This 20 minute segment of Grounded Solutions Network Video Learning Series focuses on the factors that go into setting an appropriate purchase price for Below Market-Rate homeownership units. View video.
Setting the initial affordable home sales prices is slightly more complicated than setting affordable rents because it involves a number of additional assumptions to estimate the monthly housing costs. Many of the challenges that arise for inclusionary programs stem from insufficient attention to the initial pricing of the affordable homes.
Take, for example, a two-bedroom unit in a new condo project. A city’s inclusionary program may require that units serve households earning less than 80 percent of area median income, but this general term can be applied in different ways. Developers seeking to maximize their own revenues might assume that the two-bedroom condo will be purchased by a four-person household, with a 20 percent down payment and an adjustable-rate mortgage at the lowest available rate. These favorable assumptions might produce an affordable price that is very difficult for any low-income family to actually afford.
If a program gets the initial affordable price wrong, it will be more difficult to resell these homes at affordable prices to low-income families in the future, regardless of what resale formula might be in place.
In the past, cities have sometimes left the pricing decisions to the developers. But inclusionary programs are increasingly seeking to avoid uncertainty by either publishing unequivocal guidelines for pricing or by publishing an annual table of maximum prices.
For a two-bedroom unit targeting 80 percent of AMI, for example, a common approach would be to set the price based on 70 percent of the three-person AMI, assuming a 30-year fixed-rate mortgage and a 5 percent (or even 3 percent) down payment. These assumptions generate a much lower price than the two-bedroom condo example above, but one that is more comfortably managed by a much wider range of potential buyers.
Some actual buyers may come to the table with larger down payment or larger household sizes, but most programs want their homes to be available to a range of buyers, not just to the rare buyers that developers would hand pick.
The following table illustrates how different assumptions impact the maximum price a developer may charge for an inclusionary unit:
- The first row represents more conservative pricing assumptions. It assumes target buyers earn as little as 65 percent of AMI, an interest rate of 5.5 percent (even though the current rates may be lower), and a down payment of only 3 percent.
- The second row is slightly less conservative in that it assumes a buyer earning 70 percent of AMI.
- The third row goes a bit further and also assumes a lower interest rate and a higher down payment. The result of relaxing the assumptions is an increasingly more expensive initial price.
|80% AMI||Target AMI||Rate||PITI Ratio||Taxes, Ins, HOA||Estimated Mortgage||Down Payment||Maximum Price|
|$60,000||65% = $48,750||5.5%||33%||$350||$178,000
|$60,000||70% = $52,500||5.5%||33%||$350||$196,000
|$60,000||70% = $52,500||4.5%||33%||$350||$219,350
Condominium fees can increase substantially over time, making the overall costs of homeownership unsustainable for low- and moderate-income households. Rising condominium fees are a growing problem for many municipalities that are seeing their new for-sale inclusionary homes primarily built as condominiums, including Washington, DC, Fairfax County, and Cambridge.
Program administrators can set the initial affordable home price low enough to offset high initial condominium fees but, increases in these fees over time for new amenities or building repairs, can in some cases rival mortgage payments on below-market-rate units, leading to high overall housing costs, potential default, or homeowners being forced to sell their units.
Two promising solutions emerged through the research:
- Keep condo fees manageable through proper initial pricing that also anticipates a rise in condo fees over time. Shortly after Washington DC adopted its inclusionary housing program in 2007, there were several cases where high homeowners’ association (HOA) and condo fees were compromising the overall affordability of affordable homeownership units created through a separate city program. This prompted the city to survey condo fees citywide to compare its cost assumptions about fees in its affordable homeownership program to prevailing practice. Having discovered that its fee assumptions were too low, the city lowered its standard affordable inclusionary home price in 2012 by 11 percent to better reflect prevailing condo fees in the monthly cost of the home and provide room for fees to rise over time.
- Require that condo fees be proportional to the lower home values of inclusionary ownership units. Not all states authorize localities to require lower HOA or condominium fees for lower-value properties, but some do. The city of Cambridge takes advantage of this legal permission. It requires that developers and HOAs assess fees based on the reduced value of the inclusionary home to ensure that owners of affordable units are not paying fees as high as market-rate owners. Fee increases must also be proportional. Staff works to proactively address concerns about ad valorum assessments from condominium associations by educating them about what the owners of the affordable condominiums are giving up by agreeing to restricted resale prices.
If the pricing criteria are generally stated, then jurisdictions could review the criteria every three years when evaluating program performance. But if the program publishes an annual cap or guidelines, then the figures should be evaluated annually to adjust AMI figures and interest rates.
This is an example of generally stated criteria: “The price must be affordable so that a household of (# of BR + 1) earning 65 percent of area median income with a 3 percent down payment will pay no more than 33 percent of its monthly income toward a 30-year fixed-rate mortgage at (30-year fixed-rate + 1 percent) including property taxes, HOA dues, and insurance of $100/month.
Many communities draft their inclusionary housing ordinance to include a formula for establishing the initial price for affordable homeownership units. Getting the details of this initial pricing formula right is very important to the long-term success of the program, but it can be hard to anticipate all of the factors at the outset.
For this reason, some inclusionary ordinances generally state that the homes must be priced at an affordable rate for the target income group, and more detailed language is included in the program guidelines or administrative manual. These guidelines might include things like the mortgage financing assumptions that go into the formula. This approach may make it easier for program administrators to adopt revisions to the pricing formula over time.
They should. One common problem is that it’s difficult to qualifying eligible buyers for homeownership units. In some cases, this is the result of problems in the initial pricing formula. If units are priced too high for the target income group, buyers who are below the income cutoff may have trouble qualifying for a mortgage. On the other hand, if units are priced too low, they impose a greater cost on developers with no increase in social benefit.
While developers have an obvious interest in advocating for higher prices, units that are slow to sell impact their bottom line. Developers and their sales and marketing partners will often have a much clearer sense than public policymakers about how best to balance these concerns.
An inclusionary housing program will not be successful if developers will not develop any housing as a result of some portion of the ordinance. That being said, it is not uncommon for developers to initially claim that the program will make it impossible to do business. Grounded Solutions Network has developed an inclusionary housing calculator that will help you evaluate your pricing requirements within the other constraints of the ordinance. Go to IZ Calculator ->