The Tricky Economics of Affordable Housing

According to the United States Department of Housing and Urban Development (HUD), today there is nowhere in the U.S. where a full-time, minimum wage worker can afford the local fair-market rent for a two-bedroom apartment.[i] Communities across the nation are reporting high levels of evictions, homelessness, and a lack of affordable housing.

So, let’s talk about affordable housing.

Affordable housing means different things depending on if you are an investor, property manager, tenant or government agency. For me, a commercial appraiser, affordable housing represents complex property types with a myriad of funding, ownership, and rental structures that require careful consideration to define property values, fair market rents, or physical conditions. Or put more simply, affordable housing can be very complicated!

And lining up the financing for affordable housing can seem more insurmountable than trying to convince your wife Valentine’s Day is a made-up holiday– what’s the point in even trying? There are several available sources of funding including bank loans, municipal loans, Low-Income Housing Tax Credits (LIHTC), Community Development Block Grants, tax abatements, and other local subsidies or support provided by Community Development Corporations, and other specialized subsidies, tax credits and financing such as assistance by the USDA Rural Development Office (in rural areas).

While there are a lot of possible funding sources, there are often not enough to cover the development costs and it can be tricky to qualify or take a long time to get approved.

As a commercial appraiser, I understand the financial hurdles overcome by developers and providers of affordable housing and in my work, I strive to support the financial well-being of these developments in several ways:

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Small Business

Shortly after becoming a MAI designated appraiser, I founded FRG. The firm was built on a client base of strong regional financial institutions who needed quality commercial real estate appraisals for their loans and portfolio management. For a good three or four years that client base grew as banks provided loans to small businesses that were seeking to expand their own business. However, there has been a shift over the last twenty-four months, and I have noticed a flattening and decline of financial institution business lending.

I can’t say with 100% certainty the reason for the decline, as there is no one single reason for this shift. However, over the last couple of years I have observed some bank lending trends:

Shifting Geographic Focus to High Growth Markets
Several banks that previously held a strong presence in the Midwest have shifted their focus to higher growth areas on the east coast. One such bank is First National Bank of Pennsylvania; in 2015 and 2016 they stated that the Cleveland and Pittsburgh MSAs were focus areas for growth. However, as we moved into 2017 and 2018, their focus shifted to the mid-Atlantic and Southeast. First National Bank confirmed this shift in their 2017 Annual Report, stating that Raleigh, Charlotte, Winston-Salem, Greensboro, High Point, NC and Washington, DC joined Pittsburgh, Baltimore and Cleveland as the bank’s largest commercial regions .

Prioritizing Mid-Cap Companies over Small Businesses
Banks have been shifting their lending to mid-cap companies instead of lending to small businesses. A reason for this shift could be because it is more difficult to package loans under $1M into bonds that can be sold to a third party.

Bank Consolidation and Banks Getting Larger
In the past two years, there has been a great deal of bank consolidation. For example:

• The largest bank headquartered in Michigan, Chemical Financial Corporation acquired Talmer Bank, a less than 100 branch bank also headquartered in Michigan and recently announced a merger with Minnesota-based TCF Financial Corp resulting in the bank becoming one of the 50 largest banks in the country.
• The second largest originator of SBA loans for the state, Columbus, Ohio-based Huntington National Bank acquired First Merit Bank of Akron, Ohio

The Federal Reserve Bank’s Small Business Lending Survey reported that in the third quarter of 2018, there was 1.4% growth in large institution loans for commercial & industrial small business, while mid-sized and small banks decreased their loan activity by 4.2% and 1.5%, respectively. Smaller banks are more likely than large banks to lend to small businesses. Therefore, the consolidation of the banking industry, and the rising average size of lenders, might account for some of the shift away from providing small business credit. According to the Federal Reserve’s Small Business Lending Survey, small banks offer lower interest rates on fixed rate terms loans than large banks, meaning small businesses may be able to secure more favorable loan terms from a smaller bank as well.

These shifts in lending make it hard for a small business seeking funds to expand, buy equipment or secure a building to accomplish their goals. So where can these small businesses turn? Many businesses look to the federal and local government to secure loans when financing is unavailable or too expensive elsewhere.

One example of this is the SBA 7(a) loan program, which is the SBA’s flagship loan program.  Proceeds from 7(a) loans may be used to start a business or assist with operations, acquisition or expansion of an existing business. These loans can offer more “flexibility, longer terms and potentially lower down payments compared to other financing options.”[i]  The average 7(a) loan is ~$420,000. In 2015/2016 there was a peak in both the number of 7(a) loans and the dollar amount loaned to businesses nationwide and since 2016, the number of approved loans has declined across the US.

 

In the last six years in the Midwest, SBA loans have increased. However, these states diverge from the national trends with increasing dollars loaned since 2015. Ohio holds the lead in total dollars loaned, reaching over $930 million in loans approved for the FY2018.

 

Added barrier for small business success: 2019 Government Shutdown

For small business across the United States and particularly those located in the Midwest, SBA loans are critical to support business operations and growth. Unfortunately, the recent government shutdown resulted in many businesses unexpectedly losing out on funds or not being able to obtain the finances they need. For small businesses to succeed, they need to be able to plan for growth. This means being able to reliably pay for and invest in that growth. As a fellow small business owner, I understand how important access to capital can be – and as I have observed the shifts mentioned above in financing options for small businesses, it is more important than ever that political differences be put aside and we keep the government open to ensure needed funds can get into the hands of business owners.

FRG wins contract with the Northeast Ohio Regional Sewer District

Feasibility Research Group (FRG) has been selected to provide Appraisal Services for the Northeast Ohio Regional Sewer District.

University Heights, OH (January 4, 2019) — FEASIBILITY RESEARCH GROUP (FRG) a real estate appraisal, market research and consulting firm based in Northeast Ohio, has been selected for Appraisal Services with the Northeast Ohio Regional Sewer District.

The Northeast Ohio Regional Sewer District (NEORSD), requires professional appraisal services to support its property acquisition activities.  The NEORSD programs that FRG will support include the development of various tunnel, collection sewers, plant upgrades, and green infrastructure components, which will result in a variety of real estate and property impacts.

“FRG looks forward to supporting the development of critical infrastructure with NEORSD” said Gregory Williams FRG‘s Managing Director. “Accurate and timely real estate transactions or valuations from FRG can assist NEORSD in providing superior service to Northeast Ohio residents.”

Appraisal consultants with NEORSD are selected to provide property appraisal, appraisal review, and expert witness services, depending on the needs of each individual project. As an appraisal firm experienced in working with Right of Way projects for public entities, FRG’s managing director is pre-qualified with the Ohio Department of Transportation for acquisition services specifically for value analysis, appraisal, appraisal review and title research.  FRG understands the unique challenges or potential issues that may arise during the public right-of-way acquisition process and will ensure NEORSD complies with the most current regulations and procedures.

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Supporting Adjustments with Market Data

Appraisers are analysts, problem solvers, and decision makers who need to make a professional and informed opinion of the value of a property as well be able to communicate their decision-making process. One of the most important aspects of an appraisal is the integrity of the data and decision-making used.  Appraisals must explain clearly why adjustments are being made and clearly state the reasoning for how the adjustments are being made.

Here’s a look at the process FRG requires to validate adjustments when comparing properties in a residential appraisal:

Why?

An adjustment is needed when there is a difference between the property being appraised and a comparable property that would impact the sale or rent price

  • Differences that require adjustments to value include building size, number of rooms, condition, parking, or amenities like pools or fireplaces

How?

An adjustment provides an estimated dollar value of the difference

  • Appraisers must explain the reasoning behind that specific dollar value; what makes an adjustment worth a specific amount in that market?

Simply stating that an appraiser is experienced and therefore knows how much things would sell for is not an accepted justification for adjustments in sale price. Every appraiser has their own unique perspective and bias, and it is the responsibility of that appraiser to create as objective and informed an opinion as possible.

How can appraisers remove themselves from the process and create a reasoned explanation for differences in sale prices? Here is an example:

A single-family home with 1 bathroom in a suburb is being appraised, and a sale comparable has 1.5 bathrooms. The appraiser believes buyers in this market recognize the value of an additional half-bathroom. An adjustment will need to be made, but for how much?

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Growth on the Lake: The Power of Green Technology

Over the last couple of years Cleveland has really done a lot to change outsiders’ perception of the city. No longer is the city referred to as the ‘Mistake on the Lake’. In fact, recently I was on an Amtrak train traveling from Washington DC to Baltimore, and in the seat pocket was “The National”, Amtrak’s onboard magazine. And on the front cover of the National was a gorgeous plate of food and the caption “Next Stop: Cleveland – A booming food scene is helping this postindustrial city shake off the rust”. The six-page cover story featured Cleveland’s hippest neighborhoods, celebrity chefs and their restaurants.

After reading the article, I thought to myself, Cleveland really has a lot going for it – exceptional museums, cool neighborhoods, world class healthcare, it has the 2nd largest theater district in the country, stellar higher educational institutions, home of big budget film productions and a championship sports team. And on top of all that, Cleveland is becoming known for making real advances in green technology.

Lake Erie TurbineCleveland, like most metropolitan cities has its environmental issues, whether that be runoff from urban fields or commercial sites contaminated by prior use or contaminated sediments at the bottom of Lake Erie. Cleveland is starting to find unique solutions for these issues.

One of the region’s greatest assets is the Great Lakes, which provide freshwater for drinking, transportation, power and recreation. And 21% of the world’s supply of freshwater comes from the Great Lakes.

So, I am happy that the U.S Army Corps of Engineers (ACE) and the Ohio EPA are working together to find a better solution for where to put the sediment dredged from Lake Erie, a solution that does not include dumping the sediment back into Lake Erie. Recently, it was reported that they are exploring the solution that the Port of Cleveland is using to re-purpose sediment. The Port contracts with a supplier that recycles the dredged sediment and uses some to restore wetlands near the harbors being dredged and sells some of the clean sediment to construction companies to use on their sites. Re-purposing prevented the need to build a containment dike, thus saving the Port of Cleveland $150 million.

Another green technology project in development is the placing of six (6) 3.45-megawatt wind turbines eight miles off the shore of Lake Erie. The goal of putting wind turbines in Lake Erie is to funnel renewable energy into Cleveland’s Public Power infrastructure, enough to generate energy to power 7,000 homes.

Initiatives like these are exciting to see as they build on Cleveland’s strong science and technology competency and continues to diversify the area’s economy. A diversified economy attracts diverse talent from all over the world. The need for more talent can help to increase the area’s population and ultimately increases the need for housing, retail and infrastructure development. All of which are things needed for a thriving city. It’s nice to see ‘Growth on the Lake’.

What’s the Highest and Best Use for My Property?

Professionally, I call myself many things – commercial appraiser, businessman, real estate consultant, but what I really am is an economist.  I have yet to find anything in business that I cannot apply an economic principle to.  And the intriguing thing about real estate is the economic concepts that hide in the shadows.   There is no need to understand the mathematics of optimization or understand the micro economic theory of utility maximization.  One only needs to understand four basic concepts – legally permissible, physically possible, financially feasible and maximally productive.

This brings me to the Highest and Best Use Analysis.  It is based on the economic concepts of utility and substitutions.  The highest and best use of a property determines the utility for a buyer.  A buyer will compare the purchase of a potential property to the purchase of another property with similar utilities. The buyer will ultimately purchase the property with attributes that provide the greatest utility.  As well, the seller of a property will expect to sell his/her property for a price no less than that of properties of similar utility.

Blueprint

The four tests of highest and best use are: (1) legally permissible (2) physically possible (3) financially feasible and (4) maximally productive.

 

“The reasonable, probable and legal use of vacant land or an improved property, which is physically possible, appropriately supported, financially feasible, and that results in the highest value.” Appraisal Institute

Legally permissible primarily pertains to zoning and deed restrictions on a property, taking into consideration whether the existing property is a legal non-conforming use.  For example, FRG completed a highest and best use analysis for a local Ohio school district’s administrative building which was formerly a middle school.  The subject was in an area zoned for single family houses.  The prospective buyer of the property planned to re-develop the administrative building site into multi-family townhomes.  To do so would require a re-zoning.  And the re-zoning required approval from the City Planning and Zoning committee and final approval from the residents of the city.  FRG evaluated the site as improved, assuming the new zoning would be approved, but advised the client to quickly begin the re-zoning process.

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FRG wins contract with the Cleveland Airport system

Feasibility Research Group (FRG) has been selected to provide On-Call Appraisal Services for the Cleveland Airport system.

University Heights, OH (February 16, 2017) — FEASIBILITY RESEARCH GROUP (FRG), a minority owned commercial real estate appraisal, economic market research and consulting firm based in Northeast Ohio has been selected for On-Call Appraisal Services with the Cleveland Airport system.

“We are honored that FRG was selected to provide on call appraisal services for the Cleveland Airport System” said Gregory Williams, MAI – Owner and Managing Director. “The entire FRG team is excited to provide the Cleveland Airport System with the same high quality, expert valuations that our clients expect and greatly appreciate.”

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