jeffcarroll

A) In general Notwithstanding any other provision of this section, the housing credit dollar amount with respect to any building shall be zero unless—

(iii) a comprehensive market study of the housing needs of low-income individuals in the area to be served by the project is conducted before the credit allocation is made and at the developer’s expense by a disinterested party who is approved by such agency,

Section 42 of the IRS Code

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What, exactly, does it mean to be a “disinterested” market analyst? Most everyone would agree that it precludes a market study from being provided by an equity partner affiliated with the developer. But is this all that the term means? The purpose of this article is to answer this question.

Let’s assume that a market analyst has been engaged by a for-profit developer for tax credit allocation purposes. Let’s also assume that after evaluating the developer’s proposed project, the analyst came to the conclusion that there is no market for the proposed development. The market analyst breaks the bad news to the developer. The developer wants the analyst to alter his conclusions, showing that his project is, in fact, feasible. In an effort to accomplish this, the developer offers the market analyst equity in his project, contingent on a favorable opinion.

Clearly, should the market analyst modify his conclusions to accommodate the developer, he is no longer acting as a disinterested analyst and his report no longer satisfies the “disinterested party” requirement of Section 42 of the IRS code.

Now assume that instead of offering equity, the for-profit developer offers the analyst future work to alter his conclusions, showing that the developer’s project is, in fact, feasible. Again, should the market analyst modify his conclusions to accommodate the developer, he is no longer acting as a disinterested party and his report no longer satisfies the “disinterested party” requirement of the IRS code. Although the analyst does not have an equity interest in the project, modifying his report accommodates the developer’s interest, namely to earn a development fee.

Now let’s assume that the market analyst is working for a non-profit developer who offers the analyst future work to alter his conclusions. The non-profit’s interest is philanthropic, not economic. Again, should the market analyst modify his conclusions to accommodate the non-profit developer, he is no longer acting as a disinterested party and his report no longer satisfies the “disinterested party” requirement of the IRS code. Modifying his report accommodates the developer’s philanthropic interest.

Now let’s assume that a for-profit developer hires the market analyst who, after he has completed his research, comes to the independent conclusion that the developer’s project is perfectly feasible. The developer is pleased with the analyst’s work and offers him several other projects. Has the analyst violated the “disinterested party” provision on the IRS Code? No, not at all. This is because the analyst’s conclusions were his own conclusions, regardless of what his client’s interest may be.

Here’s the point: Being disinterested is not a function of who the client is, what the client’s interests are, or whether the client offers additional work. Instead, “disinterested” means that the conclusions are entirely the analyst’s conclusions.  In short, disinterested means independent.

The National Council of Affordable Housing Market Analysts (NCAHMA) recently adopted a code of ethics which spell out the analyst’s duty to be a disinterested, independent and unbiased professional. The code of ethics were carefully crafted to assure that the analyst always operates in conformance with IRS requirements. Users of market studies should look for the NCAHMA certification to be sure that reports were completed in conformance with Section 42 of the IRS Code.

State housing finance agencies have been known to engage analysts, pressuring them to deliver predetermined results in an effort to avoid litigation from developers and/or to streamline the underwriting process. Again, it does not matter who the client is or what the client’s interests may be, should a market analyst modify his conclusions to accommodate the state, he is not acting in a disinterested, independent and unbiased manner. Users of state-ordered market studies are advised to look for a NCAHMA certification to make sure that reports satisfy the requirements of Section 42 of the IRS Code.

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Jeffrey B. Carroll is President of Allen & Associates Consulting. Mr. Carroll has over 20 years of real estate consulting experience. Since 1988, he has performed over 2,000 market study, rent comparability study, appraisal, environmental assessment, capital needs assessment, and utility allowance assignments throughout the country for affordable multifamily properties. Read more about the author here…

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A personal account of alleged impropriety in the multifamily mortgage market

The recent release of the Financial Crisis Inquiry Commission’s (FCIC) final report has re-sparked the debate over the causes of the financial crisis. In particular, the report’s finding that Fannie Mae and Freddie Mac were not primary engines in the subprime crisis elicited a lengthy dissent from noted conservative thinker and FCIC member, Peter Wallison.

Mr. Wallison asserts that the, “sine qua non of the financial crisis was U.S. government housing policy, which led to the creation of 27 million subprime and other risky loans.” In particular, he points to, “policy [that] sought to increase home ownership in the United States through an intensive effort to reduce mortgage underwriting standards”

Much of the focus on the role of the GSEs in the crisis has been on mortgages for single-family homes, the associated underwriting practices, and the government policies surrounding those practices, but Freddie Mac also has a presence in the multifamily mortgage market. It is in this regard that I have come face to face the unethical behavior that leads to questionable underwriting.

The following link takes the reader to a redacted copy of a complaint I recently filed with the Federal Housing Finance Agency (FHFA) alleging that Freddie Mac and/or its affiliated lender pressured me to deliver predetermined conclusions in the valuation of a $5,680,000 affordable multifamily property:

Letter, FHFA, Revised 2011-01-26 (Redacted)

Because FHFA is the agency charged with providing “effective supervision, regulation and housing mission oversight of Fannie Mae, Freddie Mac and Federal Home Loan Banks” it seemed appropriate that I refer this matter to them.

While this piece is not intended as a thorough analysis of Freddie’s underwriting standards, it is my belief that these situations occur all too often. Over the past few years, I have had several, similar experiences on HUD and Fannie Mae multifamily transactions and suspect I will be faced with similar requests in the future. As the role of Fannie and Freddie in causing the financial crisis continues to play out in the public forum, I will play my own personal part in keeping the GSEs honest by reporting any impropriety to the FHFA and publishing my complaints here.

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(A) In general Notwithstanding any other provision of this section, the housing credit dollar amount with respect to any building shall be zero unless—

(iii) a comprehensive market study of the housing needs of low-income individuals in the area to be served by the project is conducted before the credit allocation is made and at the developer’s expense by a disinterested party who is approved by such agency,

Section 42 of the IRS Code

On January 18, 2006 my firm was engaged by the North Carolina Housing Finance Agency (NCHFA) to complete five tax credit market studies. The NCHFA market study guidelines required analysts to submit primary market area (PMA) conclusions to the agency for review prior to completing our reports. We did our research, provided our conclusions, and obtained notification from the Agency that they “agreed” with our market area determinations prior to commencing with our studies. NCHFA guidelines also called for the use of 2-person households when computing demand for age restricted projects. This is exactly what our market research suggested.

On February 27, 2006 we completed our research, wrapped up five 200-page reports, and certified our findings to the agency. I personally certified the reports with the following required language: “To the best of my knowledge, the market can support the demand shown in the study.”

Four of our reports were elderly. One of these elderly projects was in Asheville. Our analysis indicated that the Asheville elderly project had significant unit mix and income targeting problems. It appeared that the developer was proposing to build too many 2-bedroom units at 60% of AMI. There just were not enough potential renters earning between $20,070 and $23,900 in our PMA to fill these units quickly.

The developer – a large national firm – obtained a copy of our report and challenged our conclusions. After meeting with the developer, NCHFA requested that we increase our PMA and the number of persons in the 2-bedroom units for this project. We were not invited to the meeting.

On March 15, 2006 I received a voice mail message from Tara Hall, market study coordinator with NCHFA, with the following request: “We need you to increase the PMA for the Asheville projects.”

On March 23, 2006 I received an e-mail from Ms. Hall with the following request: “In an effort to maintain consistency across the board, we will need to request an extension of the income limits for a 2BR elderly unit to include 3 persons.”

[click to continue…]

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Market Data, Damascus, Virginia, 2010-10-14

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Market Data, Wytheville Virginia, 2010-10-14

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Market Data, Stuart, Virginia, 2010-10-14

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The government intervenes in real estate markets each and every day. Specific examples include favorable terms for government loans, tax deductibility of mortgage interest, and zoning and land use restrictions. The purpose of this study is to evaluate the impact of these factors on real estate values in today’s marketplace.

Favorable Terms for Government Loans

According to First Financial Services, Inc. (a Charlotte-based mortgage brokerage firm), government loans (which include FHA, VA, USDA-RD, FNMA and FHLMC loans) account for over 80 percent of mortgages currently being originated in the marketplace. FFSI reports the following current loan terms for FNMA mortgages (which make up the majority of government loans):

FNMA Financing
Interest Rate, 4.5 percent
Amortization Period, 30 years
Loan to Value, 80 percent
Maximum Qualification Ratio, 32 percent

FFSI quoted the following loan terms for conventional market rate financing:

Conventional Market Rate Financing
Interest Rate, 5.5 percent
Amortization Period, 30 years
Loan to Value, 80 percent
Maximum Qualification Ratio, 32 percent

Favorable loan terms for government mortgages tend to inflate market values. This is because borrowers, with a specified monthly income, can borrow more using favorable government financing than with conventional financing.

Consider the following example. Assume that Buyer A earns $5,000 per month and is pre-qualified for up to a $1,600 monthly payment (PITI / Monthly Income = 32 percent). Buyer A begins looking for a home but does not desire to pay more than $1,500 per month for his/her new home. The buyer finds a home in which he/she is interested and makes a $271,000 offer. As the accompanying table illustrates, this is the maximum offer that Buyer A can make with conventional market rate financing (assuming property taxes of 1.00 percent of value and insurance of $50 per month).

Buyer B, who earns $5,000 per month, is also willing to pay up to $1,500 per month for the same property. Buyer B learns about the favorable FNMA interest rates and offers $297,500 for the home. As the accompanying table illustrates, Buyer B is able to purchase the property for 9 percent more than Buyer A because of the favorable financing terms available under the FNMA program.

This competitive situation is played out thousands of times each day throughout the United States, propping up home values and resulting in government loans representing the overwhelming majority of mortgages being originated in the marketplace.

Government’s reach into mortgage markets is not limited to just FNMA mortgages, however. Indeed, the US Treasury recently purchased $1.2 trillion of mortgage-backed securities, injecting public-sector funds into the private sector. Here’s a couple links to articles regarding this:

http://online.wsj.com/article/SB126291088200220743.html

http://www.npr.org/templates/story/story.php?storyId=125358080

Loss of Tax Deduction

Tax deductibility of mortgage interest also has a significant impact on real estate values. Consider our previous example in which Buyer A offers to pay $271,000 for a certain property using market rate financing. As the accompanying table illustrates, Buyer A would pay $1,500 per month, including $225 in property taxes and $50 for insurance, leaving $1,225 for mortgage principal and interest.

Now assume that the mortgage interest tax deduction is repealed. In this case, Buyer A would need to pay additional income tax on top of his/her monthly payment. Consequently, Buyer A would need to offer less for the property, given a $1,500 monthly budget. As the accompanying table illustrates, Buyer A would be able to pay $1,053 per month for mortgage principal and interest after accounting for $194 in property taxes, $50 for insurance, and $203 in taxes associated with the lost tax deduction (assuming a 25 percent marginal income tax rate). This principal and interest payment would support a $233,000 offer. This is 22 percent less than the price someone could pay using FNMA financing without the loss of the mortgage interest tax deduction.

A link to a recent podcast regarding the effect of income tax policy on real estate markets follows:

http://ne.edgecastcdn.net/000873/dailypodcast/jamesadorn_proppinguphomeprices_20100902.mp3

Zoning and Land Use Restrictions

The obvious implication of zoning and land use restrictions is to limit supply by designating which properties are eligible for certain uses. The less obvious implication is to limit supply by increasing pre-development and construction costs and extending the development timeline for specific properties. Shifting the supply curve in this way results in increased prices in the marketplace.

Much has been written regarding this, including a recent study conducted by Harvard University professor Edward L. Glaeser and Wharton Business School Professor Joseph Gyourko. A link to this study follows:

http://www.cato.org/pubs/regulation/regv25n3/v25n3-7.pdf

The literature suggests that values may be propped up as much as 40 percent or more in certain markets.

Conclusion

Government intervention in the marketplace appears to materially inflate real estate values. Our analysis suggests that the combined effect of government intervention in the mortgage markets and the deductibility of mortgage interest prop up values by over 20 percent. Zoning and land use restrictions also affect values, depending on the specific submarket. Because of these restrictions, values in some submarkets may be inflated by as much as 40 percent or more.

September 14, 2010

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