If you are like me and you are new to the development space, the number of alien financial terms and acronyms may be a source of overwhelm. Have no fear, I believe in us, we can sort out the heads and tails of “all things funding and financing” lingo.
The Toolbox+ team has been compiling a list of the most common terms and concepts that both clients and participants often inquire about. The following quick article will highlight some of the main terminology of finance and funding used in affordable development.
Cahdco views funding sources in two main categories: pre-development and construction funding. Within each category, there are a range of programs which provide grants, repayable loans, and in some cases a hybrid of the two (grant and loan).
Simply put, loans are funds that your organization will borrow temporarily from a lender. You will pay this money back within a specified timeframe. Alternatively, grants (often called non-repayable loans) do not require repayment. These are like gifts from a funder to help reach your organizational mission when it is aligned with the funders’ mandate.
If you are new to accessing loans, there are some basics to keep in mind. You will hear the term principal. This is just the total amount you have borrowed. However, loans have a cost associated with them – interest. An interest rate is basically a fee on the money that has been loaned to you, it is calculated as a percentage of the total borrowed amount (that remains).
The amortization period of your loan is the total length of time you have to pay the loan back to the lender. Your loan payments (including interest) are calculated based upon the amortization period. Conditions of the loan (such as interest rate) will be negotiated for a specific term or period within your amortization period. Typically, interest rates on a mortgage are set at a fixed rate, meaning the interest rate does not change, even if the market fluctuates, for the duration of the term. (It is possible to have a variable interest rate as well, but more risky.) For example, if you were granted a 30-year amortization period with three 10-year terms, you would sit back down with your lender to re-negotiate the terms and conditions of your contract every 10 years during the 30-year period.
Each month, you are slowly hacking away at the total principal amount throughout the duration of your amortization period. A longer amortization period will allow you to borrow more, but you will pay more interest over the life of the mortgage on the principal amount. A shorter amortization period limits your total borrowing amount, but of course is paid off quicker, and you pay less interest overall over time.
You can do some calculations on your own with a mortgage calculator* to see how much a bank would loan you (aka your principal amount) under various conditions. The calculation requires your net operating income, and you can play around with the interest rate and amortization periods.
*Note: The Blueprints program by Toolbox+ gives participants access to (and support with) a mortgage financing calculator.
The main funding providers for affordable housing development in Canada are the Canada Mortgage and Housing Corporation (CMHC), and the Federation of Canadian Municipalities (FCM); and the Community Housing Transformation Centre (CHTC) provides some funding and capacity support. CMHC and FCM often look for additional government support from the municipality or province/territory to ensure that funding provided by the federal government aligns with the objectives of the local government. Having multiple funding opportunities align and complement one another is calling stacking your funding, or a funding stack.
Pre-Development
Pre-development costs include all costs related to getting a project from ideation/feasibility to construction. This could include a feasibility analysis, fees associated with any planning approvals, or hiring consultants to create drawings or schematics.
Before construction, you will draft various iterations of a proforma. A proforma is a spreadsheet that allows you to determine project financial viability based on calculating costs and revenues.
*Note: The Blueprints program by Toolbox+ goes over proformas in detail, and provides participants with a proforma template for their own projects.
There are CMHC and FCM programs which cover pre-development costs, such as CMHC Seed Funding, FCM Planning Grant and FCM Study Grant (both through FCM’s Green Municipal Fund (GMF)).
Construction
Construction costs include all costs incurred to build a building. This includes material costs, labour costs, and sometimes insurance or other service fees.
One of the main funding sources for construction funding is the CMHC Affordable Housing Fund (AHF), formerly known as the Co-Investment Fund. The AHF provides capital funding for construction through a low-interest, repayable mortgage with potential non-repayable loans (grants) that can be accessed if the project qualifies for them. Similarly, to other CMHC programs, the AHF requires a 5% equity contribution from the project owner, and the project must meet minimum debt coverage ratios (DCR).
Debt coverage ratio? Equity? Let’s sort out these terms.
Equity is what your organization owns/ can contribute outright, minus any liability. You will need to contribute some amount of equity to get a project off the ground. However, this does not necessarily need to be cash, it could be an in-kind contribution, staff time, or the value of the land (if you own it outright).
A debt service coverage ratio (DCR or DSCR) is a metric used to understand an organization’s financial health, or “ability to repay its loans, take on new financing and make dividend payments” (BDC glossary). The DCR is the ratio between the net operating income (NOI) (defined below) and the debt obligations (mortgage payment). A DCR allows a bank to manage the risk associated with the uncertainties in your revenues and expenses. DCR creates wiggle room – it assumes that you are not making X percent “extra” each month and bases your mortgage off of that lower number. For example, if you have a higher-than-expected vacancy rate, the DCR helps to account for that loss in expected revenue. CMHC’s programs are designed to promote a 1.0 DCR, meaning that every dollar you would make in operating income would go to mortgage payments. We suggest a DCR of 1.2 or 1.1 to allow for more security and wiggle room in the event of unexpected costs or payments.
In the Construction Phase of development, you may also consider bridge loans and lines of credit. Bridge loans (or bridge capital) are as they sound, they create a bridge to cross a financing gap over a shorter period of time. These will often have a high interest rate and are associated with waiting for longer term financing to come into place. These are loans that you will pay back immediately once you receive other funding that you are waiting for. A line of credit can be used for similar purposes. However, a line of credit is not a set amount, rather you choose how much of it (within a limit) that you need to access, and you pay that amount off over time. You can continue to dip into your line of credit over time without needing to re-apply, and interest rates are comparatively low (to bridge loans).
Operations
During the feasibility stage, you will assess whether you will be able to stay afloat once you reach operations. Rental housing requires a viable operating budget to work (not only a viable capital budget). Understanding net operating income, or NOI, is key. Taking your revenues (revenues from rent, rent supplements, parking, laundry, etc.) minus all of your expenses (utilities, maintenance, insurance) gives you your net operating income, which then influences how much debt you are able to take on. The larger your NOI, the more mortgage you are able to afford.
Hopefully this served as a good refresher and/or provided some clarity around funding and financing that can get you started. Soon enough you yourself will the pro in proforma!
Resources
- For more information on the Green Municipal Fund, visit the GMF website.
- For a glossary of financial terms, visit: https://www.bdc.ca/en/articles-tools/entrepreneur-toolkit/templates-business-guides/glossary