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Military housing projects are built on or near military bases and are structured so that military personnel have preference in renting the units. The rent is paid by the military tenants and is set at the service members' basic allowance for housing (BAH), an allowance legislated by Congress as part of military service members' compensation. These privatized military housing projects may have various types of Department of Defense (DoD) subsidies, such as donated or leased land at nominal cost, donated housing units, cash equity investments in the joint ventures that own the housing, subsidized utilities or infrastructure, and below-market-rate subordinate debt. The DoD has the legislative authority to and may make available loan guarantees for these projects in the event of mortgage defaults due to base closures, base realignments, or Armed Forces deployments.
Bonds financing housing projects under the MHPI are eligible to achieve high investment-grade ratings for three reasons: Rental income from the project comes from a military housing allowance system, which, although subject to annual appropriations, has a long history of congressional support with no funding delays. Monies are typically transferred directly from the DoD to the trustee to pay bondholders. Military housing privatizations are project-specific and are tied to specific bases, but the BAH as a component of service members' pay is not appropriated for individual bases. Rather, military pay is a federal expense incurred on behalf of the members of the military.
Second, the MHPI is a strong program consisting of quality housing with strong demand at most military bases with DoD contributions that enhance project feasibility while offering below market rents. Third, the program authorizes the use of appropriate protections, as needed, for lenders against base closure, realignment, or deployment.
The analysis of bonds secured by military housing projects will focus on four key areas:
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A review of the essentiality of the military base as an indicator of future demand for military housing on base and related military base closure, realignment and deployment issues, and related loan guarantees;
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The military housing aspects, including housing allowance payment history and mechanisms, DoD subsidies, ground leases, and any other operating agreements with the DoD related to the housing;
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A real estate analysis including real estate quality, location, market demand, construction issues, net cash flow and real estate program administration; and
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Bond structure, reserves, and investments.
Military Essentiality Analysis |
Privatized military housing transactions must be financially feasible in the event of a military-related event such as base closure, base realignment, or long-term military deployment. Military bases are national assets, and most will not be closed because of their necessity for national defense. However, the DoD is under pressure to find savings in the defense budget to finance military modernization. Therefore, savings through base closures that eliminate redundant DoD operations are periodically considered.
In the event that there are further rounds of base closures, some bases are more likely to close than others, and although there may be political considerations in the decisions over which bases to close, the potential for some types of bases to be selected for closure is able to be analyzed based on current and future projections of military force structure, base capabilities, geographic location and the results of rankings from previous BRAC rounds. The results of the latest BRAC round in 2005 are a good indicator of the military's view of essentiality. Standard & Poor's designates military bases as highly essential, moderately essential, and essential. If the base is not deemed to be moderately or highly essential, and is located in an area where the economic impact of such a closing on a local economy would be very negative, then the military housing transactions may need to have some form of DoD debt guarantee in order to be investment-grade.
Exceptions to this case might be where the base is in a large metropolitan area of at least one million population and the combined military, military-dependent, and DoD civilian employee population in the area from all military-related activities is less than 5% of the total population and the base housing is of good quality (e.g. location, design, physical condition, among others).
The DoD may desire to have any military-related debt guarantees drop off in the event of a base closure and the project successfully transition to civilian housing. In this case, Standard & Poor's will review the transaction to ensure that the project meets an appropriate DSC test for an adequate time period before the guarantee can drop off.
Despite the existence of the DoD base closure guarantees, Standard & Poor's will evaluate the project to determine its feasibility as civilian housing in the event of a base closure or realignment. Consequently, Standard & Poor's will review a feasibility study of the military housing project as military and civilian affordable housing. The developer should complete a transition plan and stress tests addressing the project transitioning to civilian affordable housing. The transition plan must cover:
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Property management;
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Marketing to civilians;
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Transition to local taxation;
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Utility conversion;
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Provisions for local government services, including police and fire coverage;
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Access to schools and transportation; and
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Permanent base access.
The mechanics of base closure guarantees |
For investment grade ratings, mortgage loan debt service guarantees from the DoD should embody the following concepts:
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The guarantee should cover base closure or realignment and a temporary deployment from the base of a significant portion of military personnel assigned to the base;
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The guarantee should be specific relating to identification and calculation of triggers driven by the number of personnel affected by a military-related event; and
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The guarantee should be a full faith and credit obligation of the U.S.
With regard to the mechanics of payments under such a guarantee, the guarantee should meet Standard & Poor's criteria for payment guarantees. (See "Legal Criteria for U.S. Structured Finance Transactions - Guarantee Criteria")
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Real Estate Analysis/Construction Risk |
Real estate analysis |
Standard & Poor's Ratings Services rating criteria for bond issues that are secured by privatized military housing projects constructed or rehabilitated under the MHPI is a combination of rating approaches for subsidized and unenhanced affordable housing transactions and federally appropriated debt. The real estate analysis includes a site visit as discussed below, a review of the ownership entity, and a review of third party environmental and physical needs reports. A full description of the real estate analysis is described in the "Public Finance Criteria: Unenhanced Affordable Housing Project Debt".
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Construction risk |
Construction risk is inherent in military housing privatization transactions due to the program consisting of renovation and new construction of military housing. Construction risk is typically mitigated in these transactions, by the fact that the owner takes title to occupied units of military housing upon closing. In addition, the owner represents that they will keep a certain number of units on-line during the initial development period. Military tenants are typically moved out of old housing upon completion of new housing. Construction delays can be handled by delaying the movement of tenants out of the older housing. In the event units are not on line during the initial development period, Standard & Poor's may use an independent consulting engineer to determine the level of construction risk and potential mitigants. There are a number of other factors, which are important in the construction analysis of military housing privatization transactions. (Please see "Public Finance Criteria: Assessing Construction Risk In Public Finance").
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Lease-up risk |
Standard & Poor's considers lease up risk low in family military housing transactions. The fact that units are on line throughout the development period is a major mitigant to lease up risk. Often the tenants that are moved to the newly constructed or renovated units are tenants relocating from other units on base. There is strong demand from military personnel to live on base due to base amenities, support networks, schools and high security. As a result, there are frequently long waiting lists for housing on base. In addition, the rents for the units on base are usually below what service-members would pay in the general market and the newly constructed housing stock is typically more attractive than off base housing.
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Analyzing The Project As Military Housing |
In evaluating the rental income stream coming from the military housing allowances, Standard & Poor's will use the current BAH in effect for that particular military housing area (MHA) and the pay grade mix of the units as established by the DoD request for proposal (RFP) for the military housing project. Standard & Poor's will review the BAH history in the MHA to ensure the revenue projections at the project are justified by the BAH history. If the pay grade mix of the units may change or if there are provisions for lower-ranking pay grades occupying units reserved for higher pay grades, Standard & Poor's will review stress cash flows to determine what reserves are needed for differentials in pay grade mix from the pro forma rental income assumptions.
There also will be a review of the pay grade mix of the units in comparison to the mix of pay grades in units stationed at the base and to the pay grades of families on the housing waiting list. In some instances, the DoD requires that, in the event of a shortage of eligible military families, housing units must be held vacant for other categories of DoD employees. In these instances, Standard & Poor's may opt to use a higher vacancy rate in analyzing the project or look for additional leasing reserves. In addition, Standard & Poor's will look for reserves to cover delays in any mortgage payments made by the DoD under the DoD guarantee. For instance, if the DoD guarantee has a 120-day lag between the mortgage payment default date and payment date, then Standard & Poor's will look for a 120-day additional debt service reserve. In the event that rental payments by tenants are tied directly to the BAH payments, which are structured as a component of military pay to be made in arrears, then Standard & Poor's will look for an additional 30-day rental reserve in addition to the normal 30-day lag. Mortgage reserves may be provided in the form of cash reserve funds or servicing advances.
Adequate replacement reserves should be initially set up and maintained in accordance with the ongoing preventative maintenance and replacement schedule as outlined in the contract between the owner and DoD and confirmed with a structural engineering report. Standard & Poor's will analyze replacement reserves in accordance with industry standards to determine their sufficiency and if controls over disbursement are adequate. Additional reserves may be necessary to bring the property up to environmental standards.
Reserves |
Generally, Standard & Poor's will look for debt service reserve funds (DSRFs) equal to six months maximum debt service on the bonds, which may be funded with bond proceeds. Exceptions would be where the base is not deemed to be moderate to highly essential, and a transition to non-military personnel is assumed. In these instances, a DSRF equal to maximum annual debt service on the bonds will be necessary. Monies for the debt service reserve fund should be invested in investment grade securities ('BBB-' or higher), and be available to pay debt service in the event of a shortfall.
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Military housing project ground leases |
Standard & Poor's experience is that most military housing transactions in which the housing is located on base will be structured such that the DoD will use a ground lease in order to retain control of the land. Standard & Poor's can assign investment grade ratings to transactions using ground lease structures as long as the ground leases meet Standard & Poor's ground lease criteria as delineated in the criteria for CMBS transactions.
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Asset management |
Standard & Poor's will review the oversight role and capacity of issuers, outside third-party asset managers, and DoD in each transaction to assess the impact on the rated securities. In certain situations where the ownership structure of a military housing project is weak, Standard & Poor's may be unable to rate these securities without the DoD or an effective outside third-party asset manager playing a role.
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Base access |
For transactions that are not deemed to be moderately to highly essential, access to base housing will be another factor in evaluating a privatized military housing transaction to determine its feasibility as a civilian housing project. Projects on the perimeters of bases that can be physically segregated from the base are stronger transactions than projects located in the interior of military bases. For projects located in the interior of bases, Standard & Poor's will review the plans for access to the base housing by civilians in the event that higher defense conditions restrict access to the base to military personnel and other DoD personnel. Transactions where base access is more limited may need the DoD guarantees of debt service, higher reserves, or much higher vacancy factors. In addition, transactions where the base commander can restrict access to the project by the owner or property manager in cases of national emergency will be carefully evaluated.
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Military Site Visits And Documentation |
In order to evaluate the debt obligations for a rating, Standard & Poor's will make a site visit to the project securing the debt obligations at the beginning of the rating process. Due to the complexity of these transactions, there are a number of issues that Standard & Poor's would like to address during the site visit, including, but not limited to the essentiality of the military base that the housing serves.
Before the site visit, Standard & Poor's will review the project request for proposals and a summary of the base vital statistics, as well as the market study so that selection of housing comparables for the visit can be made.
Site visits should include:
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A tour of the military housing project. Standard & Poor's will visit each military neighborhood and rank each neighborhood and do interior site visits of a representative sample of units and will take photos of each neighborhood and a tour of off-base civilian housing comparable properties.
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A presentation addressing civilian housing market off base (preferably by the author of the market study) and how BAH rates and housing on base compare to civilian housing and rents off base.
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A command presentation of activities of the base (preferably by uniformed members of the U.S. Armed Forces) addressing base essentiality and contrasting the base in question with other bases of similar type. A tour of the military facilities is an important part of the analysis of essentiality.
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A presentation on each military housing neighborhood, location, pay grades housed there, date of construction and/or rehabilitation and its current occupancy rate.
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A presentation regarding environmental conditions of the housing to be privatized and how environmental issues are being addressed.
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A presentation by developer and general contractor on their companies and previous experience with building large residential communities in general and military housing projects in particular.
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A presentation by developer on development plan for the project including site plans, housing elevations, construction plan and phasing plans.
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A presentation by developer/investment banker on mitigation of construction risk for bondholders.
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A presentation by developer on how property management is to be handled.
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A presentation by developer/owner on how property asset management including debt compliance is to be handled.
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Unaccompanied Housing Privatization Criteria |
The MHPI, which allows for the privatization of family housing, also allows for the privatization of housing for unaccompanied personnel. The unaccompanied housing program poses unique risks that distinguish it from the family housing program. Most importantly, is the risk of deployment. Deployment would terminate the lease for a certain class of (lower-ranked) personnel, causing cash flow to cease.
In family housing, this risk is mitigated by the continuation of BAH payments following deployment as long as the family of the deployed service member continues to occupy the home, which is typically the case. Second, construction risk is potentially different than family housing, as these transactions may not involve the conveyance of existing units and the generation of cash flow from existing units, during the initial development period. As a result, Standard & Poor's may use an outside consultant to review the construction of these developments, and determine if the mitigants to potential construction and lease up delays are sufficient in the structure of the transactions.
Finally, in the event of a base closure, the alternate use of the real estate is not clear as the existing and proposed units appear like student housing so may not be marketable to the general public, regardless of the strength of the local housing market and depth of demand, in the event of a base closure.
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Key Credit Considerations And Major Risks |
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Standard & Poor's will analyze military essentiality using the same methodology as for the family housing program.
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Deployment history for each base will be analyzed to determine the potential impact of future deployment on the occupancy.
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Construction risk can potentially be different than family housing, as units may not be on line during the initial development period. In these cases it is important to determine the level of risk posed by the proposed construction. This analysis may include Standard & Poor's using a consulting engineer to determine these risk and potential mitigants.
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The demand analysis should include how many unaccompanied permanent party personnel are assigned to the base and/or are eligible for the privatized housing, a description of the housing for unaccompanied personnel currently available, and occupancy statistics. In addition, the market study should include information on the housing alternatives for these personnel available in the marketplace.
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Local housing market and alternate use for the real estate (layout, amenities, and location).
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The revenue and BAH structure will be analyzed to determine future rental stream.
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The bond and legal structure for these transactions is expected to be similar to family housing, including the level of reserves, and legal documentation such as the ground leases, operating agreements, and trust indentures.
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