro forma in the tools for you to use.

Completing Your Pro Forma

The sections of a pro forma are below. Use these examples for homeownership and rental projects to fill in each component.  See the Financial Modeling Tool page.

Pro Forma Component: Development Budget

A development budget captures all costs required to build your project and place it in service (or have it generally readied for occupancy).

The development budget includes the following costs:

• Land and site work costs

• Construction or rehabilitation costs

• Professional fees, including consulting costs

• Interim construction costs

• Permanent financing costs

• Soft costs, which are costs not directly related to construction labor and building materials. This includes costs such as architecture, engineering, permitting, and legal fees. Some soft costs such as insurance may continue after construction is completed.

• Predevelopment costs (Development costs that are incurred prior to construction, such as those described in the predevelopment section of this guide. This consists mainly of soft costs but will not be the only part of the process where soft costs are incurred.)

• Developer fee

• Project reserves

The sum of costs across each category represents your total development cost (TDC), or Development budget.

As you are working on your Development Budget, keep in mind that funding sources may cap the maximum cost per unit. For example, in order to apply for tax credits in Mississippi, projects are subject to the maximum cost per unit.

Pro Forma Component: Sources and Uses Statement and Permanent Financing

A “sources and uses of funds” statement is used to summarize your project’s financing and how that compares to your development budget. In other words, do you have sufficient funding to cover the costs of building your project?

This statement should capture all sources of financing, their amounts, and what costs they will cover. You have already calculated your “uses” in your development budget. These are your costs within each category mentioned above. You may want or be required to include additional details about each source of financing, such as the type (loan, grant, tax credit, in-kind support, equity investment, etc.) and whether the funding is private or public (federal, state, or local).

Have this statement prepared before you seek funding from a lender or additional funder and include documentation to demonstrate that the funding listed in the statement has been secured. This may include award and commitment letters or partnership agreements.

A sources and uses of funds statement does not include the details of when your costs and revenues will accrue over your project’s lifetime. Those details are included on your pro forma schedule of income and expenses (or cash flow analysis). See the Financial Modeling Tool and Guidance for more specific guidance and a template you can use for your own analysis. There are two sheets that help you analyze the short term and long-term revenue and costs of the project in the Financial Modeling Tool.

You can use the pro forma workbook to test the impact of different components of your development model or different funding sources on your project’s financial feasibility. Ultimately, you will use the pro forma to demonstrate to funders that you need their investment and, if applicable, will be able to pay them back. When preparing your pro forma for funders to review, you may need to provide additional documentation to back up the information included (e.g., if you say you have a certain amount of funding already secured, provide documentation that confirms this).

Pro Forma Component: Operating Income and Expenses

The operating pro forma helps to assess the amount of square footage developed relative to the amount of revenue it will generate. Do your best to get accurate data, as inaccurate assumptions can lead to dramatic swings in actual property performance. There are several factors that need to be considered to derive an accurate operating pro forma:

• Costs to Operate

• Salaries: do you need to pay a full-time or part-time property manager, is there a way to spread this time over a few properties?

• Trash and recycling fees

• Grounds maintenance

• Property insurance

• Reserves

• Type of units (number of bedrooms and baths per units)

• Number of each type of unit

• Projected rents or planned sales prices:

• For rental projects, you need to assess Fair Market Rents in your area. Make sure projected rents are reflective of current market conditions for comparable properties in your area. If you have project-based vouchers, you can assume full rent for residents at varying incomes, if not, rents should be scaled to remain affordable to the target income brackets you are setting out to serve. See calculating affordability.

• For homeownership projects, the proforma will factor in planned sales prices, which will be the project’s revenue source.

Pro Forma Component: 15-year Financing

The 15-year financing pro forma will help you assess some key financial metrics for your development. The most common metrics lenders and funders will use to determine whether and how much debt they will offer to a project are the Debt Service Coverage Ratio (DCR, DSC, or DSCR) and loan-to-value ratio (LTV or LVR). Lenders use these metrics to evaluate how likely they are to be repaid for a loan. Recognizing financial analyses are built on assumptions, lenders look for additional cushion between your NOI and the amount of debt they will authorize for your project.

The DCR, which is a ratio of your cash flow to debt payment, reflects the amount of this cushion a lender is looking for. Lenders often seek a 1.25 minimum DCR, meaning that your project cash flow must be equal to or greater than 1.25 times your required debt service. Some funders will use a lower DCR (e.g., 1.15) based on their risk tolerance or perception of risk.

For a rental project, the debt coverage ratio is determined by rental revenue, and the lender’s source of repayment is the net operating income of the property. For a homeownership project, the source of repayment is the mortgages taken out by home buyers.

Pro Forma Conclusion: Determining Your Funding Needs

With your pro forma package estimates, you will be able to project how much of a gap you have between income and expenses (i.e., your “Net Operating Income” or NOI) and how much cash you may have on-hand after paying your debt service (i.e., your “cash flow”). If either of these figures are negative, you will need to find additional funding to close that gap and/or adjust your development model (number of units, square footage, design features) to reduce costs. If you utilize the Financial Modeling Tool, the up- front gap will be evident on the permanent financing tab.