![](media/image1.wmf){width="0.6229166666666667in"
height="0.6201388888888889in"} **U.S. Department of Housing and Urban
Development**

**Office of Public and Indian Housing**

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**Special Attention: NOTICE PIH 2008-35 (HA)**

Public Housing Agencies Issued: August 20, 2008

Public Housing Directors

> Expires: August 31, 2009

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**Subject:** **Cost-Test and Market Analyses Guidelines for the
Voluntary Conversion of Public Housing Units Pursuant to 24 CFR Part
972**

**[I. Applicability:]{.underline}** This Notice applies to public
housing agencies (PHAs) who are applying to HUD under the voluntary
conversion program of Section 22 of the 1937 Housing Act and 24 CFR 972.

**[II. Background:]{.underline}** This Notice provides guidance to PHAs
in implementing elements of Section 533 of Quality Housing Work
Responsibility Act of 1998 (Title V of P.L. 105-276) (QHWRA), which
amended Section 22 of the United States Housing Act of 1937 (the Act),
and 24 CFR 972, published in the Federal Register on September 17, 2003
(FR-4476-F-04) (conversion rule). The cost methodology of the conversion
rule was published as an appendix to the rule on March 21, 2006
(FR-4475-F-02), with an effective date of April 20, 2006 (cost-test).

Section 22 of the Act and 24 CFR 972 Subpart B authorize a PHA to
request approval from HUD to voluntarily convert a public housing
property, or portion thereof, to tenant-based assistance, subject to
several conditions.

An application for voluntary conversion must incorporate a "conversion
assessment" that includes the elements described in 24 CFR 972.218
Conversion Assessment Components. One required component of the
conversion assessment is the cost analysis described in 972.218(a),
comparing the cost of public housing with the cost of tenant-based
assistance. HUD will approve the proposed voluntary conversion of a
property (including removal of a property, or portion thereof, from a
PHA's inventory only when the cost analysis component of the conversion
assessment demonstrates the total costs of ongoing maintenance and
operations for a property exceed the total costs of providing
tenant-based assistance.

The HUD Special Applications Center (SAC) approves conversion
assessments using an Excel-based cost analysis calculator for use by
PHAs. The Excel-based cost analysis calculator is available on the SAC
web site at the following link:
<http://www.hud.gov/offices/pih/centers/sac/docs/costcomparison.xls>

In addition to this cost analysis component, the conversion assessment
must also include an analysis of the market value of the property as
described in 972.218(b) (the "market-value analysis"). This market-value
analysis will evaluate various proposed development scenarios and sets
of assumptions including use of the property as public, assisted, or
market-rate housing based on the as-is and post rehab condition as
required as part of the conversion assessment set forth in the voluntary
conversion rule (24 CFR Part 972.218).

**[III. Purpose]{.underline}:** This Notice provides "how to" guidance
to PHAs regarding the procurement and use of appraisal services to
complete the required components of the conversion assessment for
properties proposed for voluntary conversion, in particular the cost
analysis and market analysis. It instructs PHAs on how they can
determine the market value or "highest and best use value" that must be
inserted into Section 5(c) of the (excel-based spreadsheet)
cost-analysis calculator, a required element of 24 CFR 972.218. This
calculator is available on HUD's Special Application Center (SAC)
website at:
<http://www.hud.gov/offices/pih/centers/sac/docs/costcomparison.xls>).

This Notice provides guidance to PHAs on preparing the market analyses
for the public housing property required as part of the voluntary
conversion assessment under 24 972.218(b) of the voluntary conversion
rule. These market analyses will assist PHAs in evaluating their
recapitalization options, including how rehabilitation and the proposed
use of the property (as public, assisted, or market-rate housing) that
may affect a property's value. Several options are available to PHAs
involving whether to undertake a voluntary conversion. These include
modernization and reuse of the existing building as public, assisted,
market-rate, mixed-income or some other form of affordable housing for
the low-income.

**[IV. Appraisal Procurement Instructions]{.underline}**

Procurement of appraisal services must be conducted by a PHA in
accordance with its procurement policy and with the Procurement Handbook
for Public Housing Agencies, HUD Handbook 7460.8 REV 2, dated March 2,
2007, or any subsequent version of the Handbook in effect at the time of
the procurement action.

The generally accepted and recognized standards of appraisal practice in
the United States are found in the Uniform Standards of Professional
Appraisal Practice (USPAP). These Standards are published and updated
periodically by the Appraisal Standards Board (ASB) of the Appraisal
Foundation, a non-profit organization authorized by Congress as the
source of appraisal standards and appraiser qualifications. Their most
recent publication is the 2008-2009 USPAP + Guidance, effective January
1, 2008.

A PHA must procure appraisal services from a provider that is qualified
and competent to perform an appraisal that addresses the requirements of
the conversion assessment. The market-value analysis component of the
conversion assessment will require appraisal of the property as
subsidized housing and, depending on the nature of the proposed
conversion, may require appraisal of the property with proposed
improvements, or in the context of altered use-restrictions. These are
relatively complex appraisal tasks. Therefore, when procuring appraisal
services, a PHA must obtain the services of a provider that is qualified
and competent generally, but that also is competent in the relevant
specialized areas, as described in the USPAP.

After a PHA procures an appraiser, the appraiser is expected to exercise
professional judgment in accordance with the USPAP, the conversion
assessment requirements of 24 CFR 972 and common industry practices
regarding market valuations of real estate.

**[V. Guidance on Conducting Market Analyses of Public Housing
Property:]{.underline}**

To conduct the cost-test and conversion assessment required by the
conversion rule, PHAs must determine the highest and best use market
value and estimates of market value based on the five distinct market
valuations listed below. The valuation listed in box #5 of this matrix
is the value a PHA must insert into the Excel-based conversion cost
calculator spreadsheet.

+----------------------------------------+---------------+------------+
| **Market Analyses**                    | **Approach    | **Market   |
|                                        | Used**        | Value      |
|                                        |               | (insert    |
|                                        | **(check      | e          |
|                                        | one)**        | stimate)** |
+----------------------------------------+---------------+------------+
| 1\. Current Value "As Is"              | (\_) Income   |            |
|                                        |               |            |
| Public Housing                         | (             |            |
|                                        | \_)Comparable |            |
|                                        | Sale          |            |
|                                        |               |            |
|                                        | (\_)T         |            |
|                                        | ax-Assessment |            |
|                                        |               |            |
|                                        | (\_)Cost      |            |
|                                        | Approach      |            |
+----------------------------------------+---------------+------------+
| 2\. Future Value "Post-Rehab"          | (\_)Income    |            |
|                                        |               |            |
| Public Housing                         | (             |            |
|                                        | \_)Comparable |            |
|                                        | Sale          |            |
|                                        |               |            |
|                                        | (\_)T         |            |
|                                        | ax-Assessment |            |
|                                        |               |            |
|                                        | (\_) Cost     |            |
|                                        | Approach      |            |
+----------------------------------------+---------------+------------+
| 3\. Current Value "As Is" (depends on  | (\_) Income   |            |
| proposed use)                          |               |            |
|                                        | (             |            |
| Select One:                            | \_)Comparable |            |
|                                        | Sale          |            |
| (\_)Assisted Housing                   |               |            |
|                                        | (\_)T         |            |
| (\_)Unassisted Housing                 | ax-Assessment |            |
|                                        |               |            |
| (\_)Market-Rate Housing                | (\_)Cost      |            |
|                                        | Approach      |            |
| (\_) Other                             |               |            |
+----------------------------------------+---------------+------------+
| 4\. Future Value "Post-Rehab and       | (\_) Income   |            |
| Conversion" (depends on zoning and     |               |            |
| proposed use)                          | (             |            |
|                                        | \_)Comparable |            |
| Select One:                            | Sale          |            |
|                                        |               |            |
| (\_)Assisted Housing                   | (\_)T         |            |
|                                        | ax-Assessment |            |
| (\_)Unassisted Housing                 |               |            |
|                                        | (\_)Cost      |            |
| (\_)Market-Rate Housing                | Approach      |            |
|                                        |               |            |
| (\_) Other                             |               |            |
+----------------------------------------+---------------+------------+
| 5\. "Highest and Best Use Market       | (\_) Income   |            |
| Value"                                 |               |            |
|                                        | (             |            |
| (Insert this value at Section 5(c) of  | \_)Comparable |            |
| the Cost Analysis Excel Spreadsheet as | Sale          |            |
| the "market value of property".        |               |            |
|                                        | (\_)T         |            |
|                                        | ax-Assessment |            |
|                                        |               |            |
|                                        | (\_) Land     |            |
|                                        | Value         |            |
+----------------------------------------+---------------+------------+

Specific instructions for completing this market analysis and highest
and best use valuation are as follows:

[Current Market Value as Public Housing (Box #1)]{.underline}: This
current value as public housing based on the "as is" condition of the
property is self-explanatory.

[Market Value as Public Housing "Post-Rehab" (Box #2):]{.underline} This
value should be based on the costs for any rehabilitation or repairs
necessary to keep the development viable for an evaluation period of 20,
30 or 40 years as selected by the PHA (depending on the degree of
modernization necessary to keep the property viable). The level of
rehabilitation is the primary factor for the remaining useful life
evaluation period a PHA will select. A 20-year remaining useful life
assumes the repairs necessary to eliminate any deferred maintenance
items and other repairs necessary for a property to comply with the
International Existing Building Codes (ICC) or Public Housing
Modernization Standards in the absence of a local rehabilitation code. A
30-year remaining useful life assumes a level of modernization that
addresses all accumulated maintenance backlog and any redesign or
reconstruction necessary to ensure compliance with current local codes
to ensure long-term viability. A 40-year remaining useful life assumes
repairs at a level equivalent to new construction that will create like
new conditions within a property. The PHA must provide the appraiser
with a capital needs assessment prepared based on the degree of
modernization necessary to keep a property viable in accordance with the
remaining useful life evaluation period selected by a PHA.

  ------------ --------------------------------- ------------------------
  Useful Life  Level of Rehabilitation           Market Value

  20 Years     Compliance with existing local or Based on operation as
               International Building Codes      public, assisted,
               (ICC) or Public Housing           unassisted, or
               Modernization Standards.          market-rate housing and
                                                 a sale based on the
                                                 remaining value in the
                                                 property at the end of
                                                 the specified term
                                                 assuming no further use
                                                 restrictions. This value
                                                 should be stated as a
                                                 Net Present Value.

  30 Years     Eliminates all accumulated        
               maintenance and backlog of        
               repairs and includes redesign     
               necessary to ensure long-term     
               viability.                        

  40 Years     Equivalent to "Like New"          
               standards.                        
  ------------ --------------------------------- ------------------------

[Current Value in "As Is Condition" (as Assisted, Unassisted or Market
Rate Housing (Boxes #3]{.underline}): 24 CFR 972.218 requires PHAs to
describe the proposed use for a public housing property proposed for
conversion and to describe the means and timetable to complete the
conversion and relocation of impacted households. The PHA must inform
its appraiser how the property will likely be used after conversion.
This value should be based on the proposed use and either the comparable
sale, income, or most feasible appraisal method to determine an accurate
estimate of market value. If a developer/ partner or contractor has
already been properly procured conditioned upon the approval of this
conversion application, then that future use should be provided to the
appraiser. The proposed future use of the development will largely
depend on site location and physical condition, land use regulations,
property tax considerations, local market conditions, financing options
and the zoning limitations or restrictions placed on the property.

[Future Value "Post-Rehab" (Assisted Housing, Unassisted or Market Rate
Housing (Boxes #4]{.underline}): 24 CFR 972.218 requires PHAs to
describe the proposed use for a public housing property proposed for
conversion and to describe the means and timetable to complete these
redevelopment activities. The instructions for conducting this market
analysis are the same as for (Box \# 3), except when considering
rehabilitation needs, at a minimum a PHA must consider the repair needs
identified under the conversion cost-test that are necessary to keep a
property viable for the remainder of its useful life during the
evaluation period of 20, 30 or 40 years as selected by the PHA under the
conversion cost-test. See information and chart above at Box #2 for more
explanation on useful life.

[The "Highest and Best Use Market Value" (Box #5):]{.underline} HUD
requires PHAs to enter the appraised market value of a property into the
cost-test in Years 1 through 5 when a PHA anticipates selling a property
or receiving income generated from the sale of a property. Under the
conversion cost-test after the "highest and best use market value" is
determined, a PHA will determine the net residual value of the property.
The net residual value is determined by calculating the estimated market
value for the property based on the appraisal, minus any costs required
for demolition and remediation paid by the PHA. (See Federal Register
pp. 14337 and 14338 for the final rule for the Conversion Cost
Methodology).

This valuation should be based on the use that provides the greatest
potential return to the PHA from the sale of the property in accordance
with local zoning requirements and market conditions. The "Market Value"
or "Highest and Best Use Value" always assumes a use of the property
that will generate the highest economic return associated with a sale of
the subject property (as residential or commercial property taking into
consideration applicable zoning requirements). This value may be
determined with or without regard to the plans of the PHA or a developer
procured by a PHA. An appraiser may evaluate existing or proposed uses
in the area as well as recent changes in the marketplace which may not
yet be reflected in comparable sales. If a new highway interchange has
just been announced or a large corporation has just proposed
construction of its world headquarters across the street, the impact of
those announcements on the value and future use of the subject property
may be considered.

**[VI. Definitions of Housing]{.underline}**: The following definitions
should be used for purposes of this Notice.

[A. Public Housing]{.underline} is property built and operated under an
Annual Contributions Contract (ACC) and the Act.

[B. Assisted Housing]{.underline} is housing with some form of subsidy
provided by private, state or local agencies, the Rural Development
Agency, Tenant-based Housing Choice Voucher assistance, or other
non-public housing funding. The income levels of tenants in such
properties may be regulated or limited by state or local regulations.

[C. Unassisted Housing]{.underline} has no subsidy, but provides for a
rental cap such as property rent controls consistent with state
regulated Low Income Housing Tax Credits or other statutory or
regulatory caps or rent controls. The income levels of tenants in such
properties may be regulated or limited by state or local regulations.

[D. Market Rate Housing]{.underline} has no restrictions on rental
rates, operating costs, profits, rental rate increases, or improvements
that can be made to the property.

**[VII. Appraisal Methods]{.underline}**

To determine the market-value that must be inserted into the cost-test
calculator, the PHA must procure an appraiser 24 CFR 972. While PHAs are
urged to use an appraiser to assist with prepraring a market analyses,
this is left to the discretion of a PHA. In light of the low-income
purpose of the public housing program, HUD recognizes appraisers may
need to make special adjustments in valuing properties. HUD expects
appraisers will select the most feasible appraisal methods. In the
section below basic appraisal methods are described for the (Market
Comparison Approach, the Cost Approach, the Income Approach, or the
Tax-Assessment Approach). PHAs and (procured appraisers) may exercise
their professional judgment in deciding on the most feasible valuation
method(s) that will be used to conduct the market analyses and
appraisals required for the conversion assessment based on market
conditions and common industry practices.

In general, public housing developments rarely generate net income,
profit, or market value since its tenants pay rents that are equal to or
less than the actual operating expenses. Operating expenses for a
property may frequently be greater than an authority's income and the
federal subsidy it receives never exceeds its operating deficit. With no
cash flow above expenses the housing units would have no value in a
conventional appraisal. Only when an appraisal considers the potential
income of public or assisted housing under the conditions established
below using a flat rent, a Housing Choice Voucher assistance rent, or
rent from a comparable property in a market in the vicinity of the
proposed building, may the relative value of a property potentially be
established and evaluated. These special considerations present
significant challenges to an appraiser in establishing rental income
levels and selecting a vacancy rate or allowance. However, the following
appraisal methodologies are outlined with guidance for appraisers and
PHAs to consider to derive a reasonable and good-faith estimates of
market value for properties proposed for voluntary conversion.

**[A. Income Capitalization Appraisal Approach]{.underline}:** The
income capitalization appraisal approach (Income Approach) is used to
prepare an estimate of the current value of a property by projecting a
property's potential net income in the future and the expected rate of
return on investment a reasonable investor would expect to earn in the
future. Appraisers will project the future income a property will
generate in addition to the estimated expenses. In general, these cost
estimates are based on the recent income and expense history for a
property. After subtracting expenses from income, the net income for a
property is calculated and converted to its present value by dividing it
by a capitalization rate or the rate of return investors would expect to
earn on their investment. Although there is a degree of speculation
associated with this methodology, this method can be used as an
indicator of market value, or to project the estimated value of a
property for a potential investor.

There are ten key elements that need to be considered in determining the
appraised value of affordable housing units using the Income Approach.
These elements are:

Rental Income

Vacancy Rate or Allowance

Operating expenses

Capital Reserves

Property Taxes

Net Operating Income

Debt Service

Net Income

Capitalization Rate

Market Value

A review of the elements used in the Income Approach covers every aspect
of a property's operation. Some of the individual elements considered
will have an impact on limited aspects of each of the other appraisal
approaches. For instance when using the Market Comparison Approach it
will be essential to compare the rents established in the Income
Approach with the actual rents of the comparable property used in the
Market Comparison Approach. Using the Income Approach requires that an
accurate long-term economic projection called a pro-forma be created for
the subject property. This pro-forma contains estimates of all ongoing
income and expenses related to the property on an annualized basis. The
pro-forma projects the amount of cash flow or profit that will remain at
the end of the year for a specific development scenario. Based on the
rate of return an investor would want to invest in a property of this
type, the projected annual income is capitalized based on that desired
return to determine the current value of the investment (see example
below.) This value may be further increased by the presence of any Low
Income Housing Tax Credits (LIHTC) associated with the property. The
annualized value of any tax credits are added to the actual cash flow
from the property to establish an Internal Rate of Return (IRR) over a
projected period of time that may further increase the value of the
property to the initial investor.

[(1) Rental Income]{.underline} - Public housing rents are generally
established as a function of a household's income instead of based on
market forces. Although many households within a public housing complex
may pay an income-based rent, PHAs are required to establish flat rents
for all buildings within a PHA's inventory that are reflective of the
local rental market and in accordance with the bedroom size and
amenities associated with the applicable property. These flat rents must
be market-based and fully cover a property's operating costs.

As an alternative, to estimate rental income for a public housing
property, PHAs are permitted to use Housing Choice Voucher assistance
rents or rents for comparable properties within the local rental market
to estimate the value for a property using the Income Approach. HUD has
established income limits for its Housing Choice Voucher (HCV)
assistance. .... program based in part on the Area Median Income (AMI)
adjusted for family size and set Fair Market Rents (FMR) for local
markets. In order to create a uniform basis for establishing project
income in the Market Value appraisals for public or assisted housing
appraisals when using HCV-based rents, the appraiser for the subject
property shall use rents based on the percentages of AMI set forth in
the table below for each bedroom size. If, these rents differ
significantly from existing Tenant-based Housing Choice Voucher
assistance FMRs, a housing authority's flat rents, or a broad and
clearly established local market [rent]{.underline} for assisted
housing, an appraiser may use the local standard when an adequate
justification is provided as part of the appraisal. In no event,
however, shall the rents used in any appraisal exceed the Tenant-based
HCV assistance rents for the area in which the subject property is
located. In addition, PHAs may conduct a Rent Comparability Study (RCS)
to assist them in determining the rental income of a property.

See Chapter 9 of the Section 8 Renewal Policy Guidebook, available on
HUDclips.org and at
<http://www.hud.gov/offices/hsg/mfh/exp/guide/s8renew.pdf>. See also
HUD-92273 and HUD-92273-S8.

  -------------------- ------- ------- ------- ------- ------- ------- -------
  Rental Rates                                                         

  Number of Bedrooms   0       1       2       3       4       5       6

  Rent as Percent of   11%     12%     16%     18.5%   19.5%   20.5%   21.5%
  AMI                                                                  
  -------------------- ------- ------- ------- ------- ------- ------- -------

[(2) Vacancy Rate or Allowance:]{.underline} High vacancy rates in
public housing properties are generally the result of deferred
maintenance or other market factors, which represent the actual capital
repairs a voluntary conversion and recapitalization effort are intended
to address. Despite this planned effort, the actual condition of a
property should be reflected in the "as-is" Market Value appraisal. The
"post-rehab" appraisal should carry a vacancy allowance appropriate for
the local market and the unit type. Senior units in a strong market
might have a low vacancy rate due to low turnover while family units
might carry a higher vacancy rate due to higher turnover rates and
longer turn-around times for the units. The appraisal should simply
reflect the actual conditions in the marketplace, whatever they are.

[(3) Operating Expenses]{.underline} - The most accurate indicator of
future operating expenses for a property are those currently being
incurred, so long as there is not a pattern of deferred maintenance
which can be common for some public housing properties. An "as-is"
appraisal should use the pro-rated historical operating expenses for the
property or the expenses recorded in a site-based management program
approved by HUD that includes at least one full year's operating
expenses. For a housing authority these operating expenses are the sum
total of all costs associated with the operation and maintenance of its
public housing units exclusive of monies from capital grants. In no case
should the appraisal use an operating expense less than the current per
unit operating cost of the authority. Appraisals reflecting the
operating expenses "post-rehab" should utilize those expenses common to
similar affordable housing units in the local market

[(4) Capital Reserves]{.underline} -- When preparing an "as-is" Market
Value appraisal for a property the most recent Physical Needs Assessment
(PNA) prepared for the property should be used as a guide to establish
capital reserves for the purposes of an appraisal. In instances where
Low Income Housing Tax Credits will be utilized as part of the project
financing, the standard capital reserves established by the state's
housing finance authority may be used in the "post-rehab" appraisals. In
all cases the capital reserves contained in any appraisal, to the extent
they exist, should reflect the actual needs of the property and ensure
the ability of management to meet and maintain Uniform Physical
Condition Standards (UPCS) standards as well as any requirements set
forth in the PNA for the site.

[(5) Property Taxes]{.underline} - While public housing authorities do
not pay real estate taxes, many of the revitalization or development
scenarios proposed for a voluntary conversion could expose a property to
real estate taxation. The real estate taxes paid by properties
designated as affordable housing are usually reduced by local
governments using a Payment In Lieu of Taxes (PILOT) agreement between
the owner of the property and the taxing authority. The "as-is"
appraisal should use whatever property taxes are currently being paid by
the housing authority, if any. If title to the property subject to the
voluntary conversion is to remain in the name of the authority then the
appraisal should include any taxes to be paid pursuant to a PILOT, if
any. When the proposed development plan for the subject property creates
a potential real estate tax liability, then any appraisal of that
property should include, as an expense, the full real estate taxes if no
PILOT agreement is contemplated. If the appraisal assumes that any real
estate taxes will be subject to a PILOT, then evidence of such an
agreement must be provided as part of the appraisal.

[(6) Net Operating Income]{.underline} - The Net Operating Income (NOI)
of a property, sometimes known as the Net Before Debt Service is the
annual income from operating the property that remains after all
operating costs have been paid and the necessary deposits f rom
operating income to capital reserves have been made. Within the
pro-forma, NOI is the most key determinate of property value when the
Income Approach is the appraisal method used. For a housing authority
public housing property, the NOI is generally a negative number. It is
the subsidy provided by the ACC executed between HUD and every PHA
insures that the authority will not operate at a loss. However, once a
voluntary conversion has been completed a PHA can redevelop the subject
property in ways that create a positive NOI without the benefit of any
direct subsidy. This positive cash flow creates value where there was
none before and provides the justification necessary for the conversion.

[(7) Debt Service]{.underline} - When the post-conversion plan for a
public housing property will utilize debt of any kind then the Future
Market Value appraisal shall reflect the revenue generated to produce
net operating income and cover debt service associated with borrowed
financing. The underlying debt may be from a bank loan, a bond issue, a
loan from the PHA or other institutional debt. If the property has tax
credit investors who are entitled to a guaranteed return, then that
return shall be considered debt service in the appraisal. The voluntary
conversion process permits the consideration of different outcomes for
the rehabilitation, sale or other use of a property. Whenever one of
those scenarios includes debt, the debt service calculation must become
part of the appraisal for the evaluation of that option. Since debt is a
key element in determining the actual amount of the required investment
in a property, it can affect value. The example below provides some
guidance on the leverage that debt can bring to an investment.

Value in a real estate investment is created by Net Income within a
property (see below) after the payment of all expenses including debt
service, the presence of debt and the corresponding debt service has a
direct impact on the appraised value of the subject property.

[(8) Net Income]{.underline} - If the proposed re-use scenario for the
property includes debt service then the Net Income is the NOI less the
debt service. If there is no debt service and no LIHTC impact to be
considered, then the net income is equal to the NOI. Generally, the
presence of LIHTCs adds to the value of a property. This potential
result would occur after the conversion of a property if tax credits are
secured. Any tax savings associated with LIHTCs represents a source of
income to the tax credit investor that is not wholly dependant upon the
subject property and is therefore not part of the Net Income.

[(9) Capitalization Rate]{.underline} - The capitalization rate reflects
several factors including market conditions, perceived risk and
expectations of an investor regarding the rate of return desired by an
investor for capital invested in a venture. In general, the greater the
risk, the higher the return expected up to the point an investor
determines the risk associated with a project is not advisable. Public
housing represents a greater risk than conventional assisted housing and
as indicated in the example below requires a higher return for the
investor. The capitalization rate may also be dependant upon the use of
debt and the risk introduced by the borrowing associated with any
rehabilitation or reconstruction of the site. An investor's
Capitalization Rate may also change due to a desire to reinvest in the
community.

[(10) Value]{.underline} -- In this example the value is determined by
dividing the net income by the capitalization rate. This calculation
creates a simple statement of value. In the real world, however, the
determination of value is dependant upon many factors which will be
subjectively evaluated by the appraiser. Location, neighborhood
conditions, market demand and many other factors can impact the
appraised value of a property.

**Special Considerations:** Following is a list of special issues
relevant to operating public and assisted housing properties that impact
the operating income generated from properties, how they are financed
and recapitalized, and their potential market value. These particular
issues are identified for PHAs and appraisers to consider because of
their impact on the estimated market value for properties appraised
using an Income Approach.

[Utilities]{.underline} -- To encourage efficient tenant consumption, it
is HUD's objective for housing authorities to utilize individually
metered, tenant-paid utilities whenever it is feasible. In accordance
with 24 CFR 965.401, all utility service provided to residents must be
individually-metered through check meters or retail service, unless
individual meters are not practicable or permissible. Since the
"post-rehab" units will generally have individually metered utilities,
all "as-is" appraisals should be adjusted to that standard to avoid
skewing any comparison of the two appraisal results.

[Vacancy]{.underline} -- The establishment of a vacancy rate factor that
accounts for lost income for appraisal purposes can be a highly
subjective decision. If the rehabilitation of a property has been
anticipated for a long period of time the vacancy rate may have been
allowed to rise to reduce relocation costs. Appraisers may exercise
their professional judgment when considering management trends and
historical patterns regarding vacancies and lost rental income and how
these trends may be altered in the future under new management
practices.

[PNA]{.underline} - Maintenance funding may have been diverted to other
properties in anticipation of a voluntary conversion plan resulting in a
Physical Needs Assessment that is skewed towards high rehabilitation
costs.

[Low Income Housing Tax Credits (LIHTC)]{.underline} -- LIHTCs offer an
investor a fixed return over ten years that is based upon the cost of
the improvements to the subject property and the taxable income the
investor has to use stemming from the tax credits. This return is only
available to the original investor and requires that the property be
owned continuously by that investor for a period of ten years. While
LIHTCs increase the value of a property, they lessen the capital
investment required, may increase a property's Internal Rate of Return
(IRR) and provide more capital for redevelopment. If a property proposed
for conversion is eligible for, and has received a commitment of,
LIHTCs, the PHA shall provide this information to an appraiser for use
in a valuation analysis as is appropriate in accordance with their
professional judgment.

[Sample Valuation -- Income Approach]{.underline}

Project -- 100 units of public housing - 50 one bedroom units and 50 two
bedroom units.

AMI - \$50,000

Current Vacancy -- 20% Future Vacancy

Operated as: Public Housing Assisted

Rental Income

50 one bdr@\$500 per month (12% of AMI) \$300,000 \$300,000

50 two bdr@\$666 per month (16% of AMI) [\$400,000]{.underline}
[\$400,000]{.underline}

Gross Income \$700,000 \$700,000

Vacancy Rate or Allowance 20% PH [\$140,000]{.underline} 5% AH [\$
35,000]{.underline}

Effective Income \$560,000 \$665,000

EXPENSES

Operating expenses \$210,000 \$210,000

Capital Reserves \$ 50,000 \$ 50,000

Property Taxes [\$ 0]{.underline} [\$ 35,000]{.underline}

Net Operating Income \$300,000 \$370,000

Debt Service \$ 0 \$210,000

(mortgage \$3,000,000 w/.7000 debt service constant)

Net Income \$300,000 \$160,000

Capitalization Rate 10% 10%

Value \$3,000,000 \$3,700,000

Investment Required \$3,300,000 \$750,000

In this example, an investor has increased its risk by using debt to
leverage its investment while increasing its actual return on invested
capital to 22%.

**[B. Market Comparison Approach]{.underline}:** When the Market
Comparison Approach (Comparable Sale) is used to perform an appraisal,
the appraiser will look at all of the sales of similar properties within
a defined geographic area. An appraiser will identify whether there are
an adequate number of sales of similar properties within or near the
community in which the subject property is located. Generally, these
sales should have occurred within a year or two of the appraisal. These
properties must then be evaluated according to their similarity to the
subject property so that their sales price can be adjusted to reflect
any similarities or differences that might impact value. The actual
condition of the comparable property at the time of sale should be
determined and adjustments must be made in the value to reflect the
passage of time and differences in the two properties. The appraiser may
adjust for various factors including unit size, amenities, tax credits,
rental subsidies, changes in interest rates, and location. In large
metropolitan areas where there are frequent sales of assisted housing,
this can be an extremely accurate appraisal method. This is especially
true if the ultimate disposition of the subject property will include
mixed-income units or a mixed-use development for which there would be
fewer comparables in a rural community.

**[C. Tax-Assessment Approach]{.underline}**: There are rare instances
where this approach may have merit. *However, HUD, in its sole
discretion, will determine whether to accept a market analysis conducted
pursuant to this approach.* In some jurisdictions local assessors are
required to perform a fair market assessment of public housing and other
non-profit owned housing even though they do not pay real estate taxes.
In other instances, another affordable housing property may have been
the subject of litigation between the owner and the taxing authority
which established a definitive market value for the property within the
local market. Lastly, any existing PILOT agreement obtained by local
non-profit providers of affordable housing should be reviewed to
establish any long-term trends in taxation that might exist within the
subject community. If the subject property will benefit from a PILOT it
is reasonable that the agreement will expire before the evaluation or
test period used to determine project viability ends. A review of
established trends in existing and recently expired PILOT agreements
might offer some insight into whether these payments will escalate
dramatically at the end of the initial contract period.

These values, like all others, are subject to adjustment depending on
the differences and similarities between the subject property and the
comparable property. While the Tax-Assessment Approach is generally not
a precise estimate of market value there are instances when it can
clearly define the value of the subject property and therefore it should
not be overlooked. The negative aspect of the Tax-Assessment Approach is
that for political purposes some taxing authorities use highly stylized
valuation approaches when establishing the value of affordable housing.
Often these values bear no resemblance to reality, so special care must
be taken when considering this approach.

[**D. Cost Approach**:]{.underline} While the Cost approach would be of
little use in the initial Market Value Public Housing "as-is" appraisal
it will generally be at least an element of the Market Value for a
property planned for redevelopment or the "post-rehab" appraisal for a
property. The cost approach must take into account the value of the
land, which may or may not include the value of any remaining structures
if the original public housing was not demolished. Any additional costs
associated with environmental remediation would also become part of the
land cost. Added to this would be the cost of the physical improvements
to be made to the property. The sum of the land and improvement cost
would be referred to as the Hard Cost of the project.

Any costs associated with design, appraisals, bond financing, tax
credits, mortgages, real estate taxes during the construction period,
construction loan interest, relocation, advertising, and lease up costs
and any other expenses not related to the actual physical improvements
would be referred to as Soft Costs.

The total of Hard and Soft Costs becomes the Total Development Cost
(TDC) of the development. Depending on the extent of the improvements
being made to the subject property and the financing methods being used,
the TDC may differ significantly from the valuations arrived at within
the standard PNA prepared for or by the PHA. Determining this TDC value,
or cost, may become part of an appraisal using the income approach in
order to determine the amount of financing needed to support the TDC
improvements in addition to any investor capital that may be supported
by Low Income Housing Tax Credits (LIHTC.) As a general rule soft costs
can be expected to be at least as much as 20-30% of the total project
cost.

[Total Development Cost (TDC)]{.underline}

Rehabilitation of 100 units of 2 bedroom units

Hard Costs

Land (incl. buildings) 3,000,000

Demolition 400,000

Remediation 200,000

Construction [6,000,000]{.underline}

Sub Total Hard Costs 9,600,000

Soft Costs

Construction period interest 400,000

Real estate taxes 20,000

Contingency 460,000

Design 420,000

Legal 250,000

Overhead 600,000

Appraisals 20,000

Mortgage fees 120,000

Marketing 40,000

Miscellaneous [70,000]{.underline}

Sub Total Soft Costs \$2,500.000

[TOTAL DEVELOPMENT COST (TDC) \$12,100,000]{.underline}

TDC per Unit \$121,000

[**VIII. Paperwork Reduction Act**:]{.underline} The information
collection requirements contained in this document are approved by the
Office of Management and Budget (OMB) under the Paperwork Reduction Act
of 1995 (44 U.S.C. 2501-3520). The OMB control number is 2577-0075. In
accordance with the Paperwork Reduction Act, HUD may not conduct or
sponsor, and a person is not required to respond to, a collection of
information unless the collection displays a currently valid OMB number.

**IX.** Technical Assistance

Technical assistance is available for PHAs from the SAC.

U.S. Department of HUD

Special Application Center

77 West Jackson Blvd.

Chicago, IL 60604

\(312\) 886-9754

http:/www.hud.gov/offices/pih/centers/sac

[/s/]{.underline}

> Paula O. Blunt, General Deputy Assistant Secretary for Public and
> Indian Housing