The first step in creating a market analysis is to define the market area of the subject property. The market area is the most probable geographic area that the subject property will service. The size of the market area is dependent upon the type of property it is and the service it provides. For example, the market area of a convenience store is relatively small. The majority of the customers the convenience store serves typically live in less than a one-mile radius of its location. On the other hand, a larger community center development may include a variety of retail stores and offices that serve an area within around a ten-mile radius.
Typically, the general market area is the smallest geographic area that has publicly accessible economic and demographic data. The neighborhood is the area that includes any major competitors to the subject property. Consider where the subject property’s neighborhood is in the neighborhood life cycle. The life cycle contains four stages. In the growth stage, there is a lot of new construction, and the population in the area increases at an above-average rate compared to other neighborhoods in the area.
At some point, however, the growth rate slows, the neighborhood becomes fully developed, and the period of stability begins. Depending on development trends in the area along with the overall physical characteristics of the improvements, a neighborhood could remain in a relatively stable part of its cycle for a long time. During this period, vacancy rates are stable, and prices generally increase along with the national average.
Eventually, the neighborhood will begin to decline as the economic welfare of the area declines or the real estate begins to fall into disrepair. This stage is characterized by falling property values and high vacancy rates.
Often with some local government intervention, however, the neighborhood undergoes revitalization. Urban renewal or gentrification efforts bring new residents and businesses into a neighborhood in which prices are at their lowest levels. Businesses and residents are enticed into the area by the low prices along with promises of tax breaks. If successful, a neighborhood can begin the life cycle again by transitioning into a new growth phase.
Population trends can help illustrate these changes in the neighborhood. Trends in census data over time help to tell the story of the area. The market analysis should consider the population size, household size, age distribution, marital status, education level, and employment rate for the residents in the area. Population growth is fueled by economic and employment growth. In some areas, however, population growth is fueled immigration or retirement destinations in warmer locations. Population growth of this kind can bring both unique opportunities and challenges into an area, and it is important to consider those long-term implications.
There are many good data sources available for free online to assist with a demographic analysis. The U.S. Census Bureau provides extensive population and demographic data, but the only problem is the gap in the data points, since they only gather data every ten years. The Federal Reserve collects economic and financial data, and the Department of Housing and Urban Development provides access to housing data. Depending on the size of the area and the level of detail needed for the market analysis, private sources of data may be required. There are a variety of companies that provide demographic and economic data for a fee.
| Type of Data | Sources of Data |
|---|---|
| Population size and demographics | US Census Bureau |
| Unemployment rate | Bureau of Labor Statistics |
| Household income | Bureau of Labor Statistics; US Census Bureau |
| Housing prices | FRED economic research; HUD |
| Interest rates | FRED economic research |
| Daily traffic counts | Data.gov |
| Public schools | Data.gov |
| Building permits | Data.gov; Local city offices |
| Commercial real estate sales | Costar; LoopNet |
For example, here are some demographic data comparing the population of Orlando to both the state of Florida and the United States overall. One of the first observations about Orlando is that the population is comparatively young and more likely to speak Spanish compared to other parts of the state and the country. The area is densely populated. The demographic section of the market analysis would include additional data about education, age, and income over time. Growth rates illustrate the dynamic population characteristics of an area.
Population trends are an important component of understanding the real estate market in an area. Specific demographic groups have shopping preferences that can influence retail development. Populations with an older average age may need more office space and medical facilities. Areas with young or transient populations may need more of the overall housing supply dedicated to apartments and condominiums.
In addition to analyzing the population and economics of the market area and neighborhood, it is important to analyze the competition. What other properties in the area are supplying the space market for a particular property type? Find out what rental rates competitors charge and their average vacancy rate. Consult the public records in the area to find if there are any permits for new construction in the area that will also change the current supply levels and create additional sources of competition for buyers and tenants.
Organizations such as the Urban Land Institute publish statistics such as the typical retail sales per square foot across the country. After researching the typical per capita sales or per capita demand for the subject property type, research the current sales volume and rents for competitors in the market area. The population data forecasts expected demand based off growth expectations. The current real estate data show whether the existing supply of real estate is less than, greater than, or matching the current and projected national average sales or demand per square foot of space. Although the influences on supply are generally the same across property types, the demand influences can differ across commercial property types.
For instance, consider and example neighborhood with a population growth rate of a steady 3%, and a projected population of around 27,500. Multiply that population by the national forecasted per capita sales in the next year. If projected per capita sales for a specific type of retail store was $175, sales demand in the area would be $4,812,500 next year.
Then, divide that sales demand by the typical sales per square foot for similar stores around the country. If the average store had typical sales of $140 per square foot, that would equal a square footage demand in the area of 34,375 square feet. Consider whether the market area currently has less than or greater than that amount of square footage devoted to serving this demand. If demand is greater than the current supply, current owners may earn higher than average per capita sales, but there is also room for the market to absorb additional supply of real estate. If demand is less than current supply, the market tends to have lower than average sales and rents along with higher than average vacancy rates. Population demographics also determine suitable absorption rates for new developments, which is the length of time it takes to reach a stabilized occupancy level for a new commercial property.
The multiplier effect describes the propensity for economic activity to lead to job growth, population growth, and rising income levels in a region. This is why a real estate market analysis needs to include information about the population and the industries that create the local economy. In general, the higher the skill and education level requirements of the industry, the greater the multiplier effect is on the local economy. For that reason, areas with a strong technology presence are considered to benefit the most from the multiplier effect. Industries that require relatively low skill and low levels of education also have the lowest multiplier effects. Forecasting potential growth in the demand for particular types of real estate should consider the impact of economic growth in local industry along with its propensity to create new jobs and higher income for the region. The multiplier effect models changes in aggregate demand caused by cash injections into the local economy.
The intensity of the multiplier effect is represented by the change in real GDP divided by the change in the amount of cash injected into the economy.
Multiplier (k) = change in real GDP / change in cash injections
In a simple economy, the multiplier can also be represented as a function of the population’s marginal propensity to consume and marginal propensity to save. Where the marginal propensity to save is 10% and marginal propensity to consume is 90%, the multiplier effect is 10.
k = 1/marginal propensity to save = 1/.1 = 10
k = 1 / (1-marginal propensity to consume) = 1 / (1-.9) = 10
For example, a cash injection of $100,000 into the economy gets paid out as wages and then spent in the local economy on goods and services. Local businesses then pay that money out as wages, which in turn results in more spending on goods and services. If the multiplier effect is equal to 10, it means this $100,000 additional cash injection ultimately results in $1,000,000 of effective income into the region.
Although the idea of Tobin’s q was originally established to describe a firm’s decisions regarding investment in capital assets, the theory can be expanded to describe investment in real estate. The original equation for Tobin’s q was:
Tobin’s q = market value of reproducible real capital assets/current replacement cost of assets.
In real estate, the cost of reproduction is defined by an appraiser’s cost approach to valuation. So, Tobin’s q can be generalized to apply to real estate assets using the following equation:
Q = market price of existing real estate/cost of land + improvements’ construction cost.
Applying this theory to real estate and urban development, the market has the capacity to absorb additional supply if the construction is creating additional value. Mathematically, this is true any time q>1. When this is true, developers have the ability to earn enough profit to make new construction projects financially feasible. When that new inventory becomes available on the market, however, the market value of similar real estate assets will fall until the demand grows to meet the new supply. When market prices decline due to the new supply, the value of Tobin’s q also decreases. So, Tobin’s q is a useful tool for evaluating current supply and demand conditions for real estate market segments and the impact new development has on the current space market.
In this article, we briefly outlined at a high level the steps taken to complete a real estate market analysis. The first task is to define the market area, which is the geographic area a property is expected to service. Then, we discussed how and where to gather relevant market data for a property. And finally, we discussed supply and demand factors to consider, including the multiplier effect and Tobins q. Real estate market analysis is a complicated subject, and this article gives a high-level overview on how to get started.
Source: Getting Started with Real Estate Market Analysis
https://www.creconsult.net/market-trends/getting-started-with-real-estate-market-analysis/
A real estate market analysis contains a few basic sections, and each provides key information needed for analyzing the valuation and financial feasibility of any real estate investment. The first section defines the area under consideration. Defining the area is more than just finding the lot boundaries but involves defining the size of the target market most likely to generate income. Accurately defining the target market and neighborhood allows the investor to identify competition and the current supply to meet current demand in that area.
The second section contains a thorough analysis of the physical and environmental factors impacting the real estate. Physical factors include things like location, natural resources, topography, soil conditions, climate, water availability, and transportation patterns. At first glance, some of these factors may not seem terribly important to analyzing the profitability of a real estate investment. In some cases, however, the community’s location next to an ocean or pleasant climate could be an integral part of the community’s economy, industry, and desirability. It would be impossible to fully understand the community dynamics without an appreciation of these physical characteristics.
In addition to these physical factors, the market analysis may also include more information about the neighborhood features. Often, this includes detailed information about the neighborhood’s access to public goods and services. The access to and quality of public utilities can be extremely important to commercial real estate development. Real estate developers must consider whether or not a particular parcel of land has sufficient access to utilities as well as whether those utilities are capable of meeting the additional servicing demands of the new development. If not, the developer must convince the local government to invest in upgraded utility services to the area. So, the availability of adequate utility services and construction costs should not be overlooked since they can ultimately determine the feasibility of any real estate project.
After addressing the physical factors of the location, the market analysis evaluates the economic characteristics and trends in the area. The purpose of this economic analysis is to provide an understanding of the underlying population, business conditions, and the future demand for a particular type of real estate. Trends in demographic data provide some insight into the future economic health of a region. For example, a growing population is generally a good sign of economic prosperity in a region as long as there are growing job opportunities for the residents. Population age distribution, education, and income are also important indicators of regional growth patterns.
Broader economic trends in the region as well as at the national level should also be addressed in the market analysis. Although all real estate is local, larger, macroeconomic forces have ripples throughout all local markets. As a result, interest rates, current and proposed changes to tax policies, inflation, GDP growth, and unemployment rates need to be analyzed in a market analysis. All of these factors play an important role in the growth or decline of the economic base surrounding the subject property. The CCIM institute has a nice demand cycle flow chart that puts all of this together:
Investigating other new construction in the area should also be part of a market analysis. Searching for building permits can be an excellent indicator of past development as well as new supply that will be on the market in the future. New construction is a signal that a neighborhood is considered desirable, but it can also be a source of competition for tenants or buyers. Other issues related to construction are zoning and development requirements for a new construction. The market analysis should investigate the zoning and building regulations as well as the timeline, costs, and attitude of the local planning board. These three factors alone can determine whether or not a real estate investment is financially feasible or not.
Overall, the market analysis should provide a comprehensive picture of the subject property, location, neighborhood, and the larger market economic drivers. The final document should allow the reader to understand the current supply and demand conditions for this particular type of real estate as well as a picture of how these conditions may change in the future. It should also provide conclusions about the changing demographics and regulations in the neighborhood and how those factors as well as economics could impact the subject property.
Not only is a thorough market analysis necessary to understand the outlook for a real estate investment, but also, it is critical to creating the real estate proforma. Proforma forecasts are simply a best, educated guess about future performance. In order to make an educated estimate, however, the investor needs a lot of background information about the market. All of this information comes from the market analysis.
For example, consider the top line in a real estate proforma. Potential Rental Income is an estimate of the maximum rent an owner could obtain at 100% occupancy. Forecasting potential rental income requires a forecast of expected future rental rates that owner can reasonably attain. An investor could simply assume a fixed annual growth rate based on past experience. A more accurate estimate of future rental rates, however, involves an analysis of current supply as well as future supply that may be entering the market. Future demand estimates involve understanding the desirability of the location relative to neighboring areas, growth patterns and traffic patterns in the area, population growth and demographics, and overall health and stability of the neighborhood’s economic base. All of these items are components of the market analysis.
The next item on a proforma accounts for vacancy. Again, it is possible for an investor to use a fixed vacancy rate every year in the analysis. Unfortunately, it is not always realistic to assume vacancy rates will never change. The expected vacancy rate is a function of future supply and demand conditions that are generated through an analysis of current available space and expected new construction, relative market pricing, and demand generated by the economic base of the area. So, any meaningful forecast of vacancy rates requires a thorough market analysis.
Estimating future operating expenses also requires an understanding of the current market costs and how they will change over time. These changes relate back to the fundamentals of the local economy and industry as well as national macroeconomic trends. The information contained in the market analysis can help determine appropriate growth rates for operating expenses.
The bottom-line net operating income gets put into a variety of valuation and feasibility models. One of the common methods for discounting net operating income to quickly generate a valuation is by using a market capitalization rate. The market capitalization rate is a measure of how buyers discounted net operating income to value nearby comparable properties. Finding the most appropriate comparables is one more component of the market analysis. So, from start to finish, the proforma and valuation models rely on the data contained in the market analysis.
Real estate investors should never purchase a property without conducting a thorough and detailed market analysis. Although the process of researching the location, the local market, and the larger economic influences on the population and property is time-consuming, its importance should never be overlooked. Investors don’t want to put money into an asset that will not earn a target rate of return over their anticipated holding period. Making projections and decisions without the benefit of a detailed market analysis adds unnecessary risk into an investment analysis or feasibility analysis. Not paying proper attention to the market fundamentals that generate cash flows can cause significant error in the proforma financial statements. Unfortunately, these errors could cause investors to select projects that will not end up meeting their target rate of return. Alternatively, investors could also overlook a property that does have the ability to earn a target rate of return due to errors in their cash flow forecasting model.
Source: Why Is Real Estate Market Analysis So Important?
https://www.creconsult.net/market-trends/why-is-real-estate-market-analysis-so-important/
To a developer, affordable housing means lower rents than a market-rate project, lower net operating income, and thus lower returns on their investment. Accordingly, without any outside incentive a developer has little motivation to build affordable housing.
Unfortunately, the need for affordable housing is significant. According to the National Low Income Housing Coalition, “in 2013, for every 100 extremely low income renter households, there were just 31 affordable and available units.” The Coalition then noted, “in no state can an individual working a typical 40-hour workweek at the federal minimum wage afford a one- or two-bedroom apartment for his or her family.”
Recognizing the need for affordable housing, and the fact that few developers would pursue these projects when market-rate developments offer a higher return, the federal government looked for ways to make affordable housing projects financially attractive to developers. The Low Income Housing Credit (LIHTC) program is one of those ways.
This article details how the program works, including:
Let’s start with the big picture.
The LIHTC was created as a part of the Tax Reform Act of 1986, is found in Internal Revenue Code § 42, and was designed to incent developers and investors to create and operate affordable housing. Under the program a developer receives federal income tax credits over a 10-year period in exchange for (i) acquiring, rehabbing or newly constructing rental housing for low-income households, and then (ii) operating the project under LIHTC guidelines for a certain compliance period.
Unlike a tax deduction, which only reduces taxable income, the LIHTC credits offset dollar-for-dollar a party’s tax liability.
Developers sell the right to use these credits to investors who want to reduce their federal taxes. The investor’s payment for such right, its “capital contribution” to the project, reduces the developer’s need to use other financing. This then reduces the developer’s debt-service costs, allowing the development to be financially appealing even with below-market rental income. This formula has been successful in attracting private dollars to create affordable housing.
According to the U.S. Department of Housing and Urban Development (HUD), as of 2016 the LIHTC program was authorizing the use of $8 billion in tax credits annually, and has resulted in the creation of approximately 2.8 million affordable housing units.
As with all development, the opportunity to create affordable housing doesn’t always present itself in the same manner. Sometimes a developer has to build a project from scratch. Sometimes they find a suitable existing building, but need to acquire and modify it to accommodate rental units. And sometimes a developer owns an existing building, but needs to rehabilitate it to offer affordable units.
The LIHTC can be used for all three situations: new construction, acquisition and rehabilitation, and rehabilitation of a property already owned by a developer.
It should be noted that LIHTC can also be used to preserve projects funded or supported with other affordable housing programs, including, for example Federal Housing Act (42 U.S.C. § 1437f) Sections 8 (Rental Voucher Program), 236 (Rental Assistance Program), 221(d)(3) (Rent Supplement Program), 202 (for elderly households), 515 (for rural renters) and 514/516 (for farm workers).
Although the credit was authorized by federal law, and reduces federal tax liability, the federal government has put the administration of the program in the hands of the states. Each state has created a housing finance authority (HFA) that allocates credits to developers, administers the state’s criteria and bidding process for projects, and monitors developer compliance with program regulations.
A state’s criteria and regulations are set out in its Qualified Allocation Plan (QAP). While the QAP must contain certain federal law provisions, these provisions are viewed as minimums, and the states’ rules may be stricter. Additionally, a state’s QAP establishes a prioritization for the types of projects it wishes to incent. Although the goal of the LIHTC program is to create more affordable housing, each state’s housing needs are different, and their QAP priorities reflect this. For example, in Colorado, the state will generally grant credits to new construction projects before awarding them to acquisition and rehab projects.
By allowing states to create their own priorities, not only can a state address its unique housing needs, but it also encourages developers to commit to more than the minimum federal requirements. For example, if a state prioritizes new construction projects over rehabs, a rehab developer may still be able to move up the priority ladder if it offers other desirable commitments like lower rents, a higher percentage of affordable units, or that the low-income units will be available for a longer period. Of course, such factors are specific to each state’s QAP.
That being said, even though there is significant flexibility in what a state’s QAP may include, the program does require that a QAP’s priorities serve the lowest-income households for the longest period of time and that at least 10% of the credits awarded must be given to projects with non-profit developers.
To see an example of a state’s plan, take a look at Missouri’s 2015 QAP.
Because a state is allocated a limited number of credits, and the amount of credits sought by developers almost always exceeds the allocated amount, the award of credits is highly competitive. How does a developer make their project more attractive to a state, and thus more likely to receive credits? Look at the state’s QAP.
The first step in the program is the federal government’s allocation of credits to each state. The allocation is determined according to a state’s population and an annually determined percentage multiplier. Because populations change, and the percentage multiplier changes, the allocation amounts change each year.
For example, the percentage multiplier recently increased from $2.30 to $2.50. What was the impact on a single state? Well, between 2015 and 2016 the population of California grew from 39.15 million to an estimated 39.35 million. Accordingly, the credits allocated to this would increase as follows:
An increase in credits available to California affordable housing projects of $2.42M.
Note though that in order to protect small-population states from receiving very low credit allocations, there is a minimum allocation amount (currently that amount is $2.69M). For example, in 2015 Wyoming’s population was only 0.59M (as compared to California’s 39.15M), and would have, without the minimum protection, received only $2.30 x 0.59M = $1.36M in tax credits to award.
The general sequence of events in an LIHTC project involves a developer:
Additionally, as a developer is preparing its initial proposal, it typically engages in negotiations with investors to purchase the credits if the project is approved.
As mentioned above, investors make a capital contribution to a LIHTC project in exchange for the right to use the credits to offset their tax liability. In order to do so, the investor must join in the ownership of the project, typically through the formation of a limited liability company (LLC) or a partnership with the developer.
The investor purchases a share in the partnership, typically approaching total ownership (e.g., 99%). This is done because the greater the investor’s ownership share, the greater its ownership of, and right to use, the LIHTC credits. The developer also wants to grant this near-total ownership because the more credits the investor can claim, the greater the contribution the investor will make.
Of course, an investor won’t buy credits unless it is profitable to do so. Accordingly, their capital contribution is less than the total amount of credits. To determine what contribution is appropriate, the developer projects the total credits its project is expected to generate, multiplies that amount by the investor’s partnership share, and then applies a discount rate agreed to by the parties.
In an example below, a developer projects its total credit as $450,000. If the investor’s partnership interest was 99%, and the parties agreed to a discount rate of 80%, the investor would make a capital contribution of $450,000 x 99% x 80% = $356,400. The difference between the total projected credits and the contribution to buy the credits is one of the investor’s primary motivations to make the deal: it is the investor’s profit (in this example the spread is $450,000 – $356,400 = $93,600).
Additionally, an investor will require a discount to reflect the time value of money. If the projected total tax credit was $1,000,000, an investor wouldn’t pay $1,000,000 up front for credits they could only claim $100,000 a year (recall that the LIHTC tax credits awarded are claimed over 10 years). All of this is to say that an investor’s capital contribution will be for some amount less than the credits reserved for the developer.
As an aside, an investor doesn’t have to make a single up-front contribution. Often, in order to maximize its profit they will make multiple contributions over time as certain project milestones are met. As with the discount rate, the number and timing of payments are terms negotiated between the developer and investor.
Lastly, while many investors are individual institutions (e.g., a bank), a developer may market their credits with the aid of a syndicator. Syndicators combine multiple projects into a single fund, and then offer shares in the fund to individual investors.
A developer’s application will include not only a project description and estimate of its cost, but also an election of one of two “set-aside” conditions. The set-aside chosen dictates (i) the percentage of units and square footage the developer commits to renting to low-income tenants, and (ii) the level of income of those tenants. The two set-aside options are referred to as the 20% at 50% and the 40% at 60%.
If the developer elects the 20 at 50, it’s committing to renting 20% of its below-market rent units to residents whose income is no greater than 50% of the area median gross income (AMI). Similarly, if the developer elects the 40 at 60, then 40% of the rent-restricted units must be occupied by residents with incomes no greater than 60% of the AMI. It should be noted that these percentages are federally required minimums, and states are free to require higher set-asides.
Because these percentages are used in the calculation of the tax credits granted to developers, many choose to increase the percentage of low-income units to maximize credits. A simple example is helpful: If two projects are identical, and Project A commits to 50% low-income units while Project B commits to 100%, Project B will be eligible for twice the amount of credits. And the greater the amount of credits, the greater the investor contribution, and the more profitable the project.
However, because states are allocated a limited amount of credits, in order to ensure the cumulative credits awarded to all developers doesn’t exceed the federal allocation, states often limit the maximum percentage of affordable units each developer can provide. Once the state and developer agree on a set-aside commitment, the percentages are memorialized in the project agreement.
Whichever set-aside option is chosen, the developer must meet it within the first year of the 10-year credit period, and maintain it for the entire compliance period, or else lose its credit eligibility.
Many LIHTC projects include a mixture of rent-restricted units for low-income households and market-rate rental units. While there is no restriction on the amount a developer can charge for market-rate units, as to the affordable units, rents can’t be more than 30% of the income ceiling below which tenants are eligible for a low-income unit. This income amount is either 50% or 60% of the Area Median Income (AMI) depending on whether the developer committed to the 20 at 50 or 40 at 60 set-aside.
Note that the low-income rent isn’t based on an individual tenant’s income, but rather on the 30% ceiling. An individual tenant’s income is relevant only to (i) determine if they initially qualify as a low-income tenant, and (ii) determine if the developer needs to make more affordable units available if the tenant’s income increases.
If a low-income tenant increases its income up to 140% of the income limit, it may still stay in the unit at the below-market rate with no other consequences to the developer. However, if its income rises to more than 140% of the limit, then the “next available unit rule” comes into play.
Under this rule the developer must rent the next available unit (of comparable size or smaller) to a new low-income qualified tenant at the below-market rate. This is done because the program wants to encourage low-income tenants to increase their incomes (which may not occur if they knew a higher income could cost them their below-market rent), while at the same time still making the same number of units available to low-income households.
Once a project is built, the LIHTC property must comply with all LIHTC and project agreement terms for a 15-year compliance period. If the property falls out of compliance, investors can be subject to the recapture or loss of credits, including credits that were claimed while the project was still in compliance. For example, if non-compliance occurred in Year 14, credits in Year 1 may be subject to recapture.
Following the initial compliance period, a project operates under an “extended use period” (EUP) of at least 15 years (states’ QAPs may require a longer EUP, e.g., California has a 55-year EUP). During this period the project must continue to provide affordable housing, but the definitions of affordable housing and compliance may differ from the definitions required during the initial 15-year period. Such definitions and other terms are negotiated and included in an EUP agreement between the state and developer.
The LIHTC program also allows a developer the opportunity to sell the project following Year 14. To do so, the developer asks its HFA to find a buyer that will continue to operate the project as an affordable housing project through the full compliance and extended use periods.
If such a buyer is found, the developer can sell them the property. If a buyer is found, but the developer refuses to sell to them, then the developer must continue to meet its LIHTC obligations through the full period. Lastly, if the HFA can’t find a buyer, the developer is released from LIHTC requirements. However, as a condition to awarding tax credits, many states require developers to waive this right to request a sale.
How much a developer receives in credits involves the consideration of (1) the investment the developer made in the project, (2) the percentage of low-income units it creates, (3) type of project (i.e., acquisition and rehab, new construction, or rehabilitation of a developer-owned property), and (4) whether the project is also funded by tax-exempt, private activity bonds.
The first step is looking at the developer’s investment, or its “eligible basis.” The eligible basis is the total depreciable costs of completing the project, such as the cost of acquiring and rehabbing an existing building or constructing a new building. Additionally, certain soft costs related to the project, such as architectural, engineering, legal and reasonable developer fees, may be included in the eligible basis. Notably, because the value of land is not depreciable, land acquisition costs cannot included in the eligible basis. Further, if the developer receives a federally funded grant before its compliance period starts, then the developer’s eligible basis is reduced by this amount.
A quick example: Developer buys an existing building for $1M, of which $200,000 is attributed to the purchase of the land. It then spends $1M on construction hard costs, $100,000 on architectural, engineering and legal fees, and pays itself a $300,000 developer fee. Under the state’s QAP, the maximum developer fee for a project of this size is $200,000. What is its eligible basis?
Its total project costs are:
But only the following costs are included in its eligible basis:
Once the eligible basis is determined, it’s multiplied by the percentage of low-income units (calculated at the end of the project’s first year under the program) to determine the project’s “qualified basis.” Let’s look at an example where a developer applies for tax credits for two buildings.
If Building 1 had an eligible basis of $500,000 at the end of Year 1, and was to be 100% affordable units, its qualified basis would be $500,000 x 100% = $500,000. Whereas if Building 2 with a $1M eligible basis at the end of Year 1 was to house only 40% low-income qualified tenants, its qualified basis would be $1M x 40% = $400,000.
The next step in determining the projected amount of annual tax credits is multiplying the qualified basis by the applicable tax credit percentage. The applicable percentage depends on the type of project and whether it is receiving other federal subsidies.
A 9% credit percentage is available for new construction or rehabilitation projects, so long as it isn’t also funded with tax-exempt, private activity bonds. The 9% credit is designed to compensate the developer for 70% of the building’s qualified basis over the 10-year credit period (sometimes referred to as the 70% subsidy). So how does 9% x 10 years = 70%? Good question. It doesn’t.
And why not?
Let’s ask the Congressional Research Service (CRS) (they’re the folks who prepare explanatory materials for members and committees of Congress):
“The so-called 9% credit is generally reserved for new construction. Each year for 10 years a tax credit equal to roughly 9% of a project’s qualified basis (cost of construction) may be claimed. The applicable credit rate is not actually 9%; instead, the specific rate that a project will receive is set so that the present value of the 10-year stream of credits equals 70% of a project’s qualified basis. The formula used to ensure the 70% subsidy is achieved depends in part on current market interest rates that fluctuate over time. These fluctuations have also caused the LIHTC rate to change over time. Since 1986, the 9% credit has ranged between 7.89% and 9.27%.”
A quick aside: to qualify for rehabilitation credits, a developer must meet certain spending requirements, including (1) spending at least $6,500 rehabbing each affordable unit, or (2) spending at least 20% of the building’s adjusted basis, whichever is greater.
A 4% credit percentage is available for the acquisition of an existing project, and for those new construction and rehabilitation projects that are funded in part with tax-exempt bonds. If no bonds are involved, such new construction and rehabilitation projects would otherwise be eligible for the 9% credit percentage. The 4% credit is designed to compensate the developer for 30% of the project’s eligible basis over the 10-year credit period (sometimes referred to as the 30% subsidy).
As with the 9% credit, the CRS explains why the 4% credit is not actually 4%:
“Like the 9% credit, the 4% credit is claimed annually over a 10-year credit period. The actual credit rate fluctuates around 4%, but is set by the Treasury to deliver a subsidy equal to 30% of a project’s qualified basis in present value terms. At one point, the 4% credit rate had fallen to as low as 3.33%. For both the 4% and 9% credit it is the subsidy levels (30% or 70%) that are explicitly specified in the Internal Revenue Code (IRC), not the credit rates.”
As the 9% and 4% credits aren’t fixed at 4% and 9%, but rather float monthly with interest rates, an applicant will lock in a credit percentage during the allocation process based upon the then-current rate.
Continuing our sample scenario, if Building 1 was the construction of a new building, and not funded by tax-exempt bonds, its projected tax credits for Year 1 would be the qualified basis x the applicable tax credit percentage: $500,000 x 9% = $45,000. If Building 2 was the acquisition of an existing building, its projected Year 1 credit would be $400,000 x 4% = $16,000.
To project the total tax credits available for each building, the Year 1 amount is simply multiplied by 10 to reflect the program’s 10 years of credit eligibility. Accordingly, the total credits available for Building 1 is the Year 1 credit of $45,000 x 10 years = $450,000.
The developer makes the above calculation based on its expected costs and percentage of low-income units, and then includes its projected credit amount in its application to the HFA. The actual credits awarded, however, are based upon the actually certified eligible costs and actual low-income unit percentages.
When an application is approved by the state, it reserves the amount of projected credits for the developer. This amount then reduces the amount of credits it can award to other developers. For example, if both Buildings 1 and 2 are approved, the state will reserve $450,000 + $160,000 = $610,000 in credits for the developer. If the project was in Wyoming (which receives the minimum $2.69M credit allocation from the federal government), then the state would have $2.08M in remaining credits to award to other projects.
Following the construction/rehabilitation and lease-up of a building, the developer submits a placed-in-service certificate to its HFA showing that it has complied with its application and project agreement. The certificate typically includes such items as the qualified costs actually incurred, construction and design agreements, and the percentage of units reserved for low-income qualified tenants.
If the HFA approves the certificate, it sends the developer an IRS Form 8609 authorizing the use of the credits. Under the agreement between the developer and investor, the credits are then claimed by the inventor on its federal tax return, offsetting its taxable income.
The LIHTC program has successfully attracted private equity to affordable housing projects, and increased the number of units available to low-income households. However, receiving the program’s tax credits, and staying in compliance with a state’s requirements is not a simple endeavor. Accordingly, if you have any specific LIHTC issues, please talk with a lawyer well versed in the intricacies of the program.
Source: A Complete Guide to the Low-Income Housing Tax Credit Program
https://www.creconsult.net/market-trends/a-complete-guide-to-the-low-income-housing-tax-credit-program/
Multifamily sellers: How to qualify a buyer before going under contract
As the seller of a multifamily asset, it’s crucial that the buyer you select is the best possible prospect for your property. Don’t waste time, money, and opportunities: you must ensure they’re qualified and can close and execute the contract as signed.
Keep reading to learn why it’s essential to qualify a buyer before going under contract on your multifamily property and how to do it.
Why do I need to qualify a buyer?
It’s important to close with the first buyer you select. If you don’t, each buyer after that will ask themselves, “What did that other buyer discover about this property that I am missing?”.
When you enter into a contract with a refundable deposit, you’re basically giving your chosen buyer a free option on your property for a period of time, typically 30–60 days. Before you proceed, you must be confident that they can close and execute the contract as signed.
What’s more, your tenants and staff will be disturbed throughout the contract process. To minimize the period of disruption, you should do all you can to ensure the transaction will close successfully at the end of the contract process.
As a seller, you’re required to provide due diligence information to the prospective buyer. When you qualify your buyer, you’ll greatly reduce the risk of wasting a lot of time and doing a lot of work only to not close on the property.
How do I qualify a buyer?
Before you sign the contract, make sure that your prospective buyer can provide certain items. Always ask them for the following:
– Proof of funds
– Lender pre-qualification
– A list of the other properties they own
– A list of the sellers and agents that they have worked with
For added reassurance, it’s recommended that you call the buyer’s lender to confirm their pre-qualified status. You can also call the agents, sellers, and buyers they’ve closed with in the past to enquire about how the transactions went.
Has the buyer toured the property in person before making an offer? Have they reviewed the due diligence information beforehand? If they have, this is a great sign. It’s proof that they have seen and have taken into account any issues with your property, and this greatly reduces the chances that they may later want to back out of the sale, saying they were unaware of the building’s condition. Be very wary of a buyer who doesn’t tour your property in person.
A prospective buyer who shows they’re motivated and wants to move quickly is also a great sign for a successful closing. The shorter the due diligence period, the better, and the larger the deposit, the better.
When you spend the time making sure your prospective buyer fulfills these criteria, you’ll put yourself in a great position to close successfully and ensure a quick and smooth transaction.
If you need help selling your multifamily property, eXp Commercial is here. Our objective as your multifamily advisor is to help you achieve your investment goals: from determining the listing price to selecting the best buyer and handling the sale process through to the closing, we’ll facilitate a smooth transaction for you.
Source: Multifamily sellers: How to qualify a buyer before going under contract
https://www.creconsult.net/market-trends/multifamily-sellers-how-to-qualify-a-buyer-before-going-under-contract/
