Non-profits and private enterprises often approach real estate development with distinct strategies, driven by their unique objectives and markets. Despite these differences, comparing these models can be invaluable. Understanding how market-driven processes in private housing can inform and enhance affordable housing development can be particularly beneficial.
In this blog, we will delve into the differences between these approaches, especially in terms of project financing and estimation. We spoke with experts experienced in both for-profit and non-profit developments to gain insights into the intricacies of for-profit housing projects and explore how these practices might be adapted for affordable housing.
Non-Loan Funding Sources
A key difference between for-profit and non-profit funding structures is the number of funding sources involved. Non-profits often rely on a diverse range of funding streams for a project such as pre-development and capital grants, loans, seed funding, fundraising, organizational equity, development charge exemptions, and more. In contrast, market-driven developments typically rely on just three main sources: the developer’s own equity, financing from a single source, and crucially, investment funds.
This distinction affects the possible scale of the project and operations financial considerations taken into account in the feasibility stage. Non-profits generally aim to have a net operating income that covers their expenses, pays for their mortgages, and covers a small amount of risk, while for-profit developers focus on achieving a return on investment (ROI) that exceeds alternative investment opportunities. For-profits often target a return rate above 8%, prioritizing profitability over merely covering debt-service ratios (DSCR or DCR).
Additionally, the streamlined funding structure of for-profit organizations usually means they spend less time securing project funding, particularly during the feasibility and design/development stages. However, for-profits may experience delays post-design as they await favorable market conditions to maximize returns. These conditions can include better zoning approvals, lower interest rates, reduced construction costs, and quicker construction timelines, all influenced by broader economic factors and the firm’s own efforts.
Financing
The main difference in loan structures between non-profit and private developers lies in their sources and processes. Non-profits typically obtain their funding from government-associated institutions like CMHC, which provide a single loan for both construction and the mortgage. In contrast, private developers usually secure their funding from commercial banks, which offer separate loans for construction and long-term financing. Commercial banks provide a construction loan with interest payments during the construction phase, and upon completion, this loan is replaced with a mortgage.
This transition from a construction loan to a mortgage often leads to less stability in interest rates compared to the support provided by CMHC. While CMHC’s rates are typically more stable, private loans can fluctuate based on market conditions. This could be advantageous in a high-interest rate environment where rates are expected to decrease, but it may be less favorable in a low-interest environment where rates are anticipated to rise.
CMHC does offer support to for-profit developers, but through different mechanisms. Instead of direct loans like those available under the Apartment Construction Loan Program or the Affordable Housing Fund, private institutions can access MLI Select. MLI Select provides mortgage insurance rather than a loan. This means developers still need to find their own financing but can benefit from CMHC’s guarantee of mortgage payments in case of default. This insurance allows developers to secure lower interest rates by meeting certain standards for affordability, accessibility, and energy efficiency.
Capital Budgets
When forecasting the capital budget for development, for-profit and non-profit practices exhibit notable differences in their expenses before and during construction.
Overall, the make-up of the cost of developments can vary significantly between the two. For-profits often benefit from in-house services such as construction management and may use a less rigorous RFP process, which can accelerate timelines and potentially favor long-term financial benefits. However, for-profits also serve a broad audience, which can lead to the inclusion of costly amenities like pools and gyms, increasing construction costs.
In contrast, non-profits typically focus on a specific target group and design buildings to meet their particular needs. This specialized approach, combined with additional design requirements for funding—such as accessibility and energy efficiency standards—can make direct cost comparisons between the two sectors challenging.
A significant difference is that for-profits incur various regulatory costs often waived for non-profits, including substantial development charges that can reach several million dollars. Additionally, for-profits frequently engage in lengthy rezoning battles to maximize property value and construction density, incurring higher planning fees and taking on more risk. Non-profits generally avoid such extensive rezoning efforts and prefer to work within existing regulations when possible.
In conclusion, while non-profits and private enterprises approach real estate development with distinct strategies reflective of their unique goals and markets, comparing these models offers valuable insights. By understanding the diverse funding structures, financing mechanisms, and capital budgeting practices of both sectors, we can uncover potential efficiencies and innovations. Non-profits, with their varied funding sources and focus on meeting specific community needs, contrast sharply with for-profits that prioritize financial returns and market-driven amenities.