The Economics of Inclusionary Development: ULI Terwilliger Center for Housing Michael Wilkerson, Ph.D. September 9, 2016 ECONorthwest
Value Capture Value Crea)on Value Capture Public Benefit Value capture: Type of public financing that recovers some of the value that public infrastructure generates for private landowners
What is Inclusionary Housing? Policy where new developments include a por)on of the units at an affordable level (below market price) Can be a mandatory or voluntary (incen)ves) policy Can apply to ownership or rental proper)es Can be provided on site or off site, or with a fee- in- lieu
What is Affordable Housing? Follows Department of Housing and Urban Development (HUD) guidance in the U.S. 30% or less of gross income spent on housing (including u)li)es) Applies to ownership and rental housing Tied to a percent of Area Median Income (AMI) (includes family income - - based on a household size of 4) 90% of AMI for 2 Bedroom or 75% of AMI for 1 Bedroom Doesn t consider variable costs like transporta)on
Housing Market Appreciation 14.00%' 12.00%' 13.25%' 12.60%' 12#Month#Housing#Market#Apprecia5on# June#2015#to#June#2016# 10.00%' 8.00%' 6.00%' 5.10%' 4.00%' 2.00%' 2.00%' 0.00%' Toronto' Portland' Sea7le'' Denver'' Dallas'' Tampa'' Miami'' San'Francisco'' San'Diego'' Atlanta'' Las'Vegas'' Los'Angeles'' Phoenix'' Minneapolis'' Detroit' Charlo7e'' 'U.S.'NaJonal'' Boston'' Chicago'' Cleveland'' Washington'' New'York'' Source: U.S. data: S & P Case- Shiller Home Price Index, Toronto: House Price Index (Teranet and Na)onal Bank of Canada)
Less Flexible Inclusionary Zoning Policy Design More Flexible Mandatory or Voluntary Higher setaside 30% to 5% Lower setaside Lower income target Longer rent restric)on Jurisdic)on 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 restric)on Spa)al calibra)on Specific housing types Opt- outs In lieu or off site No or ineffec)ve incen)ves Public sector $ Market responsive incen)ves
Rental vs. Ownership Policy Application Policy design is more complex for ownership units NOI and cost reduc)on (rental) vs. cost reduc)on (ownership) Number of units threshold (fee in lieu) Calcula)on and calibra)on of affordable market value over )me Permanence of affordability (control or deed restric)on) Verifica)on of income over )me (program administra)on) Refinance qualifica)on 5 years vs. 30 years Calibra)on of affordable market value over )me Quality and type of units (family units, checker board) Detached vs. Condo (HOA payments): Public en)ty first right of refusal or op)on for purchase
The Market Builds High-End Housing Luxury Market Environment 120% Filtering Workforce 100% Filtering % of AMI 80% Moderate Income Filtering Rate (U.S. National Estimate) Supported Environment 60% 30% % Rental -- 2.5% Annually Ownership -- 0.5% Annually 0% Source: Rosenthal, American Economic Review, 2014
Filtering example Portland, OR 140% $2,320 Market Average Built since 2014 2 bedroom 120% $1,650 Market Average Built since 2014 1 Bedroom 100% of AMI 93% % $1,374 including u)li)es for 1 bedroom $1,280 Market Average all 1 bedroom units + 29% New Construc)on Rent Higher than Market Average 80% 60% $1,100 including u)li)es for 1 bedroom $825 including u)li)es for 1 bedroom Filtering to 100% of AMI would take approximately 10 years based on the literature Source: CoStar
Project Operating Revenues Revenues Apartment Rent Retail Parking Costs and Expenses Debt Service Opera)ons Property Tax Vacancy Reserves Returns Net Cash Flow
Net Cash Flow Distributions ( Waterfall ) Internal Rate of Return % Equity Developer 18 25% 75% Underwri)ng Target 15 12 8 60% 40% Ini)al Return Tranche Second Return Tranche Third Return Tranche
Understanding the Economics of Development Public Policy Highest and Best Use Land Development Can Occur Market Feasibility Rent and Construc)on Cost Fixed Capital Waterfall Capital is mobile
Residual Land Value RLV = Developer Maximum Land Budget Given a set of capital, construc)on, opera)ng costs, and revenue assump)ons
Land Value - Highest and Best Use Land Value ($) Landowner s Perspec)ve Developer s Perspec)ve Range of Development Feasibility Appraiser s Perspec)ve Specula)ve 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 rate of return) methodology to calculate financial feasibility 4. Does not account for different equity structures, interest rates or CAP rate projec)ons 5. Modeled market condi)ons using average construc)on costs and assumed market rent and AMI levels
Construction Prototypes Residual Land Value by Construc)on 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
Market vs. Affordable Rent Varies within Region
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 Incen)ves
IZ Policy AMI Target Impact on Feasibility Podium Construction Area A Achievable Market Rent: $3.00 PSF Area B Achievable Market Rent: $3.50 PSF Residual Land Value $/SF (Land Budget) $118 100% 15% 80% SA 60% $296 Magnitude doesn t change based on market rent With 10% setaside $0 Infeasible 100% 15% 80% SA 60% 100% AMI: $237 80% AMI: $223 60% AMI: $210
Residual Land Value IZ Policy Setaside Impact on Feasibility 40% 0% 10% 20% 50% 30% Set aside from 0% to 100% 60% 70% 80% 90% 100%
Sample Range of Income Targets (% AMI)
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 Time Up Front Incentive Options Land write downs, grants, deferred interest loan, fee waivers (unlimited) Opera)ng 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 condi)ons)
IZ Policy Offset Incentive Comparison Stacked Flat $2.25 Market Rent After Incentives Residual Land Value $/SF (Land Budget) $210 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 cause market disrup)ons (unintended consequences) One size fits all vs. sub- regional/project based market driven calibra)on Revisi)ng policy as market changes On site requirement vs. opt- out Ownership vs. Rental Policy Varied effec)veness of incen)ves TIF vs. abatement and HOA reduc)on Value is capitalized in the Land Highest and best use Ground leases
Email: wilkerson@econw.com Phone: 503.222.6060 Eugene Portland Seattle Boise