Fall in Love with Your Resale Formula –Or Find a New One!
Julie Brunner & Rick Jacobus, May 12, 2016
We work nationally, connecting local experts with the networks, knowledge and support they need.
We promote housing solutions that will stay affordable for generations so communities can
stabilize and strengthen their foundation, for good.
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1. Welcome & Introductions2. Overview of Resale Formula Types3. Social Impact Report – How are we performing?4. Evaluate and change your formula? – Case studies5. Resources
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Resale Formula Types
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Resale Formula Types
Appraisal Based Formulas
Fixed Rate Formulas
Index Based Formulas
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Appraisal Based Formula
Calculation
Original Affordable Price
% Increase of Appraised Value
= Formula Price
+
Presenter
Presentation Notes
The appraisal-based formula takes a different approach. You still begin with the affordable price the homeowner initially paid when they purchased their home, but this time you add to that number a percentage of the increase of the appraised market value of that home over time.
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Appraisal Based Formula
TIP: Percentages commonly range from 15-25%
Calculation
Original Affordable Price
25% x (Increase of Appraised Value)
= Formula Price
+
Presenter
Presentation Notes
Our CDC in Coffee Town has chosen the following formula: Original Affordable Price + 25% of the increase in value which is calculated by subtracting the original appraised value from the current appraised value. The most common percentage used is 25% of the increase in appraised value, although programs in hotter markets may use a number as low as 15%, and programs in depressed markets may choose a higher percentage.
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Appraisal Based Formula
In Down Markets
Formulas may address market downturns:
25% of the increase
25% of the change
Presenter
Presentation Notes
As we discussed in the previous modules, the formula price sets a cap on the maximum sales price—it is not a guarantee. But unlike the fixed rate and index based formulas, appraisal based formulas can have protection against market down turns built right into the formula. So in addition to stating that the homeowner gets 25% of the increase in value, some programs include language that the homeowner gets 25% of the change in value, so the homeowner shares in the loss as well.
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Appraisal Based Formula
Advantages
Fully protects program in falling markets
Ties formula price to condition of the home
Removes issues around capital improvements
Relatively easy to calculate and administer
Presenter
Presentation Notes
Advantages – As with each formula, there are some significant advantages to an appraisal based formula. One of the biggest advantages to the appraisal-based formula is that it can fully protect the program in falling markets. Depending on how the formula is written, an appraisal-based formula can put 100% of a market decline on the owner. Another advantage is that it ties the formula price to the condition of the home, at least to some extent, while preventing expensive improvements from pushing up the price. If a homeowner takes good care of their home, it will likely appraise higher than the neighboring house that suffered from deferred maintenance. Appraisal based formula remove the issues around repairs and improvements to the home as the appraisal takes those into account. � And since the appraisals are conducted by a 3rd party, the program is not in a position to make judgment calls regarding condition or capital improvement values. And although this formula is the most complicated of the three we’ve discussed, it is still relatively easy to calculate and administer.
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Appraisal Based Formula
Disadvantages
Requires a 3rd party appraisal which means time and expense
Appraisals can be inconsistent and random
Can compromise affordability in times of rapid appreciation
Does not distinguish between homeowner improvements and market forces
Direct association between price and market
Presenter
Presentation Notes
Disadvantages – *click* One of most significant down sides of an appraisal based formula is that it entails significant time and expense and the formula price can only be calculated once a 3rd party appraisal is in hand. This is not only expensive, but can mean that a homeowner or the program must pay several hundred dollars only to determine they are not actually in a position to sell because their formula price is too low. *click* Another disadvantage is that appraisals can be inconsistent and seem random. The same house that has two appraisal conducted at the same time by two appraisers may end up with wildly different values. *click* During periods of rapid market appreciation, appraisal based formulas can give an unduly high rate of return to the owners and therefore compromise affordability. *cluck* These formulas do not distinguish between improvements made by the homeowner and increases in market value attributed to market forces. So a home in very poor condition can appreciate significantly in hot markets, providing the seller of a home with significant deferred maintenance with high return. *click* Some argue that the direct association between price and the housing market is a shortcoming. Rather than perceiving the formula as something the seller “gets” in addition to what they paid (25% of the increase in this case), people sometimes focus on what they are not getting – the other 75% of the market appreciation.
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Fixed Rate Formula
Calculation
TIP: Compound annually or calculate as simple interest. Multiplier between 1% and 2%.
Original Affordable Price
Set Multiplier (over time)
= Formula Price
x
Presenter
Presentation Notes
The classic fixed rate resale formula is simple. You take the affordable price the homeowner paid when they purchased their home, and you increase it by a set multiplier over time. 1) The multiplier is a fixed percentage rate, that can be either compounded annually or calculated as simple interest ,
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Fixed Rate Formula
Choosing a Multiplier
Consider historic information on wages and housing prices.
Simple or Compound Interest
Compound interest is often selected by programs wishing to reward homeowners with longer tenure.
Presenter
Presentation Notes
A) In CoffeeTown we decide to go with a fixed rate formula of 1.5% compounded annually. To come up with this percentage rate, we did a quick assessment of census data and saw 1) that incomes have historically averaged a 2.2% increase per year. But after considering that mortgage interest rates are at historic lows, we decide to be a bit more conservative with our fixed rate of return to buffer against rising mortgage interest rates in the future. 1) While programs can choose any rate, most choose a rate somewhere between 1% – 2%. The other decision you have to make with a fixed rate formula is weather to use simple or compound interest. Programs favoring simplicity often choose simple interest, and those wanting to reward longer-term tenure often choose compound interest. With compound interest, longer tenured homeowners will see a greater return.
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Fixed Rate Formula
Formula Price is a Cap
Not a guarantee
Market Strength
Deferred Maintenance
Presenter
Presentation Notes
It is important to note that the formula price sets a cap on the maximum sales price—it is not a guarantee. There are many reasons that a seller may not be able to sell for the maximum allowable price. For example, the home may not appraise at or above the formula price because of market strength or deferred maintenance. For fixed rate formulas there are generally two approaches to addressing the market cap of the formula.
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Fixed Rate Formula
Advantages
Calculate the price at any time
Easy to understand and administer
Slow and steady increase
Presenter
Presentation Notes
As you might have guessed, there are some significant advantages to using such a simple resale formula. One is that you can calculate the formula price at any time, and in fact you can even forecast the maximum resale price for every year from the date of purchase. 1) Similarly, this formula is easy to understand and administer. Ease of administration is a high priority when crafting your resale formula. In an effort to create the perfect formula that is absolutely “fair,” programs come up with formulas that are so complicated their own staff do not understand how to calculate them, much less the homebuyers. 2)A fixed rate formula provides a slow, steady increase over time, which is what most of us are trying to achieve with our resale formulas. Providing you choose a conservative percentage, it also effectively controls affordability.
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Fixed Rate Formula
Disadvantages
Not associated with the condition of the home
TIP: Capital Improvement Credits
No incentive for longer term tenure
TIP: Compound or Stepped Formula
Disassociated from the market
Risky in falling markets
TIP: “Lesser of” clause
Presenter
Presentation Notes
Disadvantages – The most significant down side of a fixed rate formula is that it’s not associated with the condition of the home, nor does it reward homeowners for making improvements. 1) The improvements issue can be addressed by adding a capital improvements credit onto the formula. Doing so would make your formula more complicated, but it could improve the performance of the formula if you have a programmatic goal of encouraging certain types of improvements to your homes. 2) Since my formula is compounded annually, it provides a slight incentive for long term tenure, but fixed rate formulas that use simple interest provide no incentive for longer term tenure. 3) If this is a priority, you may consider a variation on the fixed rate formula which increases the rate over time. The formula may state, for example, that the home will increase by 1% for the first five years and then by 1.5% for the next five years and by 2% after that. Again, you are trading some of the simplicity to improve the performance of the formula in terms of your programmatic goal of rewarding longer-term tenure. 4) Some argue that the disassociation between the price and the market is a shortcoming. In some areas it may be difficult to defend a formula that is completely dis-associated from the pricing of market rate housing. 5) Finally, it can be risky to use a fixed rate formula because in falling markets, you may be allowing resale prices to increase faster than market prices, thereby reducing the impact of the subsidy and making the marketing more difficult. 6) This can be mitigated by using the language I referenced earlier about the “lesser of” clause, where both the program and homeowner share in market downturns.
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Index Based Formula
Calculation
TIP: Choose an index that is: Steady,Easy to Find, Updated Regularly
Original Affordable Price
% Change Index (over time)
= Formula Price
x
Presenter
Presentation Notes
The Index Based Formula works in essentially the same way. You again take the affordable price but this time you multiply it by the percent change of a published index over time instead of by a fixed multiplier.
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Index Based Formula
Choosing an Index
Area Median Income: Home and incomes increase at the same rate.
Consumer Price Index: Slow and steady increase in values.
TIPS: Consider historic information and programmatic goals.Consider where you are in an economic cycle.
• Average AMI Increase 2005- 2014 2.2%• Average AMI Increase 1995- 2004 7.7%
Presenter
Presentation Notes
A) The most commonly used index is the Area Median Income. If I am trying to make sure my program remains affordable to a specific income range, it makes sense that if I tie the increase in sales price to the change in incomes over time, my homes will remain affordable to the same income bracket as my original buyer, providing interest rates remain the same. While the AMI is the most common index used, it is not the only option. 1) In some areas, the Consumer Price Index may be a better choice, as it tends to track wages more closely than household incomes. It also tends to change more slowly and more regularly than the Area Median Income index does. So if you are striving for a slow steady increase in value, the CPI may be a good option for your program to use. And there are other options as well. Which index you choose should be a function of your programmatic goals and a careful analysis of the historic trends in the various indices available in your service area. It should also be something that is easily accessed and regularly calculated. --- In Coffee Town we decided to use the Area Median Income as our index for our resale formula. We did a quick assessment of the AMI and saw that incomes increased on average 2.2% per year for the past 10 years. That sounds like a nice slow, steady pace. 2) But if we go back 20 years, we’ll see that during the previous 10 years from 1995 – 2004, incomes increased on average 7.7% each year. So as you can see it’s important to look at the historic data and consider where your economy is in an economic cycle before you decide on an index. In Coffee Town, I think the boom is over, and therefore the AMI is not likely to jump as it did two decades ago, so I think the AMI is a safe bet.
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Index Based Formula
Advantages
Calculate the price at any time
Easy to understand and administer
Slow and steady increase
Ties formula price directly to changes in median income
Presenter
Presentation Notes
As you might have guessed, there are some significant advantages to an indexed based formula and they are very similar to those outlined for the fixed rate formula with a few additions. *Click* In addition to those, the biggest advantage in using an indexed based formula is that you can tie the formula price directly to changes in median income. This allows you to ensure your homes remain affordable to your initial target market, providing interest rates do not change significantly.
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Index Based Formula
Disadvantages
Not associated with condition of the home
No incentive for longer term tenure
Disassociated from the market
Risky in falling markets
Sporadic nature of indices
TIP: Limit average annual increase
Presenter
Presentation Notes
One of most significant down sides of an indexed based formula that is quite different from the fixed rate formula is the sporadic nature of many indices. *Click* If you do choose an index like the AMI, it can be sporadic with several flat or even declining years followed by large spikes or increase all at once. The outcome of this is that some sellers receive no increase in value and others can experience a windfall in just a few years. It is possible, however, to mitigate the windfall by putting a cap on the average annual increase in AMI as part of your formula.
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How to choose?
Which formula is best?
There is no one right answer
Local priorities
Local economic trends
One community’s problem = another community’s solution
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Why choose or change your formula?
Considerations…
Based on performance (projected or actual – SIR)
Administrative ease
Homeowners (and staff) understandability
Ability to communicate/quickly calculate value at homeowners’ request
Ability to effectively market homes
Outside factors – quality of the appraisals
Local economic conditions
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What are your concerns?
Presenter
Presentation Notes
Open Q&A
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Quick Poll – Please Respond!
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What does the data tell us?
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Social Impact Report
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Preserving Affordability
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Community Investment
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Resale Performance
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Appraisal-based
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Indexed
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Q&A – and final Poll
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Thinking of changing formulas?
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Need to change your formula?
Case Studies
OneRoof
Community Home Trust
Proud Ground
OPAL
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OneRoof
The issue…
Original formula = 25% of the increase in appraised value of the improvement only
Appraisals consistent but break out of land vs. improvement wildly different
Changed to 20% of the increase in fee simple appraised value
Social Impact Report
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OneRoof
Social Impact Report Excerpt
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Community Home Trust
The issue….
Original formula = 25% of the increase in appraised value
Appraisals wildly inconsistent
Evaluated past resales – increase approx 1.67%/year
Changed to 1.5% compounded annually
Crash of 2008 – prices increasing when market fell
Changed to AMI Index based formula
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Proud Ground
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OPAL Community Land Trust
The issue….
Original formula = Index based – AMI formula
Affluent, retired population meant incomes increased when wages didn’t, also AMI was erratic
Changed to CPI formula
CPI then increased more rapidly than AMI
Goal – slow, consistent increase in value
Changed to 1.675% compounded annually
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Appraisal vs. Fixed Rate
The issue….
Seattle v. Portland
1.5% Compounded Annually v. 25% Appraisal Based
Very similar wealth creation outcomes!
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Resources
Click the links below; they will also be sent out by email.
Join the Resale Formula Evaluation Working Group –applications due by Monday, May 16th. Find out more at cltnetwork.org/resale-formula-evaluation-working-group
Check out the Resale Formula Video Tutorials for on-demand learning about different resale formula types at affordableownership.org/video-learning
See a compiled list of these and other resources at groundedsolutions.org/resale-formula-questions-lets-answer-together
