ValuationOfSubsidizedHousing
Thepurposeofthisarticleistoanalyzevaluationmethodologyfor severalatypicaltypesofapartments.Variouscircumstancesand situationscancauseanapartmentcomplextohaveabove-orbelowmarketrentalrates,occupancyratesandoperatingexpenses.This analysisexaminesthefollowingtwosituations:
1.low-incomesubsidizedapartments,whichreceiveabove-marketrentalratesfromHUDor anothergovernmentagency,and
2.projectsthatarepartoftheLowIncomeHousingTaxCredit(LIHTC)program.
TheLIHTCprogramwasestablishedbytheU.S.Congresstoencouragedevelopmentof affordablehousingineconomicallydisadvantagedareas.Projectdevelopersreceiveataxcredit forfollowingtheguidelinesestablishedbytheprogram.Theytypicallysellthesecreditsto Fortune500corporationsfor45percentto60percentofthetotalprojectcost,excludingland.
Thefirststepinthevaluationprocessisanalyzingmarketvaluedefinitions.Thefollowingisthe definitionfromthe TexasPropertyTaxCode,Section1.04(7):marketvaluemeansthepriceat whichapropertywouldtransferforcashoritsequivalentunderprevailingmarketconditionsif:
1.exposedforsaleintheopenmarketwithareasonabletimeforthesellertofindapurchaser,
2.boththesellerandthepurchaserknowofalltheusesandpurposestowhichthepropertyis adaptedandforwhichitiscapableofbeingusedandoftheenforceablerestrictionstoits use,and
3.boththesellerandthepurchaserseektomaximizetheirgainsandneitherisinapositionto takeadvantageoftheexigenciesoftheother
Section(b)ofthe TexasPropertyTaxCode furtherrequires:themarketvalueofpropertyshall bedeterminedbytheapplicationofgenerallyacceptedappraisaltechniques,andthesameor similarappraisaltechniquesshallbeusedinappraisingthesameorsimilarkindsofproperty However,eachpropertyshallbeappraisedbasedupontheindividualcharacteristicsthataffect theproperty’smarketvalue.
Thedefinitionofmarketvalue,accordingtothe10theditionof TheAppraisalofReal Estate publishedin1992bytheAppraisalInstitute,is:marketvalueisthemostprobableprice, asofaspecifieddate,incash,orintermsequivalenttocash,orinotherpreciselyrevealed termsforwhichthespecifiedpropertyrightsshouldsellafterreasonableexposureina competitivemarketunderallconditionsrequisitetoafairsale,withthebuyerandsellereach actingprudently,knowledgeably,andforself-interest,andassumingthatneitherisunderundue duress.
Thetermwhichrequiresfurtherreviewintheabovedefinitionis“knowledgeably”Isthe purchaserknowledgeableregardingtheeffortrequiredtocomplywithsubsidizedhousing programrequirementsandtenants?Doesheconsidertheefforttoberentforrealestateor compensationforservices?DoesthepurchaserofanLIHTCprojectunderstandthatmaximum rentsarenowestablishedforatleast15yearsbasedondeedrestrictions?(LIHTCdeed restrictionsarenowrequiredfor30yearsinTexasandmostotherstates.)
Feesimpleestateisdefinedinthethirdeditionofthe DictionaryofRealEstateAppraisal publishedbytheAppraisalInstituteas:absoluteownershipunencumberedbyanyotherinterest orestate,subjectonlytothelimitationsimposedbythegovernmentalpowersoftaxation, eminentdomain,policepowerandescheat.
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ThepracticeinTexasistobasetheassessedvalueonthevalueofthefeesimpleestateas opposedtotheleasedfeeestate.Thisanalysisisbasedonvaluationofthefeesimpleestate insteadoftheleasedf
Thedefinitionofleasedfeeestateinthethirdeditionofthe DictionaryofRealEstate Appraisal is:anownershipinterestheldbyalandlordwiththerightsofuseandoccupancy conveyedbyleasetoothers.Therightsofthelessor(theleasedfeeowner)andthelesseeare specifiedbycontracttermscontainedwithinthelease.
Theprimarydifferencebetweenthefeesimpleestateandtheleasedfeeestateisthatthe tenantandlandlordareeachboundbycommitmentstopayrentandallowuseoftheproperty foraterm.Thecontractrentagreedtobetweenlandlordandtenantmayormaynotbeequalto marketrent.Forexample,ifalandlordenteredintoa30-yearleaseforrentof$5persquarefoot 15yearsago(whenmarketrentwas$5persquarefoot)andthecurrentmarketrentis$10per squarefoot,thetenanthasasubstantialadvantage.Thetenanthasaleaseholdestatewhich mayormaynothavevaluedependingonthetermofthelease,thecontractrentandmarket rent.
The DictionaryofRealEstateAppraisal definesleaseholdestateastheinterestheldbythe lessee(thetenantorrenter)throughaleaseconveyingtherightsofuseandoccupancyfora statedtermundercertainconditions.
Conversely,ifthetenantagreedtoarentalrateof$15persquarefootinastrongmarket10 yearsago,andiscommittedtopaythatrentforanother10years,thereisasubstantial advantagetothelandlord,andthetenanthasaleaseholdestatewithanegativevalue.Practice inTexasistoestablishtheassessedvaluebasedonthefeesimpleestateinsteadoftheleased feeestate.Therefore,therelevantcriteriafordeterminingmarketvalueincludesmarketrent, marketexpenses,marketoccupancyandmarketderivedcapitalizationrates.Ifataxpayermade apoorbusinessdecision10yearsagoandhassubstantiallybelow-marketrent,itisinequitable forthetaxingentitiestoreducetheiradvaloremtaxduetothebadbusinessdecisionofthe propertyowner.Conversely,ifapropertyownermadeafortuitousorwisebusinessdecisionand enteredintoanabove-marketlease,itisnotappropriatetocollectanabove-averagelevelofad valoremtaxfromhimbecauseofhisluckorprudence.
Marketrentisdefinedbythethirdeditionofthe DictionaryofRealEstateAppraisal as:the rentalincomethatapropertywouldmostprobablycommandintheopenmarket;indicatedby currentrentspaidandaskedforcomparablespaceasofthedateofappraisal.
Marketrentisthecompensationpaidfortheuseoftherealestate.Itshouldnotinclude compensationpaidforfactorsotherthantheuseoftherealestatesuchasadditionalservices whicharenottypicallyprovided.
Thenextstepinthisprocessistoanalyzevaluationofpropertieswhichparticipatein subsidizedprogramswhichreceiveabove-marketrentalrates.Thefinalsectionwilladdress valuationofprojectsintheLIHTCprogram.
ValuationofSubsidizedHousing
Thisanalysiswillconsiderboththeincomeandthesalescomparisonapproachestovalue.The costapproachisnotutilizedsinceitwouldprovidesimilarresultsaftercalculatingexternal obsolescenceduetodifferencesinrentalrates.
IncomeApproach:
Apartmentownerswhoparticipateinsubsidizedhousingprogramsmayormaynotreceive above-marketrentalrates.Formanyyears,HUDofferedabove-marketrentalratesasan inducementtopropertyownerstoparticipateintheprogram.TherearetworeasonsforHUD payinganabove-marketrentalrate:
1.tocompensatefortheinconvenienceofdealingwithabureaucraticgovernmentprogram whichmandatesdetailedinspectionsnottypicallyrequiredintheprivatemarket;and
2.tocompensateforworkingwithresidentswhotendtobeatthelowestsocioeconomiclevel inoursociety
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IthasnotbeenunusualforHUDtopaycontractrentof$0.70to$0.80persquarefootper monthforsubsidiz ojects,eventhoughthemarketrentforcompetingprojects mightonlybe$0.45to$0.50persquarefootpermonth.Therentandsalescomparablesused inthisanalysisarelocatedinaneighborhoodcharacterizedbyincomelevelsinthebottom quartileoftheHoustonarea,minimalnewconstructionofresidentialorcommercialbuildings for25yearsandheterogeneouslevelsofqualityandappeal.Somesections,suchasRiverside, haveexperiencedgentrification,butotherareasaremarkedbypoorlymaintainedproperties. Boththemarketrentprojectsandthesubsidizedrentprojectsarelocatedintheareasouthof downtownHouston,boundby288tothewest,Interstate-45totheeast,andAlmeda-Genoato thesouth.Considerthefollowingtableswhichlistrentalratesforprojectswhichdonot participateinasubsidyprogram(marketrentprojects)andprojectswhichdoparticipateina subsidizedrentprogram:
MarketRentProjects–RentalRates
SubsidizedRentProjects–RentalRates
Theaveragerentalrateforthemarketrentcomplexesis$0.45to$0.50persquarefootper monthand$311to$391perunitpermonthversus$0.70to$0.87persquarefootpermonth and$458to$538unitpermonthforthesubsidizedrentprojects.
SourcesattheHoustonHUDofficeindicatethatexpiringcontractsforsubsidizedpropertiesare beingreviewed–iftheownersodesires–foronlyoneyear.Afterthatterm,itisuncertain whichcoursetheplanwilltake.Indicationsthataresubsidizedprogramsarechangingfromthe currentcontractrentmethodtoaresidentvoucherprogram.Thevouchermethodwouldinvolve issuingcertificatestoindividualswhomaythenusethevoucheratanyparticipatingproperty Thevoucheramountwouldbebasedonindividual’sincome.Inadditiontotheplantophaseout above-marketsubsidizedrents,anotherreasonnottousecontractrentwhenvaluingsubsidized housingisitisinconsistentwithnationalpublicpolicytopenalizeapartmentoperators participatinginthisprogramsincethedifferencebetweenmarketrentandcontractrentis compensationforparticipatingintheprogramandworkingwiththelow-incomeresidents.It wouldalsobeinconsistentwithpracticeinTexastousecontractrentinsteadofmarketrent whenperformingtheincomeapproachtovalue.Thethreereasonscontractrentshouldnotbe usedinvaluationare:
1.itmayincludecompensationforparticipationintheprogramandmaynotbeequaltomarket
etoeliminatetheprogramand, 3.itisinconsistentwithnationalpublicpolicy
Anotherfactortoconsiderwhenperformingtheincomeapproachisthemarketoccupancy Sincetenantsatthesubsidizedhousingprojectsdonotpaytheirrentorpayveryminimalrent, theoccupancytendstobeatabove-marketlevel.Considerthefollowingtableswhichlistthe occupancyratesforbothmarketrentprojectsandsubsidizedrentprojects:
MarketRentProjects
SubsidizedRentProjects
Notethattheaverageoccupancyrateformarketrentprojectsinonly73percentcomparedto 97percentforsubsidizedrentprojects.
Sampleincomeapproachestovalueforamarketrentprojectandasubsidizedrentprojectare shownbelow.Bothapproachesassumea200-unitapartmentcomplexwith160,000net rentablesquarefeet.
MarketRentProjects
Grosspotentialincome@$0.70/SF
Theexampleaboveusesrentof$0.50persquarefootpermonthforthemarketrentprojectand $0.70persquarefootpermonthforthesubsidizedrentproject.Thevacancyrateis10%forthe marketrentprojectversusonly5%forthesubsidizedrentproject.Theoperatingexpensesare estimatedtobe$3.50persquarefootforthemarketrentproject–whichiswithintherange typicallyusedforlow-incomemultifamilyhousingintheHoustonarea.Thelevelhasbeen increasedslightlyforthesubsidizedrentprojecttoaccountforthecostofcommunications withthegovernmentandcompliancewiththeirspecialrequests.Thecapitalizationratesfor boththesecaseshasbeenestimatedtobe15%,whichislowaswillbedemonstratedbythe salespriceperunitinthesalescomparisonapproach.Notethatthevalueindicatedusing marketrentis$2,026,667versus$4,512,000basedonusingthesubsidizedrent.Thehigher contractrentandlowervacancyforthesubsidizedrentprojectresultsinavalueviatheincome approachthatis23%higherthanthevalueindicatedbythemarketrentproject.
SalesComparisonApproach:
Thesalescomparisonapproachanalysisfurtherdemonstratesthetypicalmarketvaluesinthis submarket.Wehaveutilizedinformationoncomparablesalesbothfromourinternaldatabase andfromtheHarrisCountyAppraisalDistrictdatabase.Mostsaleswithinthesubmarketare listed:
Thecomparablesaleswithinthesubjectsubmarketrangedinvaluefrom$550perunitto $7,995perunit,withanaverageof$4,119perunit.Themediansalespricewas$5,018perunit, andthemidpointwas$4,252perunit.Notethatmostofthesalesareintherangeof$5,000to $8,000perunit.Investorsapparentlybelieveacapratehigherthan15percentisappropriate
sincemostofthesalesarebelowthelevelindicatedbyusingmarketoccupancyandmarket r
Theincomeapproachtovalueindicatesavalueof$5,000to$8,000perunitforthesubject propertiesusingmarketrentsandmarketoccupancy.Thesalesdataindicatesavaluelessthan thevalueindicatedbytheincomeapproach.Thisindicatesthatthemarketvalueofthese propertiesisbasedontheirmarketrentandnotonthecontractrentatprojectswhichhave above-marketrentalrates.Otherwise,investorswouldpurchasetheseprojectsforslightlyless thanthevalueindicatedusingsubsidizedrentandlimitresidentstosubsidizedrentprogram participants.Italsodemonstratesthatinvestorsrequireacapitalizationrateofabove15 percentinthisarea.
ValuationofLIHTCProjects
ThekeydifferencebetweenLowIncomeHousingTaxCreditproject(LIHTC)andamarketrent projectisthattheLIHTCprojecthasdeedrestrictionswhichlimitthemaximumrentthatcanbe charged.Therestrictionsalsolimitthemaximumincomeoftheresidents.TheOregonSupreme CourtruledthattheassessedvalueforLIHTCprojectsshouldbelessthantheassessedvalue formarketrentprojectssincetherentatLIHTCprojectsislessthanmarketrent,andtherents restrictthemarket.InTexasandmostotherstates,theLIHTCprojectislimitedbya30-year deedrestrictionwhichrunswiththeland.Inotherwords,itmaynotberevokedunilaterallyby thepropertyownerevenifthepropertyissoldorforeclosed.Inexchangefortheseonerous restrictions,theLIHTCpropertyownerreceivesageneroustaxcreditallowancefromtheU.S. government.Developerstypicallysellthetaxcreditsforapproximately45percentto60percent oftheprojectdevelopmentcost.
TheprimarydifferencebetweenLIHTCprojectsandmarketrentprojectsistherentalrate. Operatingexpenseswillbesimilarineithercase,buttheLIHTCprojectwilllikelyhavehigher occupancyduetoitsbelow-marketrents.Section(b)ofthedefinitionofmarketrentin the TexasPropertyTaxCode isasfollows:boththesellerandthepurchaserknowofallthe usesandpurposestowhichthepropertyisadaptedandforwhichitiscapableofbeingused andofthe enforceablerestrictionsonitsuse
TheLIHTCprojectsarelocatedintargetedareasestablishedbythefederalgovernmentwhich havebelow-averageincomelevels.
IncomeApproach:
Thefollowingarethreeincomeanalysesofhypothetical200-unitapartmentcomplexeswhich eachhas160,000netrentablesquarefeet.Contractrentisestimatedtobe$0.62persquare footattheLIHTCprojectbasedonwhatistypicalintheHoustonarea.(Ourfirmprepares approximately20marketstudiesforLIHTCprojectseachyear.)Marketrentatnewcomplexesin theHoustonareaistypically$0.80to$1.10persquarefootpermonth.Forthepurposesofthis analysis,marketrentfornewcomplexesisestimatedtobe$0.85persquarefoot.Market occupancyisestimatedtobe96percentfortheLIHTCprojectduetothebelow-marketrents and92percentforthemarketproject.OperatingexpensesmaybeslightlyhigherattheLIHTC projecttoaccountforaccountingandcommunicationwithgovernmentagenciesbecauseof theLIHTCrequirements,butthisamountisexpectedtobeoffsetbytheloweradvaloremtaxes. Theanalysisshowsthreeincomeapproaches.InadditiontotheLIHTCandupscalemarketrent projects,amid-rangeprojectwithrentalratesroughlybetweentheothersisincludedfor comparisonpurposes.A10percentcapitalizationratefortheLIHTCprojecthasbeenincluded basedonitsbelow-marketrents,whichappeartomaketheincomestreammorestable.An11 percentcapitalizationrateisusedforthemid-rangeprojectsinceitsrentalrateswouldbefar abovemarketforthearea.Thecapitalizationratefortheupscalemarketrentprojectis9.5 percentbasedondatainourfiles.
LIHTCProject
CapRate@10%
Mid-rangeProject
Grosspotentialincome@$0.75/SF
$1,140,000
Lessvacancy@8% $115,200
UpscaleMarketRentProject
Grosspotentialincome@$0.85/SF
$1,632,000
Lessvacancy@8% $130,560
CapRate@9.5%
Indicatedvaluebyincomeapproach
Theincomeapproachindicates$5,030,000fortheLIHTCprojectbasedonmaximumrents versus$9,070,000forthenewprojectusingmarketrents.Thevalueforthemid-rangeprojectis $6,230,000.The80percentrangebetweentheLIHTCandnew,marketrentcasesillustratesthe magnitudeofthedifference.Adiscussionofthevalueindicationsprovidedbytheincomeand salescomparisonapproachfollowsthecomparablesales.
UpscaleMarketRentProjects
Greenspoint/NorthbeltAreaSales
Theaveragesalespriceforrecentlybuiltapartmentcomplexesinupscaleareasofthecityis $57,414perunitversusanaveragesalespriceunitof$9,830perunitinthe Greenspoint/Northbeltarea.Totheknowledgeoftheauthor,therearenosalesinthe Greenspoint/Northbeltareawithsalespricesof$20,000to$25,000perunitandhigher.Salesin the$10,000to$15,000perunitrangetendtoindicatetheupperrangeofvaluesforwellmaintainedprojectsinthisarea.ThequandaryforvaluationoftheLIHTCpropertiesinthislowincomeareaiscompoundedbytherelativelylowper-unitsalespricesofexistingprojectsinthe area.Itisnoteworthythattheexistingprojectsareolder(builtbetween1970to1982)thanthe newapartmentcomplexesinupscaleareas(builtbetween1992to1994).Further,itisnotclear thatthenewerprojectswithintheGreenspoint/Northbeltareasellforappreciablymorethanthe existingpropertiesbasedonthedata.Severalprojectswhichdemonstratethisare13030 Northboroughand16700Northchase.Thefirstprojectsoldfor$8,317perunitandwasbuiltin 1982,whilethesecondprojectsoldfor$11,979perunitandwasbuiltin1979.Todatethere havebeenfew,ifany,salesofLIHTCapartmentcomplexesintheHoustonarea.However,itis notclearifaLIHTCprojectintheGreenspoint/Northbeltareawouldsellfor$25,150perunit(the valueindicatedbytheincomeapproach)whilemostofthecomplexesintheareaaresellingfor $5,000to$15,000perunit.However,itdoesappearclearthattheLIHTCprojectinthe Greenspoint/Northbeltareawouldclearlynotsellfor$45,350perunit(thevalueindicatedfor theupscalemarketrentproject).
ItappearsclearthatusingmarketrentinthevaluationofanLIHTCprojectwouldproducean appropriateresult.Further,itappearsthecapitalizationrateusedinvaluationoftheLIHTC projectusingcontractrentswouldoverstatethevaluesbasedoncomparablesales.While investorswouldappreciatethestableincomestreamduetothebelow-marketrents,few investorswouldwanttopay$25,000perunitforanapartmentcomplexinanareawheremost complexessellfor$5,000to$15,000perunit.
Valuationsofrealpropertywithabove-andbelow-marketrentalratesofferchallengesto propertyownersandassessmentofficers.Therewilllikelybelegitimatedifferencesofopinion fortheforeseeablefuture.Usingthesalescomparisonandincomeapproachestovalue
indicatesawiderangeofvalue.Thoughtfulconsiderationandnegotiationwillberequiredto formaconsensusontheseissues.
By:PatrickO'Connor|Postedon03/26/2006with0comments
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