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