Chapter 40B Housing Comprehensive Permit Projects In Foreclosure

Posted in on March 14, 2014

Any wise banker, investor or developer formulates an exit strategy before undertaking a new venture. However, when that venture is a comprehensive permit project and the tangled web of Chapter 40B regulations, guidelines, policies and regulatory agreements lack guidance on a particular conundrum, even the savviest participants must venture into uncharted territory. Thus is the latest chapter unfolding regarding Chapter 40B housing in Massachusetts. With the remnants of the real estate bubble leaving behind partially complete comprehensive permit housing projects and unsold affordable housing units, stakeholders are seeking guidance on the rules of the game post-foreclosure.

In particular, banks and investors that come to own a comprehensive project through foreclosure want to know what obligations they may have under Chapter 40B, particularly with regard to profit limitations that accompany any comprehensive permit development. Unfortunately, the answer is unclear as no subsidizing agency has published official rules or guidelines regarding the treatment of projects in foreclosure. Most for-profit ventures developing comprehensive permit projects are so-called limited dividend entities. A project’s subsidizing agency is responsible for determining compliance with that agency’s own limited dividend rules. Traditionally, a developer’s profit on a comprehensive permit development is limited to 20% of total development costs. However, in foreclosure, it is unlikely that the project’s original proponent is available to certify its costs; therefore, total development costs may not include costs incurred by prior owners. Where a bank is involved it is able to document its own loss on a particular loan; however, is the bank’s loss an “allowable cost” under relevant sections of Chapter 40B and its implementing regulations?

The answers to these questions are not expressly found in the DHCD’s Comprehensive Permit Guidelines. The May 2013 version of the Guidelines provides:

Profit to Limited Dividend Organizations, including all partners, shall be limited to no more than 20% of total allowable development costs, and such other sums as the Subsidizing Agency may determine constitute a Developer’s contribution to the project, provided that calculation of total allowable development costs shall not include any fee paid to the Developer. Profits accrued in excess of 20%, as defined herein, shall be distributed to the municipality for the purpose of developing and/or preserving Affordable Housing.

The DHCD does not define “allowable” however recent experience suggests that a Bank’s documented loss on a project will not be allowed as an element of total development costs. Furthermore, since prior owners are in parts unknown and certification of their costs is impossible, such costs have recently been disallowed in the profit analysis for post-foreclosure owners. The DHCD has recently taken the position that any post-foreclosure owner must independently complete a separate cost certification which accounts for that owner’s particular acquisition cost (i.e. price paid at foreclosure auction), plus its subsequent development costs, pursuant to Chapter 40B guidelines regarding cost certification. Subsequent investors cannot utilize losses incurred by prior developers and the bank on a project and are limited to 20% profit on their own documented costs.

This analysis runs contrary to the traditional notion that profit from any particular project cannot exceed 20%. To be sure, the language of most standard regulatory agreements generally provides:

The Developer [which is defined together with successors and assigns] agrees that the aggregate profit from the Project which shall be payable to the Developer or to the partners, shareholders or other owners of Developer or the Project shall not exceed twenty percent (20%) of Total Development Costs (the “Allowable Profit”) which development costs have been approved by the Subsidizing Agency.

Although this language would suggest that costs and revenues for the entire duration of a project should be tallied, this has not been the case in foreclosures. Simply put, where the subsidizing agency retains the right to approve development costs, they have chosen to disallow costs incurred by other owners in calculating any particular owner’s profit. Each owner is limited to 20% profit on that particular owner’s costs, without regard to profit and loss realized by any other owner.

In the absence of official guidance on the issue of foreclosures it remains to be seen whether this analysis will become the law of the land. Depending on the circumstances, this analysis could severely disincentivize investors from completing a floundering Chapter 40B housing development. Furthermore, this analysis could lead to illogical results where an initial proponent incurred significant costs upfront, only to lose a development to foreclosure with a distressed sale price serving as the new owner’s acquisition cost. In some instances and under certain circumstances, older NEF and LIP regulatory agreements relieve purchasers at foreclosure from any obligation to comply with profit limitations, but municipalities and the DHCD are unlikely to accommodate that result given recent criticism of Chapter 40B’s regulatory scheme.

Fortunately, most municipalities are anxious to see abandoned projects completed; therefore, with the right guidance they will assist in streamlining approvals necessary to move a project forward. However, Chapter 40B’s critics will most assuredly use the foregoing as ammunition against the law and projects that they oppose.