Appraisal - Valuation of Subsidized Housing

8/3/2019 Appraisal - Valuation of Subsidized Housing

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Title:

Appraisal - Valuation of Subsidized Housing

Word Count:

1377

Summary:

The purpose of this article is to analyze valuation methodology for several atypical types of apartments.

Various circumstances and situations can cause an apartment complex to have above-or below-market rental

rates, occupancy rates and operating expenses.

Keywords:

real estate, appraisal, tax, HCAD

Article Body:

The purpose of this article is to analyze valuation methodology for several atypical types of apartments.

Various circumstances and situations can cause an apartment complex to have above-or below-market rental

rates, occupancy rates and operating expenses. This analysis examines the following two situations:

1.low-income subsidized apartments, which receive above-market rental rates from HUD or another

government agency, and2.projects that are part of the Low Income Housing Tax Credit (LIHTC) program.

The LIHTC program was established by the U.S. Congress to encourage development of affordable housing

in economically disadvantaged areas. Project developers receive a tax credit for following the guidelines

established by the program. They typically sell these credits to Fortune 500 corporations for 45 percent to 60

percent of the total project cost, excluding land.

The first step in the valuation process is analyzing market value definitions. The following is the definitionfrom the Texas Property Tax Code, Section 1.04 (7): market value means the price at which a property

would transfer for cash or its equivalent under prevailing market conditions if:

a.exposed for sale in the open market with a reasonable time for the seller to find a purchaser,

b.both the seller and the purchaser know of all the uses and purposes to which the property is adapted and

for which it is capable of being used and of the enforceable restrictions to its use, and

c.both the seller and the purchaser seek to maximize their gains and neither is in a position to take advantage

of the exigencies of the other.

Section (b) of the Texas Property Tax Code further requires: the market value of property shall be


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determined by the application of generally accepted appraisal techniques, and the same or similar appraisal

techniques shall be used in appraising the same or similar kinds of property. However, each property shall

be appraised based upon the individual characteristics that affect the property's market value.

The definition of market value, according to the 10th edition of The Appraisal of Real Estate published in

1992 by the Appraisal Institute, is: market value is the most probable price, as of a specified date, in cash, or

in terms equivalent to cash, or in other precisely revealed terms for which the specified property rights

should sell after reasonable exposure in a competitive market under all conditions requisite to a fair sale,

with the buyer and seller each acting prudently, knowledgeably, and for self-interest, and assuming that

neither is under undue duress.

The term which requires further review in the above definition is "knowledgeably." Is the purchaser

knowledgeable regarding the effort required to comply with subsidized housing program requirements and

tenants? Does he consider the effort to be rent for real estate or compensation for services? Does the

purchaser of an LIHTC project understand that maximum rents are now established for at least 15 years

based on deed restrictions? (LIHTC deed restrictions are now required for 30 years in Texas and most other

states.)

Fee simple estate is defined in the third edition of the Dictionary of Real Estate Appraisal published by the

Appraisal Institute as: absolute ownership unencumbered by any other interest or estate, subject only to the

limitations imposed by the governmental powers of taxation, eminent domain, police power and escheat.

The practice in Texas is to base the assessed value on the value of the fee simple estate as opposed to theleased fee estate. This analysis is based on valuation of the fee simple estate instead of the leased fee estate.

The definition of leased fee estate in the third edition of the Dictionary of Real Estate Appraisal is: an

ownership interest held by a landlord with the rights of use and occupancy conveyed by lease to others. The

rights of the lessor (the leased fee owner) and the lessee are specified by contract terms contained within the

lease.

The primary difference between the fee simple estate and the leased fee estate is that the tenant and landlordare each bound by commitments to pay rent and allow use of the property for a term. The contract rent

agreed to between landlord and tenant may or may not be equal to market rent. For example, if a landlord

entered into a 30-year lease for rent of $5 per square foot 15 years ago (when market rent was $5 per square

foot) and the current market rent is $10 per square foot, the tenant has a substantial advantage. The tenant

has a leasehold estate which may or may not have value depending on the term of the lease, the contract rent

and market rent.

The Dictionary of Real Estate Appraisal defines leasehold estate as the interest held by the lessee (the tenant

or renter) through a lease conveying the rights of use and occupancy for a stated term under certain

conditions.


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Conversely, if the tenant agreed to a rental rate of $15 per square foot in a strong market 10 years ago, and is

committed to pay that rent for another 10 years, there is a substantial advantage to the landlord, and the

tenant has a leasehold estate with a negative value. Practice in Texas is to establish the assessed value based

on the fee simple estate instead of the leased fee estate. Therefore, the relevant criteria for determining

market value includes market rent, market expenses, market occupancy and market derived capitalization

rates. If a taxpayer made a poor business decision 10 years ago and has substantially below-market rent, it is

inequitable for the taxing entities to reduce their ad valorem tax due to the bad business decision of the

property owner. Conversely, if a property owner made a fortuitous or wise business decision and entered

into an above-market lease, it is not appropriate to collect an above-average level of ad valorem tax from

him because of his luck or prudence.

Market rent is defined by the third edition of the Dictionary of Real Estate Appraisal as: the rental income

that a property would most probably command in the open market; indicated by current rents paid and asked

for comparable space as of the date of appraisal.

Market rent is the compensation paid for the use of the real estate. It should not include compensation paid

for factors other than the use of the real estate such as additional services which are not typically provided.

The next step in this process is to analyze valuation of properties which participate in subsidized programs

which receive above-market rental rates. The final section will address valuation of projects in the LIHTC

program.

Valuation of Subsidized Housing

This analysis will consider both the income and the sales comparison approaches to value. The cost

approach is not utilized since it would provide similar results after calculating external obsolescence due to

differences in rental rates.

Income Approach:

Apartment owners who participate in subsidized housing programs may or may not receive above-market

rental rates. For many years, HUD offered above-market rental rates as an inducement to property owners to

participate in the program. There are two reasons for HUD paying an above-market rental rate:

1.to compensate for the inconvenience of dealing with a bureaucratic government program which mandates

detailed inspections not typically required in the private market; and

2.to compensate for working with residents who tend to be at the lowest socioeconomic level in our society.

It has not been unusual for HUD to pay contract rent of $0.70 to $0.80 per square foot per month for

subsidized housing projects, even though the market rent for competing projects might only be $0.45 to $


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0.50 per square foot per month. The rent and sales comparables used in this analysis are located in a

neighborhood characterized by income levels in the bottom quartile of the Houston area, minimal new

construction of residential or commercial buildings for 25 years and heterogeneous levels of quality and

appeal. Some sections, such as Riverside, have experienced gentrification, but other areas are marked by

poorly maintained properties. Both the market rent projects and the subsidized rent projects are located in

the area south of downtown Houston, bound by 288 to the west, Interstate-45 to the east, and Almeda-Genoa

to the south. Consider the following tables which list rental rates for projects which do not participate in a

subsidy program (market rent projects) and projects which do participate in a subsidized rent program:

http://www.poconnor.com/article.asp?id=48

Online project management software
http://www.filocity.com/feature/project-management-software-online/http://www.filocity.com/feature/project-management-software-online/

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Appraisal - Valuation of Subsidized Housing