Construction Risk Financing

Risk Financing of a Multi-unit Retirement

Residence Project

Construction options for building affordable housing for

seniors

Alan McCafferty

December 2009

Executive Summary

The following presentation is the result of a report designed to offer

insight into the risks and financing options required to build

affordable housing for a retiring or 55+ demographic

Risks and Financing

Costs of housing should not exceed 30% of the net disposable income

Housing sale prices are fixed after a sale for a period of up to 2 years while

construction material cost both increase and decrease during the same period

Construction and operational risks are both present because a project takes

numerous years to fully develop (ie people are living in the community while its

still being built)

Assumptions1. Hyde Park is used as a sample construction project for checking financing and construction

assumptions

2. Sample costs based on initial Hyde Park build are used as the “Status Quo” option unless

otherwise noted

Background Information and Retirement Demographics

As stated by David Foot in his book entitled Boom, Bust & Echo demographics

explains about two thirds of everything (Foot, 2000, p. 8). The Canadian baby

boomers born between 1947 and 1966 represent almost one third of the

population. Their sheers numbers have a profound affect on the economy and will

significantly alter the retirement industry over the next thirty years.

“Percentage of Canadian Population Comprised of

Persons Aged 65 or Older, 1921 to 2005 and

Projections to 2056 (Turcotte & Schellenberg, 2007,

p. 11)“Median Age at Retirement, by Class of Worker, Canada,

1976 to 2005” (Turcotte & Schellenberg, 2007, p. 123)

Is there a need for affordable housing?

Affordable Housing1

A term used to describe dwelling units whose total housing costs are

deemed "affordable" and do not exceed 30% of before tax household

income. Although the term is often applied to rental housing that is

within the financial means of those in the lower income ranges of a

geographical area, the concept is applicable to both renters and

purchasers in all income ranges.

Acceptable Housing2

On the other hand acceptable housing is defined as housing that is

adequate, suitable, and affordable.

In 2001, 28.7% of senior households lived in housing which did not meet one

or more of the three housing standards

Of the 30%, 59% fall below the standard due to insufficient income

1. Source: Wikipedia: http://en.wikipedia.org/wiki/Affordable_housing

2. Jakubec, J. (2005). 2001 Census Housing Series: Issue 9 Revised, The Housing Conditions of Canada’s Seniors. Canadian Mortgage and

Housing Corporation. Socio-Economic Series 05-006. Ottawa, Ontario. Retrieved July 5, 2009, from

http://www.cmhcschl.gc.ca/odpub/pdf/63820.pdf

City of Ottawa Housing Continuum

10th 20th 30th 40th 50th 60th 70th 80th

$17,048 $30,055 $42,345 $54,273 $66,839 $80,311 $96,429 $117,834Household Income

Income Percentile

Average CMHC

Market Rent

Resale Housing

(MLS)

New Housing

Prices (MLS)

Ho

usin

g S

up

ply

Rental

Ownership

$426 $751 $1,059 $1,357 $1,671 $2,008 $2,411 $2,946

$56,606 $99,792 $140,599 $180,206 $221,931 $266,660 $320,180 $391,253

Initial Purchase Price Other Builders Initial Purchase Price

Builder’s Goal

• 1 Bedroom Suites

• 1 & 2 Bedroom Apartments

• 2 Bedroom Courtyard Homes

Bach Apt 2 Bed Apt

1 Bed Apt

3 Bed Apt

Condo Apt Row/Link Semi-detached

Single Detached

Single Detached

Row house

Condo Apt

City of Ottawa Definition of

Affordable Housing Prices

Financial Risk

Source: City of Ottawa Housing Continuum

Sample Construction Swim Lanes

2009 2010 2011 2012 2013

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

Apartment 1 Construction

Apartment 2 Const Apartment 3A Const

Apart 3B Const

$6M

mortgage

begins

Mktg &

Sales

Phase 2: Marketing & Sales Phase 3: Marketing & Sales

Apt 1

Mktg &

Sales

Apt 2

Mktg &

Sales

Apt 3

Mktg &

Sales

All

Units

Sold

Monthly 1% (ramp + income)

Long-term monthly mortgage payments

1. Project

Launch

2. Budget

Updated

Site Plan

Submitted

1. Site Plan

Approved

2. Project

Tendered

3. Budget

Updated

Building

Permits

Budget Management

Sales

Launch

Establish

Financing

Need

Secure Financing

Repay

Financing

Residents

Move In

Ph 1

Rev Based

on 85%

Capacity

First

RevenueRamp Payment

Notes:

1. Except where noted swim lanes are for

Phase 2 only

2. Ramp payment is calculated in the sale of

units to owners

Residents

Move In

Ph 2

Residents

Move In

Ph 3A Residents

Move In

Ph 3B

Construction Risks

The table below identifies 4 risks associated with building a community

For financing purposes:

Units are sold the price is fixed until delivery which has been the status quo

Material cost can change significantly during this period in particular Lumber, Steel, Concrete, Drywall, Copper, Asphalt

The builder would look to adopt the required insurance only during the construction phases and should look for the appropriate insurance that can be phased so that:

Premiums will be kept to a minimum

Potential losses during the construction phases are addressed accordingly

Risk of Change in Material Cost

Overall Construction Costs versus Material Costs

Overall cost have increased 60%

Material cost vary significantly in any two year period

Material/hard costs represent 70 % of the total costs

Material Costs Analysis Using Hedging

Notes

1. Copper includes electrical and limited plumbing fixtures

2. Key material is 33% of the 70% of project hard costs

3. Cost of Capital = (1+0.07)2

Apartment 1

Construction Conclusions

1. Material hedging is only viable in a very volatile market

2. Fixed prices should be calculated with a projected cost of inflation

3. Project costs should be separated and monitored

Hard costs should be limited to 70% of the budget

Hard costs should be monitored as whole and forecasted based on

industry indexes if the material market is not volatile

Construction Budget Soft Costs: Should be 30% of overall budget

Builder’s Overhead and Profit: Part of the hard costs therefore

negotiate a split of take out financing and profit sharing as an option

Architect Fees: Part of the hard costs therefore negotiate a split of take

out financing and cost recovery bonus

Construction Risk Insurance Plan

1. Premium = Material Costs X Rates

2. Premium = Limits Selected and Underlying Premiums x Rates

3. Premium = Payroll/Sales x Rates x Experience

4. Premiums = Payroll x Rates x Experience Factor

2. Umbrella or Excess

(Depends on the project

requirements)

1. Builders

Insurance

3. General

Liability4. Workers

Compensation

Project Status Quo

• 1. $5k/project year

• 2. None

• 3. $5k/year

• 4. Not Released

Operational Risks

The table below identifies the 4 main operational risks that

management or a management company will need to address

For financing purposes management would look to adopt a modular

insurance plan that addresses the needs as they arrive yet can be

adjusted independently if required

Proforma Statement of Financial Position

NOTES:

1. Project is a Not For Profit

2. Capital assets are recorded at cost and depreciated using straight-line method

3. Promotion, and marketing costs start six month prior to opening and continue at the same rate for six months then decrease proportionately to the occupancy rate

4. Financial forecasts are based on conservative estimates and represent 50% slower ramp up time then observed in similar bui ldings

5. Reserve Fund Contribution is the proportional amount for the Building, Site Works and Water System Funds.

Risk Financing Options

Notes:

1. Business interruption is equal to 3 months of revenue in order to repair

the damage, place residents in temporary housing or offset the loss of

key business personnel

2. General Liability Premium = Payroll/Sales x Rates x Experience

3. Property is equal to 80% of the construction costs this represents the

hard costs and 10 to 15% new soft costs

4. Professional Liability assumes up to 4 people

Immanuel House Insurance Landscape

Pro

pe

rty I

ns

ura

nc

e =

$2

0M

Business

Interruption

Primary

Insurance = $1M

Business

Interruption

Excess

Insurance = $2M

General Liability

Insurance = $1M

Professional

Liability

Insurance = $2M

Umbrella Liability Insurance = $3M

to offset risk of injuries in the

community centre and theatres

etc…

Note: Project is not built therefore there is not Status Quo at this time

Recommendations

Conclusion

Building affordable housing for the 20th to 40th percentile of the housing

continuum includes both risks and financing challenges

Recommendations

Traditional construction model is very difficult to fit into this model

If the builder is active for all phase then Umbrella Insurance is required

to offset risks between phases and once operations start

Material hedge is only viable in a volatile market

Business interruption insurance has a higher weight than usual because

of the age of the clients

Keep the construction and operations separate even if the phases

overlap