| The purpose of this article is to analyze valuation | | | | pay contract rent of $0.70 to $0.80 per square |
| methodology for several atypical types of | | | | foot per month for subsidized housing projects, |
| apartments. Various circumstances and situations | | | | even though the market rent for competing |
| can cause an apartment complex to have | | | | projects might only be $0.45 to $ 0.50 per square |
| above-or below-market rental rates, occupancy | | | | foot per month. The rent and sales comparables |
| rates and operating expenses. This analysis | | | | used in this analysis are located in a neighborhood |
| examines the following two situations: | | | | characterized by income levels in the bottom |
| low-income subsidized apartments, which receive | | | | quartile of the Houston area, minimal new |
| above-market rental rates from HUD or another | | | | construction of residential or commercial buildings |
| government agency, and | | | | for 25 years and heterogeneous levels of quality |
| projects that are part of the Low Income | | | | and appeal. Some sections, such as Riverside, |
| Housing Tax Credit (LIHTC) program.The LIHTC | | | | have experienced gentrification, but other areas |
| program was established by the U.S. Congress to | | | | are marked by poorly maintained properties. Both |
| encourage development of affordable housing in | | | | the market rent projects and the subsidized rent |
| economically disadvantaged areas. Project | | | | projects are located in the area south of |
| developers receive a tax credit for following the | | | | downtown Houston, bound by 288 to the west, |
| guidelines established by the program. They | | | | Interstate-45 to the east, and Almeda-Genoa to |
| typically sell these credits to Fortune 500 | | | | the south. Consider the following tables which list |
| corporations for 45 percent to 60 percent of the | | | | rental rates for projects which do not participate |
| total project cost, excluding land.The first step in | | | | in a subsidy program (market rent projects) and |
| the valuation process is analyzing market value | | | | projects which do participate in a subsidized rent |
| definitions. The following is the definition from the | | | | program:Sources at the Houston HUD office |
| Texas Property Tax Code, Section 1.04 (7): | | | | indicate that expiring contracts for subsidized |
| market value means the price at which a | | | | properties are being reviewed - if the owner so |
| property would transfer for cash or its equivalent | | | | desires - for only one year. After that term, it is |
| under prevailing market conditions if: exposed for | | | | uncertain which course the plan will take. |
| sale in the open market with a reasonable time | | | | Indications that are subsidized programs are |
| for the seller to find a purchaser, both the seller | | | | changing from the current contract rent method |
| and the purchaser know of all the uses and | | | | to a resident voucher program. The voucher |
| purposes to which the property is adapted and | | | | method would involve issuing certificates to |
| for which it is capable of being used and of the | | | | individuals who may then use the voucher at any |
| enforceable restrictions to its use, and both the | | | | participating property. The voucher amount would |
| seller and the purchaser seek to maximize their | | | | be based on individual's income. In addition to the |
| gains and neither is in a position to take | | | | plan to phase out above-market subsidized rents, |
| advantage of the exigencies of the other.Section | | | | another reason not to use contract rent when |
| (b) of the Texas Property Tax Code further | | | | valuing subsidized housing is it is inconsistent with |
| requires: the market value of property shall be | | | | national public policy to penalize apartment |
| determined by the application of generally | | | | operators participating in this program since the |
| accepted appraisal techniques, and the same or | | | | difference between market rent and contract |
| similar appraisal techniques shall be used in | | | | rent is compensation for participating in the |
| appraising the same or similar kinds of property. | | | | program and working with the low-income |
| However, each property shall be appraised based | | | | residents. It would also be inconsistent with |
| upon the individual characteristics that affect the | | | | practice in Texas to use contract rent instead of |
| property's market value.The definition of market | | | | market rent when performing the income |
| value, according to the 10th edition of The | | | | approach to value.The three reasons contract |
| Appraisal of Real Estate published in 1992 by the | | | | rent should not be used in valuation are: it may |
| Appraisal Institute, is: market value is the most | | | | include compensation for participation in the |
| probable price, as of a specified date, in cash, or | | | | program and may not be equal to market rent, |
| in terms equivalent to cash, or in other precisely | | | | current plans are to eliminate the program and, it |
| revealed terms for which the specified property | | | | is inconsistent with national public policy Another |
| rights should sell after reasonable exposure in a | | | | factor to consider when performing the income |
| competitive market under all conditions requisite | | | | approach is the market occupancy. Since tenants |
| to a fair sale, with the buyer and seller each | | | | at the subsidized housing projects do not pay |
| acting prudently, knowledgeably, and for | | | | their rent or pay very minimal rent, the |
| self-interest, and assuming that neither is under | | | | occupancy tends to be at above-market level. |
| undue duress.The term which requires further | | | | Consider the following tables which list the |
| review in the above definition is "knowledgeably." | | | | occupancy rates for both market rent projects |
| Is the purchaser knowledgeable regarding the | | | | and subsidized rent projects:Sales Comparison |
| effort required to comply with subsidized housing | | | | Approach:The sales comparison approach analysis |
| program requirements and tenants? Does he | | | | further demonstrates the typical market values in |
| consider the effort to be rent for real estate or | | | | this submarket. We have utilized information on |
| compensation for services? Does the purchaser | | | | comparable sales both from our internal database |
| of an LIHTC project understand that maximum | | | | and from the Harris County Appraisal District |
| rents are now established for at least 15 years | | | | database. Most sales within the submarket are |
| based on deed restrictions? (LIHTC deed | | | | listed:Valuation of LIHTC ProjectsThe key |
| restrictions are now required for 30 years in | | | | difference between Low Income Housing Tax |
| Texas and most other states.)Fee simple estate | | | | Credit project (LIHTC) and a market rent project |
| is defined in the third edition of the Dictionary of | | | | is that the LIHTC project has deed restrictions |
| Real Estate Appraisal published by the Appraisal | | | | which limit the maximum rent that can be |
| Institute as: absolute ownership unencumbered by | | | | charged. The restrictions also limit the maximum |
| any other interest or estate, subject only to the | | | | income of the residents. The Oregon Supreme |
| limitations imposed by the governmental powers | | | | Court ruled that the assessed value for LIHTC |
| of taxation, eminent domain, police power and | | | | projects should be less than the assessed value |
| escheat.The practice in Texas is to base the | | | | for market rent projects since the rent at LIHTC |
| assessed value on the value of the fee simple | | | | projects is less than market rent, and the rents |
| estate as opposed to the leased fee estate. This | | | | restrict the market. In Texas and most other |
| analysis is based on valuation of the fee simple | | | | states, the LIHTC project is limited by a 30-year |
| estate instead of the leased fee estate.The | | | | deed restriction which runs with the land. In other |
| definition of leased fee estate in the third edition | | | | words, it may not be revoked unilaterally by the |
| of the Dictionary of Real Estate Appraisal is: an | | | | property owner even if the property is sold or |
| ownership interest held by a landlord with the | | | | foreclosed. In exchange for these onerous |
| rights of use and occupancy conveyed by lease | | | | restrictions, the LIHTC property owner receives a |
| to others. The rights of the lessor (the leased fee | | | | generous tax credit allowance from the U.S. |
| owner) and the lessee are specified by contract | | | | government. Developers typically sell the tax |
| terms contained within the lease.The primary | | | | credits for approximately 45 percent to 60 |
| difference between the fee simple estate and the | | | | percent of the project development cost.The |
| leased fee estate is that the tenant and landlord | | | | primary difference between LIHTC projects and |
| are each bound by commitments to pay rent and | | | | market rent projects is the rental rate. Operating |
| allow use of the property for a term. The | | | | expenses will be similar in either case, but the |
| contract rent agreed to between landlord and | | | | LIHTC project will likely have higher occupancy |
| tenant may or may not be equal to market rent. | | | | due to its below-market rents. Section (b) of the |
| For example, if a landlord entered into a 30-year | | | | definition of market rent in the Texas Property |
| lease for rent of $5 per square foot 15 years ago | | | | Tax Code is as follows: both the seller and the |
| (when market rent was $5 per square foot) and | | | | purchaser know of all the uses and purposes to |
| the current market rent is $10 per square foot, | | | | which the property is adapted and for which it is |
| the tenant has a substantial advantage. The | | | | capable of being used and of the enforceable |
| tenant has a leasehold estate which may or may | | | | restrictions on its use.The LIHTC projects are |
| not have value depending on the term of the | | | | located in targeted areas established by the |
| lease, the contract rent and market rent.The | | | | federal government which have below-average |
| Dictionary of Real Estate Appraisal defines | | | | income levels.Income Approach:The following are |
| leasehold estate as the interest held by the lessee | | | | three income analyses of hypothetical 200-unit |
| (the tenant or renter) through a lease conveying | | | | apartment complexes which each has 160,000 net |
| the rights of use and occupancy for a stated | | | | rentable square feet. Contract rent is estimated |
| term under certain conditions.Conversely, if the | | | | to be $0.62 per square foot at the LIHTC project |
| tenant agreed to a rental rate of $15 per square | | | | based on what is typical in the Houston area. (Our |
| foot in a strong market 10 years ago, and is | | | | firm prepares approximately 20 market studies |
| committed to pay that rent for another 10 years, | | | | for LIHTC projects each year.) Market rent at |
| there is a substantial advantage to the landlord, | | | | new complexes in the Houston area is typically |
| and the tenant has a leasehold estate with a | | | | $0.80 to $1.10 per square foot per month. For the |
| negative value. Practice in Texas is to establish | | | | purposes of this analysis, market rent for new |
| the assessed value based on the fee simple | | | | complexes is estimated to be $0.85 per square |
| estate instead of the leased fee estate. | | | | foot. Market occupancy is estimated to be 96 |
| Therefore, the relevant criteria for determining | | | | percent for the LIHTC project due to the |
| market value includes market rent, market | | | | below-market rents and 92 percent for the |
| expenses, market occupancy and market derived | | | | market project. Operating expenses may be |
| capitalization rates. If a taxpayer made a poor | | | | slightly higher at the LIHTC project to account for |
| business decision 10 years ago and has | | | | accounting and communication with government |
| substantially below-market rent, it is inequitable for | | | | agencies because of the LIHTC requirements, but |
| the taxing entities to reduce their ad valorem tax | | | | this amount is expected to be offset by the |
| due to the bad business decision of the property | | | | lower ad valorem taxes. The analysis shows three |
| owner. Conversely, if a property owner made a | | | | income approaches. In addition to the LIHTC and |
| fortuitous or wise business decision and entered | | | | upscale market rent projects, a mid-range project |
| into an above-market lease, it is not appropriate | | | | with rental rates roughly between the others is |
| to collect an above-average level of ad valorem | | | | included for comparison purposes. A 10 percent |
| tax from him because of his luck or | | | | capitalization rate for the LIHTC project has been |
| prudence.Market rent is defined by the third | | | | included based on its below-market rents, which |
| edition of the Dictionary of Real Estate Appraisal | | | | appear to make the income stream more stable. |
| as: the rental income that a property would most | | | | An 11 percent capitalization rate is used for the |
| probably command in the open market; indicated | | | | mid-range project since its rental rates would be |
| by current rents paid and asked for comparable | | | | far above market for the area. The capitalization |
| space as of the date of appraisal.Market rent is | | | | rate for the upscale market rent project is 9.5 |
| the compensation paid for the use of the real | | | | percent based on data in our files.It appears clear |
| estate. It should not include compensation paid for | | | | that using market rent in the valuation of an |
| factors other than the use of the real estate | | | | LIHTC project would produce an appropriate |
| such as additional services which are not typically | | | | result. Further, it appears the capitalization rate |
| provided.The next step in this process is to | | | | used in valuation of the LIHTC project using |
| analyze valuation of properties which participate in | | | | contract rents would overstate the values based |
| subsidized programs which receive above-market | | | | on comparable sales. While investors would |
| rental rates. The final section will address valuation | | | | appreciate the stable income stream due to the |
| of projects in the LIHTC program.Valuation of | | | | below-market rents, few investors would want to |
| Subsidized HousingThis analysis will consider both | | | | pay $25,000 per unit for an apartment complex in |
| the income and the sales comparison approaches | | | | an area where most complexes sell for $5,000 to |
| to value. The cost approach is not utilized since it | | | | $15,000 per unit.Valuations of real property with |
| would provide similar results after calculating | | | | above- and below-market rental rates offer |
| external obsolescence due to differences in rental | | | | challenges to property owners and assessment |
| rates.Income Approach:Apartment owners who | | | | officers. There will likely be legitimate differences |
| participate in subsidized housing programs may or | | | | of opinion for the foreseeable future. Using the |
| may not receive above-market rental rates. For | | | | sales comparison and income approaches to value |
| many years, HUD offered above-market rental | | | | indicates a wide range of value. Thoughtful |
| rates as an inducement to property owners to | | | | consideration and negotiation will be required to |
| participate in the program. There are two reasons | | | | form a consensus on these issues.Pat O'Connor, |
| for HUD paying an above-market rental rate: | | | | MAI is president of O'Connor & Associates, |
| to compensate for the inconvenience of dealing | | | | 130-person firm in business since 1974. O'Connor |
| with a bureaucratic government program which | | | | & Associates is the largest tax consultant in |
| mandates detailed inspections not typically | | | | Texas, handled more than 43,000 administrative |
| required in the private market; and | | | | appeals in 100 counties in 2005 and is currently |
| to compensate for working with residents who | | | | coordinating over 2,000 judicial appeals. O'Connor |
| tend to be at the lowest socioeconomic level in | | | | & Associates also provides real estate appraisal, |
| our society.It has not been unusual for HUD to | | | | cost segregation and market research services. |