The Economics of Inclusionary Development: ULI Terwilliger Center for Housing Michael Wilkerson, Ph.D. September 12, 2016 ECONorthwest
Less Flexible Inclusionary Zoning Policy Design More Flexible Mandatory or Voluntary Higher setaside 30% to 5% Lower setaside Lower income target Longer rent restric8on Jurisdic8on wide All housing types No opt outs 0% to 120% Permanent to 10 years City to neighborhood # units or ownership or Higher income target Shorter rent restric8on Spa8al calibra8on Specific housing types Opt- outs In lieu or off site No or ineffec8ve incen8ves Public sector $ Market responsive incen8ves
S & P Case Shiller Home Price Index 14.00% 12.00% 12.60% 11.00% 12 Month Housing Market Apprecia5on June 2015 to June 2016 10.00% 8.00% 6.00% 6.40% 5.10% 4.00% 2.00% 2.00% 0.00%
Portland Housing Market Appreciation 20.00% 15.00% S & P Case Shiller Home Price Index - - Portland Monthly from July 2007 to June 2016 13.5% 9.6% Increase from peak 205 220 200 10.00% 187 Annual Rate of Change 5.00% 0.00% - 5.00% 180 160 140 Home Price Index (2000=100) - 10.00% - 15.00% - 16.3% 129 31% Decrease from peak 120-20.00% 100 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Ownership Affordability in 2015 20% Down Payment Source: RLIS an HUD
One Bedroom Affordability in the City of Portland $1,400 $1,300 Average Market Rent vs. MFI 100% MFI $1,280 $1,200 Average Monthly Rent $1,100 $1,000 $900 $800 1 Bedroom Avg. Rent + 106% 2000 to 2016 $700 $600 $620 60% MFI $500 $400 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: Costar and HUD Note: $100 (2016$) was deducted to account for u7li7es in the affordability calcula7on
The Market Builds High-End Housing 140% 120% $2,320 Market Average 2 bedroom (Built since 2014) $1,650 Market Average 1 bedroom (Built since 2014) + 41% Compared to a 15% increase in MFI from 1 bedroom to 2 bedroom 100% Of MFI 93% % $1,374 1 bedroom (including u8li8es) $1,280 Market Average All 1 bedroom units + 29% New Construc8on Rent Higher than Market Average 80% 60% $1,100 1 bedroom (including u8li8es) $825 1 bedroom (including u8li8es) Source: CoStar
Project Operating Revenues Revenues Apartment Rent Retail Parking Costs and Expenses Debt Service Opera8ons Property Tax Vacancy Reserves Returns Net Cash Flow
Net Cash Flow Distributions ( Waterfall ) Internal Rate of Return % Equity Developer 18 25% 75% Underwri8ng Target 15 12 8 60% 40% Ini8al Return Tranche Second Return Tranche Third Return Tranche
Understanding the Economics of Development Public Policy Highest and Best Use Land Development Can Occur Market Feasibility Rent and Construc8on Cost Fixed Capital Waterfall Capital is mobile
Land Value - Highest and Best Use Land Value ($) Landowner s Perspec8ve Developer s Perspec8ve Range of Development Feasibility Appraiser s Perspec8ve Specula8ve Income Comparable Replacement Unconstrained RLV Constrained RLV (zoning or policy)
ULI Report Methodology 1. Analyzed only apartment (for rent) development 2. Did not model off site provision of units or fee in lieu 3. Used a return on cost (unleveraged) methodology to calculate financial feasibility 4. Does not account for different equity structures, interest rates or CAP rate projec8ons 5. Modeled market condi8ons using average construc8on costs and assumed market rent and AMI levels
Residual Land Value RLV = Developer Maximum Land Budget Given a set of capital, construc8on, opera8ng costs, and revenue assump8ons
Construction Prototypes Residual Land Value by Construc8on Prototype $600 Stacked Flats $500 $400 $300 $200 Stacked Flat $100 $0 4 over 1 (podium) - $100 4 over 1 Tower - $200 - $300 $2.50 Residential Tower $3.00 $3.50 Rent per Square Foot RLV = $ per gross square foot of land $4.00
Markets Vary Within a Region Apartment Construction Financially feasible building types if the land value is $0 Residential tower 4 over 1 Stacked flats Doesn't pencil Insufficient data
The impact of IZ without incentives How does the setaside change feasibility? From res. tower to 4 over 1 From 4 over 1 to stacked flats From stacked flats to infeasible No change (still feasible) No change (still not feasible) Insufficient data IZ Policy 20% Set Aside 80% of MFI $0 Land Price No Incen8ves
IZ Setaside vs. Income Target Tradeoff 4 over 1 (podium) - - Rent @ $3.25/SF Stacked Flat - - Rent @ $2.25/SF Indifference Curve 21% vs. 17% setaside 61% vs. 31% setaside
Direct subsidies Subsidies Reduced Parking One 8me Up front Incentive Options Land write downs, grants, deferred interest loan, fee waivers (unlimited) Opera8ng subsidies Subsidies Code requirement Ongoing Limited by market demand, target affordable units Property tax abatements (limited by millage rate) Density Bonus Code based Height limit and/or FAR (limited by market condi8ons)
IZ Policy Offset Incentive Comparison Stacked Flat $2.25 Market Rent After Incentives Residual Land Value $/SF (Land Budget) $70 Current Market IZ Policy: $50 20% set aside 80% AMI target +$9 ($59) Full property tax abatement: (1.5% rate reduction) +$7 ($57) Parking Reduction 50% of spaces $66 ($50 + $9 + $7) $0 Infeasible
IZ Policy Offset Incentive Comparison 4 over 1 Podium $3.25 Market Rent After Incentives Residual Land Value $/SF (Land Budget) $0 $210 Current Market $145 $80 IZ Policy: 20% set aside 80% AMI target $157 +$35 ($115) Full property tax abatement: (1.5% rate reduction) +$95 ($175) Parking Reduction 50% of spaces $210 ($80 + $35 + $95) Infeasible = Stacked Flat $3.25 Market Rent
Summary Flexible programs are less likely to impact market rate development (unintended consequences) One size fits all vs. sub- regional/project based market- driven calibra8on Revisit policy as market changes On site requirement vs. opt- out/fee- in- lieu Value is capitalized in the land Highest and best use IZ alone will not solve the affordability crisis; need a broader toolkit of policies and incen8ves
Email: wilkerson@econw.com Phone: 503.222.6060 Eugene Portland Seattle Boise