How to Build an Early Affordable Housing Development Pro Forma: 5 Tips Organizational Decisionmakers Can Use
Even if your organization is just beginning its journey as an affordable housing owner-developer, you and your leadership team know that sound financial modeling plays a crucial role in making good development decisions.
But you may be wondering how to start building a financial pro forma for a prospective affordable rental housing development—or when and how to refine your assumptions and evaluate the results.
Two seasoned affordable housing developers, HDC’s Travis Phillips and Salem Housing Authority’s Jessica Blakely, teamed up to offer guidance.
You can scroll down to view their full presentation, delivered at the Housing Oregon 2024 Conference in September. Designed for senior executives and managers, board members, and other nonprofit organizational leaders, it walks through the process of building an early-phase development pro forma for affordable rental housing.
The presentation answers questions such as these:
How can I use financial modeling short cuts to help my team move quickly to a go/no-go decision about a proposed rental housing development project?
Which financial assumptions should I refine first, if I am considering multiple possible programmatic and funding scenarios?
What do I need to know before I can identify appropriate financing sources to pursue?
Don’t have time to watch the full 79-minute video today? Read on for five key takeaways.
1. Understand the core components of a development pro forma and how the components work together. Then, grab a template and start to fill in the blanks.
There are hundreds of ways to fill in a development pro forma and just as many different pro forma templates. But nearly all pro formas have some basic things in common.
A typical development pro forma is built as an Excel workbook. It contains, at minimum, the following data and calculations:
Use the “pro forma template” link below to access the Excel workbook shown in this screen shot.
Unit Mix and Rents. When you build your pro forma, you will make some starting assumptions about the housing units at your property. You’ll estimate their quantity, their size (number of bedrooms and square footage), and their rent prices. These assumptions will drive your development-cost, operating-income, and operating-expense projections.
Operating Budget. You will project your annual operating revenue and expenses (including debt service) over an extended time period. This projection will tell you if you can meet financial targets set by your organization and project funders.
Development Costs. You will want to consider the full spectrum of costs involved in getting the project designed, built (or acquired and rehabbed), and leased up. This includes hard costs, such as construction. It also includes soft costs, such as architecture, permitting, and financing.
Development Sources. The funding sources for your project must cover the development costs. They must also supply the project with sufficient capital to operate sustainably.
As you can see, the different parts of the proforma work together. A readymade template will have budgetary line items and formulas built in. You’ll be able to see how shifting any one variable will affect others.
Here is a basic pro forma template you can use to get started.
2. Rough out a single scenario, then refine.
Here’s simple piece of advice for getting started: Don’t be intimidated by all the blank cells in your pro forma. And don’t play around with all the unknown variables at once. Instead, rough in key assumptions, starting with a single scenario.
Maybe you have a detailed programmatic vision for your project. Maybe your only “known” is a specific property site. Regardless, from a financial modeling standpoint, many key data points are surely unknown. Real estate development is an iterative process with many factors in flux. Given the uncertainties as well as the costs involved, it’s best to resist getting too far into the weeds too early.
For variables such as unit count, plug in “best guess” values—such as the greatest or least number of units likely to be built. Then, move on. Use easily available data to fill in other key assumptions. It’s okay to input a total value for a whole column of line items (such as operating expenses or construction costs) if granular data isn’t easily available.
Try to answer this question: “Is it financially feasible to develop a project that looks sort of like this?” Once you have an answer, identify where refinements are most important.
3. Use funder requirements to guide assumptions.
Unless you intend to fund your development largely through private donations, you will almost certainly seek financing from both public funders and private lenders.
Your public and private funders will require you to demonstrate that your project is financially structured to operate stably—and to meet its financial obligations over an extended period of time.
Additionally, public funders want their housing investments to be used effectively to achieve affordability goals and other public priorities. They will require that many financial metrics stay within prescribed thresholds.
When testing and refining your initial scenarios, use the variables your funders care about to help populate data in your pro forma.
These are four funding requirements that can quickly inform an early pro forma:
Debt Service Coverage Ratio. Your project’s net operating income (NOI) is its operating revenue less operating expenses. Its debt service coverage ratio (DSCR) is the ratio of the NOI to debt service payments, usually viewed annually. Your permanent lender will typically want to see a DSCR in the range of 1.15 to 1.20—higher if there are special risk factors—throughout the term of the loan. In other words, for every $1 in loan payments it owes each year, the project will need to have $1.15 to $1.20 of net operating income. Using this guideline, you can easily estimate the size of the mortgage the project may be able to support.
Operating Expense. If you are developing affordable housing in Oregon, you will probably seek funding from the state housing finance agency, Oregon Housing and Community Services (OHCS). OHCS’s 2024 funding guidelines require projects to have operating expenses of between $5,500 and $8,500 per unit per year (PUPY). (Limits are higher for permanent supportive housing projects.) If you have recent operating expense data for a comparable project, use it. Otherwise, for purposes of testing your other initial assumptions, an easy shortcut is to assume a PUPY operating expense value at the high end of OHCS’s limits.
Square Footage. Construction and other costs can be estimated based on the square footage of the structures(s) and individual housing units you intend to build. Early on, your project’s design may not have reached the level of refinement where you know these square footage values. But you can refer to OHCS guidelines to make ballpark estimates—and to make sure your project’s unit sizes comply with OHCS requirements. In its Core Development Manual, OHCS sets minimum and maximum limits for unit square footage based on unit size (number of bedrooms). Based on these guidelines and the total number of units and mix of unit sizes you expect to build (this can be a “best guess” scenario), you can estimate your project’s total residential square footage.
Rent Revenue. Most public funding is restricted to projects serving households who earn 60% of area median income or less. Rents for publicly funded affordable housing units are set based on unit size (number of bedrooms). In Oregon, OHCS provides data about income and rent limits broken down by county. Using these tables and your unit-mix assumptions, you can easily determine the maximum amount of rent revenue your project could generate.
4. Investigate comparable data to estimate development costs.
Of course, understanding if your project is feasible also requires understanding how much it might cost to develop.
Leveraging the expertise of a skilled general contractor (GC) will be essential to understand actual construction costs. But there are ways to estimate construction costs prior to having a GC carefully review your architectural plans.
Watch the full presentation.
A GC may be willing to share a high-level cost estimate (potentially with lots of qualifiers) based on your project’s rough program and square footage. Cost estimates can be derived from recent comparable projects, as well. You may have comparable projects in your own portfolio that offer clues about what your project’s per-square-foot and total construction costs will be. You can also refer to data for projects recently completed or underway in the region, such as information in OHCS’s Housing Stability Council documentation.
Alert: It is important that referenced projects are truly comparable to yours. Differences such as construction type, site conditions, sustainability measures, the presence or absence of elevators, and many other factors can have big impacts on overall construction costs.
After construction costs (hard costs) have been established, other development costs can be more easily estimated. You’ll need to budget for a range of softs costs as well as construction contingency costs, meaning unknown costs in excess of budgeted construction line items.
To estimate these other costs, you can gather direct feedback from project partners, such as architects and engineers. Or you can plug in funder maximums as a shortcut. For instance, OHCS allows funded projects to budget for construction contingency costs equal to 5% of total hard costs if the project is new construction and 10% if it is rehabilitation. OHCS also prescribes that a project’s total soft costs should be no more than 30% of hard costs.
5. Identify potential funding sources.
The last step in assessing your project’s feasibility and making a go or no-go decision is to understand whether it has a high likelihood of securing sufficient funding.
There are many types of funding sources that your project might be eligible to pursue. Broadly, they include…
Permanent debt (conventional loan), based on the debt service coverage the project can sustain, as mentioned above.
Low-income housing tax credit (LIHTC) equity, based on the eligible costs of the development and the price an investor will pay for the credits.
Grant funding that the project or project sponsor may be able to acquire.
Additional (non-LIHTC) tax credits and incentive funds for energy efficiency, renewable energy generation (often solar), and transit-oriented development.
In addition to the types of sources listed above, developer fees can be used as a source in your project’s development budget if their payment is deferred. Once the project is in operation, the cash flow available after paying operating expenses and debt service becomes the source for these deferred fees. The portion of the developer fee that can be deferred is typically the amount that can be paid within the first 10-12 years of operation.
Usually, permanent debt and LIHTC equity are the first two sources you’ll want to incorporate into your funding model. At this stage of building your pro forma, you will have already evaluated how much permanent debt the project can support. Additionally, you will have determined your development costs, which will enable you to estimate how much LIHTC equity the project can generate if the intent is to apply for LIHTCs. (Note: LIHTC eligibility requirements, calculations, and compliance obligations are complex. It is highly recommended that you obtain skilled guidance in this area if you don’t already have relevant expertise.)
From here, you can quantify the rest of your project’s financing gap and begin to examine how well your project aligns with the policy goals and requirements of various public funding programs. Two types of requirements to pay attention to for purposes of defining target funding amounts:
Per-unit subsidy limits. Public funders typically prescribe per-unit subsidy limits which vary based on a project’s unit sizes and the income levels of the residents to be served. Larger units and units which serve lower-income households are often eligible for higher subsidies. For example, maximum subsidies in OHCS’s 2024 ORCA manual for urban new-construction projects range from $230,000 per unit for a studio serving a 60% AMI household to $385,000 per unit for a 2-bedroom unit serving a 30% AMI household.
Geographic location. OHCS offers regional set asides and establishes different maximum funding amounts for rural projects compared to urban projects. In addition to state funding, your project may be eligible for funding offered by its local jurisdiction.
What are the next steps?
Building an early, high-level pro forma won’t give you the final answer as to whether your development concept can successfully become reality. But if you’ve used the five pieces of guidance above, you will be well on your way to understanding whether it makes sense to continue your exploration. If your project that looks sort of like this appears to be feasible or comes close, your next steps are to further refine, test, and play around with the model. Consider investing additional time and resources in acquiring better-quality data. Ask what would happen if your assumptions were too rosy or too conservative. Test alternate scenarios and use the results to inform your ongoing decision-making.
Don’t say goodbye to your pro forma.
By definition, a pro forma is a tool for identifying and testing financial assumptions and projections. You will continue to use your pro forma throughout the development process to document your assumptions, as they evolve, and inform your decisions. By understanding how a development’s financial model works and by continuously updating the model at different stages of the development process, developers and organizational leaders can make sound decisions as the project moves forward.
Next expert assistance? Contact HDC’s development team.