A utility allowance (UA) can make or break a Low-Income Housing Tax Credit (LIHTC) deal because it directly affects allowable rent, net operating income (NOI), debt sizing, compliance risk, and equity certainty. Since the tenant UA affects revenue, not expenses, the impact is amplified through the Debt Service Coverage Ratio (DSCR). The magnitude can be shown with a simple example: a 60% AMI gross rent limit of $1200 and a UA of $250 vs $200. The $50 difference in the UA could decrease the NOI by approximately 10%. With a DSCR of 1.2, an interest rate of 6.5%, and an amortization period of 35 years, this could limit the loan amount by about 10%. And that may force a team to require more soft debt, sponsor equity, or deferred developer fees to keep the deal alive.
With UAs, accuracy is paramount. Overstating the UA results in artificially low rents, lower NOI, reduced loan sizing, and equity gaps, as shown above. However, understating the UA can result in the tenant’s actual utility costs exceeding the gross rent and LIHTC limits. This can lead to non-compliance with 8823 filings, rent refunds, and potential credit recapture.
As a further challenge, the United States economy remains in a persistent state of high inflation and volatile energy prices. For instance, resident
ial retail electricity prices were up 7.4% in September over the same month last year, reaching 18.07 cents/kWh1. Compared to other costs, “Energy prices have risen roughly twice as fast as overall inflation since the COVID-19 pandemic.”2 With an aging electric grid, increased demand from energy-hungry AI data centers, and a volatile international energy market, we are unlikely to experience any relief. Thus, it’s imperative that LIHTC properly forecast UAs and, importantly, incorporate cost-effective energy- and water-efficiency designs.
Many UA schedules rely on lagging data or rough averages that risk:
- Overestimating or underestimating true costs
- Misaligning incentives for energy efficiency
- Reducing units’ effective affordability
- The engineered-method performed by qualified energy professionals provides more accurate, fair, and transparent results.
For LITHC transactions, there are four approved methods for preparing a utility allowance:
- Utility company estimate
- State Housing Finance Agency (HFA) estimate
- HUD’s Utility Schedule Model (HUSM)
- Energy-consumption model (ECM) or the Engineered-based method
Utility company estimates are dependent on the cooperation and timeliness of the utility provider. Often these estimates simply include historic usages from similar properties and thus are imprecise with wide error margins. This is especially true for properties that are or will be more energy and water efficient than the baseline property.
Some state HFAs publish UA schedules that provide standardized estimates for tenant-paid utilities for various unit sizes and types. While these may be easier to use, they are likely to be inaccurate for newer, energy-efficient buildings and can quickly become outdated. Some states, such as Virginia, attempt to make adjustments for the number of exposed walls (which can greatly affect energy usage) but as many practitioners understand, the projected energy usage of a home or apartment unit is affected by many factors, including the thermal envelope (insulation and windows) and the building systems (HVAC, water heating, etc). Relying on a static HFA utility allowance schedule is likely to overstate the utility allowance for newly constructed or renovated units.
HUD’s Utility Schedule Model (HUSM) was initially released in 2003, and the current online version was last updated in 2016. HUSM was initially designed to provide more consistency and reduce complexity. The tool primarily uses data from the 2009 Residential Energy Consumption Survey (RECS). While there have been some updates with newer data such as NOAA weather, U.S. Geological water data, as well as the American Housing Survey, the method and limitations of the tool can greatly overestimate a UA for new construction or for a renovation project. This tool also depends on users to properly translate complex utility rate structures with mixes of fixed and variable components, tiered rate structures and complex utility riders. So, users of the tool need to exercise caution. The Government Accountability Office (GAO) studied PHA use of the HUSM tool and found that many PHA users found the tool too difficult to use with specific comments about the complexity of utility rate structures. (source: https://www.gao.gov/products/gao-24-105532).
The Engineered-based method provides the most accurate UA estimate when prepared by experienced, qualified energy professionals. In this process, qualified energy professionals are engaged to review building plans and specifications in order to generate projected energy and water savings using approved modeling tools. Those professionals then apply the specific utility rate structures to generate a more accurate forecast of the utility consumption and costs. Typically, as part of that same analysis, these professionals can also forecast the owner-paid utilities for the common areas and master-metered portions of the project. Those forecasts can help development teams produce more accurate operating budgets.
A second and often overlooked benefit of the engineered-based methodology, is that the energy professionals can work with the LIHTC design team to make cost-effective energy and water efficiency recommendations. For instance, in many rehabs, additional attic insulation may not automatically land on the initial scope of work. But taking the example above, imagine if we were renovating an older building that had limited attic insulation (e.g. R20-R30). Increasing the insulation to levels consistent with newer energy codes (e.g. R49-R60) would decrease the heating and cooling costs. The actual savings would depend on the existing insulation levels, the HVAC efficiency and the local utilities. But assuming this could save about $10/month in UA, that may lead to a 2% improvement in NOI and about $130,000 of incremental loan proceeds for our sample project. In this example the incremental cost might be $75,000-100,000 for additional insulation. So, there is a net improvement after the extra costs.
Proceed with Caution
Inaccurate UAs risk LIHTC deal viability and financial sustainability. Overstating the UA by using HUSM or published schedules can result in artificially low rents, lower NOI, reduced loan sizing and equity gaps. LIHTC Developers and design teams should partner with experienced firms like D3G who can help the design team address these UA risks and opportunities. As additional benefit, D3G provides a full-service LIHTC resources under one integrated, experienced team. D3G has supported LIHTC projects across 52 states and territories with environmental reporting, capital needs assessments, architectural and cost reviews as well as green building consulting and verification. D3G has worked with diverse financing and capital stacks and are well-versed in program requirements. Our teams are ready to help your team get your project over the finish line.
Sources
- https://www.utilitydive.com/news/residential-electricity-prices-eia-lng/806562/
- https://www.bls.gov/news.release/cpi.nr0.htm
Author
Stephen Evanko
LEED AP, NGBS Master Green Verifier, BPI MFBA/HHE, HERS Rater
Vice President of Energy and Sustainability
