chapter 7: Financial Feasibility

Learning Objective: Users will have the tools and information to estimate the financial feasibility of a development project and identify relevant resources that may help close financing gaps.

Introduction to financial feasibility analysis

The purpose of financial feasibility analysis is to ensure you have adequate financing to complete your project. Generally, for a project to be 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. The analysis will identify any financial gaps you have to fill and help prove to funders and policymakers that your project is a sound investment.

There are different ways to understand financial feasibility. Your purpose will affect what you focus on in the analysis and what level of detail you need. To get a baseline sense of your project’s viability, you may only need to conduct “back of the envelope” calculations (BOE calculations).

You may conduct these types of calculations very early in your development process to inform what development model you select. See Chapter 3: Housing Development Models, Team, and Roles for more information. You may also revisit BOE calculations at later stages of your project as a quick check to inform other decisions (e.g., types of funders to explore relationships with). BOE calculations can provide rougher but quicker estimates of your project’s anticipated cash flow. You can do this on your own by estimating likely project income relative to building costs or you can use online calculators that allow you to customize different assumptions and evaluate impact on your project’s feasibility.

You can find examples of BOE calculators here:

• The Inclusionary Housing Calculator captures varied building types and is not specific to Colorado.

• The Urban Institute’s “The cost of affordable housing: Does it pencil out?” calculator is based on Denver metro building costs and is limited to rental buildings that are either 50 or 100 units.

To secure a specific source and amount of financing, you may need a more detailed financial analysis. This analysis may be used to show there is a specific need the financing would fill and that there is little risk of the funder not getting a return on their investment. For more detailed analyses, you may want to engage a consultant or technical assistance provider.

No matter how detailed your analysis is, you will need to make assumptions in the analysis. The types of assumptions you make will determine how realistic your results are. Demonstrating you’ve made thoughtful, reasonable assumptions to support your development budget and pro forma, and forecast the long-term viability of your development, is key to building lender confidence in your project, especially if this is your first development. Specific assumptions or estimates you will need to make in a financial feasibility analysis are detailed below.

If you have completed the CHFA market study template, use the comprehensive comparable rent chart as a source of data for rents. You can also review past project examples or ask local governments that administer development financing resources for past project applications, such as applications for HOME funding. You can also ask trusted experts with knowledge of the local context to review your assumptions and financial analysis. This could be members of your development team, your board, another developer, consultants, local lenders, CHFA, and/or DOH. You will likely need to refine your financial assumptions over time.

Potential data sources to develop your assumptions include:

• Redfin

• Zillow

• RSMeans

• CoStar

• FHFA SF land costs data

• NAHB report on soft costs

• HUD income limits and fair market rents

• CHFA’s Affordable Housing Development Cost dashboard is available here.

Even if you are engaging a consultant to conduct a financial feasibility analysis of your project, it is important that multiple members of your development team understand the different components so you can use the information most effectively. There are three primary ways to summarize that information to obtain funding for your project:

1. A development budget

2. A sources and uses statement

3. An operating pro forma, also known as a pro forma schedule of income and expenses

Many refer to all three 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.

Development budget

A development budget captures all costs required to build your project and place it in service or have it generally ready for occupancy. See the Financial Modeling Tool and Guidance.

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, which are 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).

Sources and uses statement

A sources and uses of funds statement is used to summarize your project’s financing and how that compares to your TDCs. 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 detail 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 and include documentation to demonstrate that the funding listed in the statement has been secured. This may include award and commitment letters and partnership agreements.

Pro forma

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. The following chart walks through what should be included. See the Financial Modeling Tool and Guidance for more specific guidance and a template you can use for your own analysis.

This analysis may differ slightly based on your development model discussed in Chapter 3: Housing Development Models, Team, and Roles.

For units intended to be sold instead of rented after construction, you will still need to calculate development costs and make sure your sources and uses balance out, but you will also have proceeds from the sale of the property as a source of funds. In this instance, your NOI will be determined by the difference between expected revenue (including sale proceeds) and costs for maintaining and financing the project until all units are sold. As a result, you will likely have shorter projections in a for-sale pro forma than for a rental pro forma.

If there is an existing structure on the land that is not a part of your project, you will have demolition costs in addition to any land acquisition and site work costs.

If you are renovating a property instead of building new, you may have a shorter construction timeline and may be able to start lease-up or enter a sale more quickly, which would affect your pro forma schedule of income and expenses over time. You may also need a larger budget for site work or environmental clean-up, including lead or asbestos remediation, depending on the age and upkeep of the building. Properties with existing residents may have costs associated with moving tenants temporarily or permanently.

Financial metrics

The most common metrics lenders 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 financial viability. Recognizing financial analyses are built on assumptions, lenders look for additional flexibility 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 flexibility 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 lenders will use lower DCR (e.g., 1.15) based on their risk tolerance or perception of risk.

The LTV reflects the maximum debt a lender can offer to a project as a percentage of the property value. A range of 0.7 to 0.8 (or 70 percent to 80 percent) LTV is common. The estimated property value used in this ratio is usually based on an appraisal. See Chapter 5: Predevelopment for more information. For instance, if your property’s appraised value is $100,000 and your lender has a 0.75 LTV standard, the maximum loan they can provide to your project is $75,000.

It is possible a lender will provide less than the maximum amount their LTV standard allows, depending on their assessment of your project’s risk, including whether your project meets their standard DCR and other funding sources you have secured.

Using your financial feasibility analysis results

Adjusting your model based on feasibility findings

The financial feasibility analysis may identify or highlight project weaknesses. You may find you need to adjust your development model to address any issues, such as:

• Your project is costlier than you expected.

• You won’t be able to meet lending standards (DCR or LTV) or achieve the rate of return you or your investors require.

• You are uncertain about assumptions that may have a major impact on the financial feasibility of your project. However, note that you will not have absolute certainty about your costs/incomes before a project is complete.

Strategies you can pursue to contain the potential variation and uncertainty in your costs:

• Work with experienced contractors.

• Collect estimates from a variety of sources.

• Create systems or processes for managing finances that will help you identify cost overages proactively. See Chapter 8: Project Construction for more information.

• Leave sufficient soft and hard cost contingencies to cover overages. Two percent and 5-10 percent of soft and hard costs, respectively, are healthy standards to use.

• Recognize there may be greater uncertainty in later years of your project’s lifetime (e.g., 10 to 20 years out) and account for this with more conservative estimates in your operating pro forma (e.g., real estate taxes might change, so consider increasing your tax estimates in later years).

After the feasibility analysis is complete and you’ve made adjustments to your development model, you will need to address the “gaps” by either cutting costs and/or generating more equity, generally through grants. This may include identifying cost drivers or potential sources of cost overruns to pinpoint adjustments; pursuing cost-saving mechanisms, such as fee waivers or lower interest rates on financing; using energy-efficient measures to reduce operating expenses; changing your unit mix; or decreasing the size of non-revenue-generating community space. Cost-cutting measures may be referred to as “value-engineering” during construction when you find alternative materials or construction methods that cost less but maintain the value of your development. Any of these measures may impact community buy-in so it is important to keep all stakeholders updated on these changes and the reasons for them.

You may also identify ways to increase project income by utilizing new funding sources or subsidies, increasing the number of vouchers used, providing new services with associated fees you can collect, or increasing rents, if possible. All of the above factors can be financially assessed through your pro forma analysis.

Financial analysis organization and formatting

Different funders may require you to submit your development budget and pro forma analysis in different formats to make it easier for them to review across applications.

Some funders may group reserves, fees, and financing costs within soft costs; others may consider soft costs and predevelopment costs interchangeable. Having detailed assumptions will help you aggregate and disaggregate information as needed.

Sometimes financial analyses are reported in total for a project or annual totals and other times they are reported as totals per unit or per square foot. Price per square foot is most helpful for comparing across properties. You don’t want your price per square foot to be out of sync with the market because that may indicate you or your funders are not getting a good value for your investment or your product may not be competitive in the market.

Price and total development cost per unit can help communicate what your funders’ investments are supporting in a more tangible way. You can demonstrate, for example, this $100,000 is creating a specific number of units priced affordably for a target income range.

To calculate cost per unit, divide your total development costs by the number of units. To calculate total development costs, multiply the per unit or per square foot development cost by total units or total square footage. These formulas are built into the Urban Institute’s The cost of affordable housing: Does it pencil out? financial analysis tool.

Funding sources also have different requirements and priorities, so you may need to customize information for some funders, including presenting your analysis in different formats. While a conventional lender may focus exclusively on DCR and LTV standards, mission-driven lenders, such as CDFIs, may also focus on broader goals or community needs that should be addressed. Grants and some low-interest loans may also specify outcomes a project needs to accomplish. This includes providing a specific number of affordable units to a specified number of households at a target income level to qualify for funding.

Gap funding applications may also require that you’ve exhausted other financing options or efforts to obtain other support. Some gap funding will prioritize projects that have received financial or in-kind support, such as fee waivers, from the municipality where your project is located.

Identifying your gap and assembling gap financing

Your “gap” is the amount by which your funding sources are short of meeting costs. Your gap needs to be eliminated to move forward with your development.

One option to close the gap is to lower your development costs. As discussed in Chapter 3: Housing Development Models, Team, and Roles, the model you choose, including building materials, unit size, and target populations will directly impact how costly your project is.

Another option is to find additional funding sources or “gap financing,” such as second or third loans, grants, or in-kind donations that might include lower-cost labor and discounted or free land. Each funding source has unique restrictions and requirements, which can add complexity, compliance burden, and cost. For these reasons, ensure that your gap financing aligns with your project goals and model, and provides sufficient funding to justify the additional cost.

Also note funding sources’ regulatory requirements, including hiring practices and labor laws. Some states or localities may require or prioritize funding to projects that hire a certain percent of local labor. There may be Minority-/Women-owned Business Enterprises (M/WBE) contracting requirements that support diversity, equit​y, and inclusion policies by requiring large projects to contract a certain percentage of their budget to M/WBEs. In addition, most federal funding sources, including HOME and CDBG, are subject to the Davis-Bacon Act, which requires developers to pay all laborers federal prevailing wages, provide certain benefits, and submit documented payrolls. There are several related labor laws that may also apply when federal funding is used. For example, the Contract Work Hours and Safety Standards Act, The Copeland (Anti-Kickback Act), and the Fair Labor Standards Act.

To save time and costs when applying for different funding sources, you may want to use the following strategies:

• Clarify use restrictions with each funding source to ensure you understand how all restrictions apply.

• Use your sources and uses statement to track how your sources are aligning with uses and confirm you are abiding by any funding restrictions.

• Wherever possible, copy and paste—and then adjust where needed—when filling out various funding applications. While it is important to consider the specific interests and priorities of each funder, there will usually be some standard information about your project and vision that can remain consistent.

Another strategy to improve your gap financing applications is to build project champions beyond your development team. This is an area where strong community and partner engagement can benefit your project. They will help you build funder trust and identify project weaknesses or hurdles you may have otherwise missed.

Examples of project champions and their roles may include:

• Public sector partners can champion your project and help you navigate public application and funding approval processes.

• Contacting area city council members is often a good place to start. They are recognized community leaders and may be able to help you relate your development to their constituents’ needs and public sector program goals.

• Grant writers and consultants can help you compile and submit your funding application materials, and are particularly helpful regarding lengthy or complicated requirements, or highly competitive funding sources.

• Community member support can determine whether you get funding, particularly from public sources.

It is important to account for the time needed to meaningfully engage the community early and often. If you do not engage with the community from the beginning, you may experience unexpected project delays, which can impact the financial feasibility of your project. See Chapter 4: Engaging the Community for more community engagement recommendations.

Types of gap financing

Hard debt comes from a traditional loan, with required repayment schedules and standard interest rates. This debt is usually secured by a first-position lien on the property. Subordinate hard debt is debt that is paid back after higher-ranking debt is repaid. Subordinate debt typically has higher LTV and lower DCR requirements.

Soft debt comes from more flexible loans, or “soft loans,” in which repayment may be deferred, forgiven, or only required upon certain conditions, such as if there is excess cash flow.[14] These generally come from the public or philanthropic sector. Examples of soft debt include HOME, CDBG, Federal Home Loan Bank programs, and other state and local housing programs. These may also be known as “deferred-payment loans,” “non-amortizing loans,” and “zero-percent interest loans.” Soft debt is generally considered a subsidy and should not be included in your calculation of hard debt when determining debt coverage ratio.

How much financing lenders will provide to a project may be limited to reduce their risk (see Working with Lenders above). As a result, developers must find other sources of funding, like equity investments.

Equity is money paid by investors into the project in exchange for an ownership percentage. Investors are paid back through revenues generated by the project, either rental income or capital gains from selling the property. Investors may also receive tax benefits through partial ownership of the property. Development revenues, or lack thereof, affect repayment to investors. Investors are likely to only invest if they expect to receive a certain rate of return.

Grants are funding given with no requirement of repayment. Some grants may have use restrictions, including activities and timeframes. Grants may require reporting to demonstrate that the funds are being used in compliance with these terms. Like soft debt, grants are considered “soft money” or a “subsidy.”

In-kind support refers to non-cash contributions to your project that lower your development costs. This may include free or discounted land, labor, or materials. The Colorado Legislature requires the state to maintain an inventory of public lands suitable for affordable housing development.

Deferred fees are professional fees that developers and project team members with ownership interest do not collect or defer payment of until there is sufficient cash flow. The time period of deferment is usually articulated in the project’s partnership agreement.

Public financing, commercial financing, and philanthropic funding

Public financing comes from the public sector, which could be the local, state, or federal government. This financing usually takes the form of soft debt or grants. Public agencies can also offer in-kind support and tax incentives to increase the financial feasibility of your project.

Commercial financing comes from the private sector, usually consisting of banks. Commercial financing usually takes the form of hard debt. There are mission-driven commercial financing options, such as Impact Development Fund, Enterprise Community Loan Fund, Mercy Community Capital, Capital Magnet Fund, and CDFIs, which offer more flexible development financing than conventional loans in order to support more housing development in low-income and underserved markets in Colorado.

Philanthropic funding is funding from foundations, usually consisting of grants or in-kind support.

State agencies and authorities

There are several state agencies to familiarize with when pursuing affordable housing development in Colorado that provide financing and can help connect you with other funding sources.

Colorado Housing and Finance Authority (CHFA) strengthens Colorado by investing in affordable homeownership, the development and preservation of affordable rental housing, business lending, and community partnerships.

To support homeownership, CHFA sponsors statewide homebuyer education classes and invests in fixed-rate home mortgage loan programs and down payment assistance through its statewide network of Participating Lenders.

To support affordable rental housing, CHFA offers a suite of products including affordable multifamily loans, the CHFA Housing Opportunity Fund (HOF), tax-exempt bond financing, credit enhancement tools, and state and federal Housing Tax Credits to meet the state’s diverse needs.

CHFA multifamily finance programs include:

• Construction and permanent loans

• Middle Income Access Program for housing designed to serve populations with incomes between 80 and 120 percent of Area Median Income

• Mobile home park financing to preserve affordability

• Small-scale Housing Permanent Loan and Collateral Support for developments with 20 units or fewer

• Flexible gap funds that may be used as a first mortgage or paired with CHFA senior loans, interest rate subsidy, or grants to support deeper affordability

CHFA also offers technical support assistance, grants and trainings, plus data and informational resources like this guide and the Colorado Housing Gap Map to accelerate investment in affordable housing and community development across the state.

To learn more about CHFA's full suite of programs, please visit chfainfo.com or contact a CHFA community relationship manager in your region.

The Colorado Division of Housing (DOH) is a department within the Colorado Department of Local Affairs (DOLA). DOH works with local municipalities to provide direct assistance to renters, homeowners, and people experiencing homelessness. DOH also administers several state and federal programs that provide development financing such as: Home Investment Partnership Program (HOME), Housing Development Grant Fund​s (HDG), Housing Development Loan Fund (HDLF), Neighborhood Stabilization Program (NSP), Colorado Housing Investment Fund (CHIF), National Housing Trust Fund (HTF), and Private Activity Bond​s (PABs). Some of these programs are passed on to local governments and housing authorities to administer in their jurisdictions as “pass-through funds.”

DOH also offers the following resources:

• DOH’s Affordable Housing Guide for Local Officials

• Colorado Housing Affordability Data Explorer

• DOH has development specialists based in different regions across the state who can assist you with questions related to the programs they administer

There are also municipal, county, and tribal agencies that administer direct assistance and development financing.

Tax incentives and housing tax credits

Tax incentives can help make affordable housing financially feasible. Tax reductions can help ensure rents stay affordable to your targeted population and can limit your after-construction costs over time. Tax benefits after construction can also draw equity investors to your project.

State resources

Housing Tax Credit

The Colorado Affordable Housing Tax Credit (state credit), modeled after the federal Housing Tax Credit program and administered by CHFA, helps attract investors to affordable rental housing by providing a tax incentive for their investment.

Tax exemptions

Public housing authorities in Colorado are exempt from local and municipal taxes and typically pay a reduced amount called Payment In Lieu of Taxes (PILOT). This applies to housing developments owned by, leased to, or under construction by PHAs. This means that affordable rental housing development solely or partially own by a PHA is exempt from traditional property tax and, during construction, from state and local sales and use taxes. Whatever percentage of the project is dedicated for occupancy by low-income households is the percentage of taxes that will be exempted.

There is a property tax exemption for nonprofit-owned affordable housing. This property tax exemption was recently strengthened by the CO Legislature: HB 19-1319, which limits property tax exemption “claw back” for affordable rental housing projects to increase lender comfort with investment in affordable housing, and thereby make it easier to assemble financing.

Municipalities and counties can provide additional tax benefits to incentivize affordable housing development, including exemptions or abatements of property taxes and sales and use taxes. More information on these kinds of programs, and other practices local governments can pursue to incentivize affordable housing development, may be found in DOLA’s Affordable Housing Guide for Local Officials.

Federal resources

Federal programs that provide tax incentives for development, including affordable housing development, include: Housing Tax Credits, Historic Tax Credits (HTC), New Markets Tax Credits (NMTC), Opportunity Zones, and depreciation rules.

The Housing Tax Credit program is the primary source of financing for the construction and preservation of affordable rental housing in the United States. Developers apply for Housing Tax Credits, and if awarded, their development may be more attractive to investors, who will receive a tax incentive in exchange for their investment. Such investments provide equity for financial feasibility. CHFA is the allocating agency for Housing Tax Credits in Colorado and sets priorities for the allocation of Housing Tax Credits via the Qualified Allocation Plan (QAP). There are two types of federal Housing Tax Credits: (1) the 4 percent credit, which is designed to raise equity sufficient to cover approximately 30 percent of a development’s costs, and (2) the 9 percent credit, which is designed to raise equity sufficient to cover approximately 70 percent of a development’s costs. The state credit is leveraged with the federal 4 percent credit. The state credit provides additional resources to 4 percent credit developments which might not have been financially feasible without the state credit. Projects with 4 percent credits must receive at least 50 percent of funding through tax-exempt Private Activity Bond​s.

Financing small- to medium-sized multifamily housing

Many affordable housing financing products were designed for single family residential (one to four units) or larger multifamily purposes, which makes it difficult or impossible to use those resources to finance small- to medium-sized multifamily housing (SMMF), consisting of multifamily buildings with five to 40 residential units. In fact, many lenders view SMMF as a “niche” financing market.

However, there have been intentional efforts to expand financing for this market segment nationally and in Colorado. For instance, SMMF properties have been prioritized by FHFA’s Duty to Serve efforts, particularly in rural areas, and CHFA has launched the Small-scale Housing Program and Small-scale Affordable Housing Technical Assistance Program.

National sources that can support SMMF development and preservation include:

• HUD: FHA 223(f) Multifamily Loan Insurance Program, project-based vouchers, HOME, CDBG

• Freddie Mac: Small Balance Loan Program, Value-Add Loan for light renovation, NOAH Preservation Loan and Impact Gap Financing for nonprofits pursuing the preservation of unsubsidized SMMF properties

• Fannie Mae: Multifamily Small Loan Program

Colorado-specific sources that can support SMMF development and preservation include:

• CHFA's Small Multifamily Permanent Loan Program (SIMPLE) can provide up to $3 million in uninsured permanent financing for developments supported with federal 9 percent Housing Tax Credits.

• CHFA’s Small-scale Housing Program provides technical assistance services for developers of smaller housing projects (under 30 units). Financing products (for projects with less than 20 units), including direct permanent loans, small grants for soft costs, and multifamily collateral support, are also part of the project. See CHFA’s website for more information about these programs.