REPORT TO HOUSING AND HUMAN SERVICES COMMISSION
SUBJECT
Title
Consider New First Mortgage Refinance Loan of $3.3 Million in Housing Funds to MidPen Housing Corp. and Modification of Outstanding Loans to Finance Phase Two of Eight Trees Apartments Rehabilitation at 183 Acalanes Drive, Sunnyvale
Report
BACKGROUND
Eight Trees Apartments (Eight Trees) was acquired in 2002 by a non-profit homeless shelter operator now known as HomeFirst SCC (HomeFirst) with City assistance in the form of several Housing loans and a private first mortgage (the “Combs loan”). The outstanding loan amounts and related details are provided in Attachment 5. Eight Trees was built in the early 1960’s as a two-story market-rate apartment building with 24 modest units, surface and carport parking, limited perimeter landscaping and a small pool in a central courtyard.
HomeFirst was not able to obtain the project-based vouchers it had hoped to obtain to support its vision for the property to provide affordable housing to: clients transitioning out of homelessness, and other very low income households. After struggling to maintain and manage the property and make the required loan payments for the first 10-12 years, HomeFirst staff approached City of Sunnyvale Housing staff to discuss options for stabilizing Eight Trees. Ultimately, following some executive staff turnover at HomeFirst, by 2016 HomeFirst had decided that it wanted to exit the business of rental housing management and focus on its core mission of operating homeless shelters and providing services to homeless clients. HomeFirst notified staff that it was seeking a non-profit rental housing provider to take over the property and the existing debt. Around that time, MidPen Housing Corp. (MidPen) was looking for sites in Sunnyvale for a new affordable housing project, including possible acquisition and rehabilitation of existing housing. The high price of market-rate properties of any kind was making that process very difficult.
Given the circumstances, staff cross-referred these agencies and suggested they consider options for Eight Trees, although staff also provided HomeFirst with the names of other local housing providers, to provide a range of options. Eventually both non-profits (MidPen and HomeFirst) reached agreement on initial terms for the transfer. The two agencies approached staff at the City, County, and Housing Authority to discuss options for stabilizing this at-risk property. MidPen applied for project-based vouchers from the Housing Authority, but was denied because the Housing Authority was only accepting proposals for newly built projects at that time. The County was only interested in providing funding to convert the property into permanent supportive housing for County clients. That would have displaced most of the families currently renting there, so that was not considered feasible or desirable. With no viable funding sources from the County or Housing Authority, the parties focused on structuring a proposal for City approval, which was required for the transfer due to terms in the City loan documents. MidPen also began analyzing the potential for an application for tax credits to refinance the existing debt. The existing debt was at much higher interest rates than are currently available, and was creating an unsustainable debt burden for the property.
In June 2016 (RTC No. 16-0442), City Council approved the property transfer, and assignment and assumption of the outstanding City debt, from HomeFirst to MidPen. That report also included a two-phased plan and term sheet proposed to stabilize the property financially and generate funds for a substantial rehabilitation project. Phase One consisted of MidPen’s assumption of the property and its existing debt, and a new City loan of $600,000 to MidPen for urgent repairs and related costs to stabilize the property for the short term. Phase Two as proposed then (and currently pending) consisted of refinancing and rehabilitating the property to make it sustainable for the long-term, including a tax credit syndication. This report provides an update on the progress made to date in implementing Phase One, and an overview of the updated funding proposal for Phase Two.
In August 2016, the property title transferred from HomeFirst to MidPen, and escrow closed on the new City loan to MidPen for urgent repairs. The loan funds were made available, on a reimbursement basis, for urgent repairs, an interim operating reserve, preliminary design work for the Phase Two rehabilitation, and to pay off the outstanding balance (approximately $100,000) on one of the original City loans that was due in June 2016. Most of the urgent repairs were completed by the end of 2016, with a few minor repairs completed more recently. The 2016 assignment and assumption agreement also included an agreement by the City, as lender, to suspend certain loan payments that were otherwise due semi-annually under one of the older City loans, until all of the outstanding debt could be restructured during Phase Two, pending City Council approval of the funding proposal described below. In June 2016 it was noted in the Report to Council that Phase Two funding was conceptual and subject to change based on the availability of various funding sources.
The City Council is scheduled to consider this item on November 28, 2017.
EXISTING POLICY
General Plan, Housing Element
Goal A: Assist in the provision of adequate housing to meet the diverse needs of Sunnyvale’s households of all income levels.
Goal B: Maintain and enhance the condition and affordability of existing housing in Sunnyvale.
ENVIRONMENTAL REVIEW
This project is exempt from the requirements of the California Environmental Quality Act (CEQA) as a Class 1 project involving only rehabilitation of existing structures involving negligible or no expansion of use beyond that presently existing. (CEQA Guidelines section 15301(d).) No federal funds will be used for this project, therefore federal environmental review under the National Environmental Policy Act (NEPA) is not required.
DISCUSSION
MidPen has worked with staff to further refine the scope and design for the substantial rehabilitation work and the financial restructuring plan, including the federal low-income housing tax credits (LIHTC) application that, if successful, would generate an estimated private equity investment of approximately $9.44 million for the project. MidPen has submitted a planning application for the proposed rehabilitation, and the project will be scheduled for a Zoning Administrator public hearing for a decision on proposed modifications to the site. In exchange for the proposed new loan and restructure of the outstanding loans, the required term of affordability would be extended for 55 years from the date of recordation of the new regulatory agreement. The affordability restrictions currently in effect will expire in 2023 (HOME) and 2046 (CDBG).
Consistent with the two-phased plan attached to the 2016 RTC, MidPen has applied for a new loan for Phase Two through an open Request for Proposals (RFP) issued by the Housing Division. Since that time, MidPen has refined the rehabilitation scope of work to meet current Building, Fire, and Planning requirements as well as address functional needs for the project. Those refinements, as well as general escalations in construction costs, resulted in slightly higher project cost estimates, which then impacted the project’s refinancing plan. After analyzing various options for funding Phase Two, staff and MidPen have concluded that a City loan of approximately $3.3 million, plus an application for an allocation of LIHTC, is the most feasible option, for the reasons explained below. The proposal also requests the modification of four outstanding City loans on the property to forgive a combined total of approximately $670,000 in interest accrued to date, extend the maturity dates to coincide with that of the new loan, adjust the interest rates to zero, and add residual receipts payment requirements to all of them, as explained below. A vicinity map of the project site is provided in Attachment 1. An updated plan and term sheet is provided in Attachment 2. The funding application is provided in Attachment 3. The rehabilitation scope of work and budget is provided in Attachment 4. The Proposed Debt Restructure is provided in Attachment 5.
Rehabilitation Scope of Work
The Eight Trees property is dated, as it has not been significantly renovated since it was built more than fifty years ago. Renovation is needed to extend the useful life of the buildings, improve energy- and water-efficiency, add common areas for resident services and property management, and improve safety and comfort within the units and throughout the property. A fire sprinkler system will be added as well. The proposed renovations will also improve the property’s appearance from the public street and within the property. To qualify for tax credits, several units need to be reconfigured: eight 2-bedroom units will be converted into four 1-bedroom units and four 3-bedroom units. Currently the property includes mostly 2-bedroom units, but more 3-bedroom units are required to qualify for the tax credits, to accommodate larger households. A small community building will be added in the courtyard between the two apartment structures, replacing the existing swimming pool with a community room and leasing office. The new community building will provide space for resident meetings and services and a property management office. Please see Attachment 4 for the detailed scope of work and project budget. The applicant has structured the physical rehabilitation scope, financing plan, and other aspects of the proposed project strategically to maximize the likelihood of obtaining an LIHTC award during the next application period, and estimates that the project has a strong chance of success. If the project does not receive the LIHTC allocation during the first round, the applicant will reapply in the following application period in June 2018.
Refinancing Proposal
There are four outstanding City loans on the property with a combined outstanding principal balance of $1.75 million, and approximately $670,000 in accrued interest (see Attachment 5 for details). In addition, the private first mortgage loan has a projected pay-off amount of about $2.35 million by January 2018. The interest rate on the senior loan will increase to 9% in February based on the current loan terms. At that point the first mortgage payment would exceed the existing rental income generated by the property, posing a risk of default on that loan if the proposed refinance does not occur.
The refinancing proposal consists of the following requested City assistance:
• New City HMF loan of $3.3 million, with 55-year loan term, at 0% interest, with annual residual receipts (RR) payments;
• Forgive all interest accrued to date on outstanding City loans (approximately $670,000) and adjust interest rates on all loans to 0% for balance of terms;
• Extend maturity dates of existing loans to 55 years, with an end date consistent with that of new HMF loan;
• New affordability restrictions will be placed on the property by the City ensuring its affordability to lower-income households for another 55 years.
While the above loan terms differ slightly from the City’s typical preferred Housing loan terms (i.e., 3% interest), this approach will help the project earn a more competitive score on its LIHTC application. If it does not score high enough, it will most likely not win an LIHTC allocation, which appears to be the most feasible way to stabilize this property in which the City has already invested significant housing funds. Staff encouraged MidPen to seek other possible sources of matching funds, in addition to the tax credits, such as the Silicon Valley Housing Trust, State funding, Measure A, and/or Housing Authority vouchers. MidPen researched all these possibilities and contacted all these agencies, and none of them have any available funding programs that would work for this project, for various reasons: project type is ineligible, no funding available, loan or program not compatible with project, etc.
MidPen had initially submitted a proposal requesting a new City loan of $2.7 million (Alternative 2), with a refinancing plan that would have included obtaining a private first mortgage of approximately $670,000 to complete the necessary permanent financing. However, MidPen and City staff thought that, given the City’s substantial existing investment in this property, and potential new funding, it would not be ideal for the City to remain in second lien position to a senior lender with such a small loan amount. In addition, increasing the amount of the City loan to eliminate the need for a private first mortgage will also significantly increase the project’s score when applying for tax credits. Nonetheless, staff has included this option as Alternative 2 for City Council’s consideration.
Aside from the above alternatives, the only other alternative to preserve the City’s existing investment and avoid default would be to sell the property at market value by releasing the current affordability restrictions, which would most likely displace the current tenants, and might create compliance issues and/or logistical difficulties for the City related to the initial use of federal funds (CDBG and HOME) for this project.
Available City Funds
Staff issued a Request for Proposals (RFP) in early 2015, making available $10 million in Housing funds for new affordable housing capital projects. Since then, the City has awarded funding to two proposals through that RFP: one to First Community Housing, which is still a conditional award pending satisfaction of certain funding conditions (RTC No. 16-0302), and another to Charities Housing (RTC No. 16-0785), which has been funded and the rehabilitation work is in progress. Those two funding commitments equaled nearly $6.5 million in total, leaving $3.5 million still available through this RFP. The Eight Trees application is the only application staff has received since the last two commitments were made, although several inquiries have been received. Additional funding remains available in several Housing funds beyond the amount made available through this RFP, and additional Housing revenues are projected based on approved projects in the development pipeline.
Proposal Evaluation
Housing staff evaluated the proposal based on the qualifications of the proposer, the need for the proposed project, and other criteria set forth in the RFP. MidPen Housing is one of the largest developers and owners of high-quality affordable rental housing in Northern California. MidPen Housing has collaborated with the City of Sunnyvale on many projects including Homestead Park, Aster Park, Garland Plaza, Fair Oaks Plaza, Morse Court, and Onizuka Crossing, among others. The proposal is largely consistent with the plan for Eight Trees presented to Council in 2016. Phase two is urgently needed to prevent a default under the existing senior loan, which poses risks for the property’s long-term affordability and stability, as well as to address the needs for physical improvements.
MidPen has prepared a community outreach plan to engage residents in the proposed renovation plan. Before beginning the rehabilitation work, MidPen will hold outreach meetings with the tenants to discuss the work and address any questions or concerns. Service providers will assist tenants with temporary relocation, to the extent necessary, and any support tenants might need during the construction period. Funding for tenant assistance and temporary relocation is included in the budget.
The proposed project aligns with the goals and objectives of the RFP and City policy. The rehabilitation work will create a safer and better living environment for residents, preserve Eight Trees as an affordable housing resource, and extend the term of affordability for another 55 years.
FISCAL IMPACT
The recommended action will not impact the General Fund, but it would create a new expenditure of $3.3 million in Housing Mitigation Fees (HMF) in the form of a 55-year residual receipts loan to be secured by the property. The recommended debt restructuring would result in forgone interest payments of approximately $670,000 accrued to date on the acquisition loans, as shown in Attachment 5. However, based on the financial projections for the property following project completion, the new loan could generate more in residual receipts payments for the City over the long-term than the forgiven interest amount, particularly if the rental income stream remains consistent.
The HMF and other Housing funds exist to finance affordable housing projects, and the recommended action is consistent with that purpose and various City policies regarding affordable housing. Funding for the recommended new loan is available in the HMF. If recommended for approval by the Commission, staff will include a budget modification with the Council report to allocate $3.3 million in HMF to this project.
PUBLIC CONTACT
Public contact was made through posting of the Housing and Human Services Commission agenda on the City’s official-notice bulletin board, on the City’s website, and the availability of the agenda and report in the Office of the City Clerk.
ALTERNATIVES
1. Approve a new first mortgage refinance loan of $3.3 million in Housing Mitigation Funds for the Eight Trees Phase Two Project and authorize the City Manager to execute a new first mortgage refinance loan and amendments to the existing City loans to forgive accrued interest and adjust interest rates to 0%, as further described in Attachments 2 and 5 of the report.
2. Approve a new junior loan of $2.7 million in Housing Mitigation Funds for the Eight Trees Phase Two Project, and authorize the applicant to obtain a new senior loan of approximately $670,000 from a private lender as part of the tax credit syndication process, and authorize the City Manager to execute a new junior loan and amendments to the existing City loans to forgive accrued interest and adjust interest rates to 0%, as further described in Attachments 2 and 5.
3. Other alternative as recommended by the Commission.
RECOMMENDATION
Recommendation
Recommend to Council Alternative 1: Approve a new first mortgage refinance loan of $3.3 million in Housing Mitigation Funds for the Eight Trees Phase Two Project and authorize the City Manager to execute the new first mortgage refinance loan and amendments to the existing City loans to forgive accrued interest and adjust interest rates to 0%, as further described in Attachments 2 and 5 of the report.
Staff recommends Alternative 1, which would give the City more leverage over the property as the senior lender. Given the relatively small difference in loan amount required, staff recommends this extra investment to position the City as senior lienholder. The new loan will enable MidPen to complete Phase Two of this acquisition/rehabilitation project, improve resident services, establish long-term reserves for maintenance and contingencies, and add much more functional common areas and amenities for the residents. The project is consistent with the City’s Housing Element goals to maintain the quality of the City’s existing affordable rental housing stock and preserve at-risk affordable properties. As noted above, Alternative 2 is also a possibility, however staff does not recommend it due to the less favorable lien position for the City, and because it would make it less likely that the project would be successful in obtaining an allocation of tax credits.
Prepared by: Katrina L. Ardina, Housing Programs Analyst
Reviewed by: Suzanne Isé, Housing Officer
Reviewed by: Trudi Ryan, Director, Community Development
Reviewed by: Teri Silva, Interim Assistant City Manager
Approved by: Kent Steffens, Interim City Manager
ATTACHMENTS
1. Vicinity Map
2. Updated Plan and Term Sheet
3. Funding Application
4. Scope of Work and Budget
5. Proposed Debt Restructure