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8. Capital for Small Rental Properties: Preserving a Vital Housing Resource
- Brookings Institution Press
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277 Nearly one-fifth of the rental housing stock in the United States is in smaller, multifamily apartment buildings with five to forty-nine units. Although relatively large shares of these units are occupied by lower-income families, the overwhelming majority is unsubsidized, and many are at risk of loss owing to disinvestment or conversion to higher-income occupancy. Unfortunately, little is known about the property ownership, management, and financial condition of this housing. What is known is that the scale and value of these properties makes it difficult for the current owners to achieve economies in property management and to absorb the high fixed cost of gaining access to debt or equity capital needed to operate, maintain, and preserve these units. Indeed, in a paper prepared for the Millennial Housing Commission, the Finance Task Force notes that financing for apartment buildings with five to forty-nine units “is one of the most significant gaps in the mortgage industry.”1 Drawing on previous work by Shekar Narasimhan, this chapter explores the potential for developing innovative new housing and capital market strategies targeted to the small, unsubsidized multifamily rental stock.2 We use the U.S. Census Capital for Small Rental Properties: Preserving a Vital Housing Resource william c. apgar and shekar narasimhan 8 1. Millennial Housing Commission, Finance Task Force, Policy Option Paper, “Small Multifamily Properties” (October 1, 2001) (govinfo.library.unt.edu/mhc/papers/smallmf.doc), p. 1. 2. Shekar Narasimhan, “Why Do Small Multifamily Properties Bedevil Us?” Capital Xchange, November 2001 (www.brookings.edu/printme.wbs?page=/es/urban/capitalxchange/article8.htm). 278 william c. apgar and shekar narasimhan Bureau’s Residential Finance Survey and other data to examine the ownership, management, and condition of the housing in five- to forty-nine-unit properties, both in general and in comparison with the same elements confronting owners of properties with fifty or more units. In many ways, the distinction between five- to forty-nine-unit properties and those with two to four units is an artificial one created by the secondary-market practice of combining single-family and two- to four-unit properties into a common category. Although they differ in terms of some aspects of financing, on the ground a four-unit and a five-unit property have much in common. Small multifamily rental properties, defined for this chapter as multifamily properties with less than fifty units, are important in meeting the housing needs of low-income households, and the owners of these properties face special problems. What would it take to expand access to capital for this segment of the housing market? Currently, this market niche is filled by depository institutions at a relatively higher cost to the borrower. There is reason to believe, however, that investment and lending in the small-property market can be profitable. A number of creative lending institutions have engaged successfully with this sector, and the capital markets are now actively testing models.3 Other new initiatives are under active consideration by industry leaders. These include expanding information sharing among lenders for benchmarking, improving mortgage insurance products , and creating a new rating system for small-property owners akin to the credit-scoring systems used to rate the likelihood that borrowers will repay home and consumer loans.4 Although most of the literature on small-property finance focuses on debt, this chapter explores the possible role that equity-side solutions could play. One solution proposed here is the creation of a federally sponsored small real estate investment trust (S-REIT) that would aggregate ownership of older, smaller multifamily properties with low or modest rents. Although this model has not been undertaken by the market, the concept makes economic sense. To test this proposition , we recommend piloting an S-REIT type aggregation strategy using an essential function bond approach, as the structural components are in place to begin executing this structure without regulatory changes. An S-REIT structure would allow properties to be financed on a portfolio rather than a property-by-property basis and would bring economies of scale and professional management to what is generally a poorly managed segment of the housing market. This model also holds the potential to improve the efficiency of federal subsidy mechanisms, for example, by developing the potential for allocat3 . Examples of these lending institutions include Shorebank (www.shorebankcorp.com) and the Community Preservation Corporation (www.communityp.com/). 4. Comments made at Improving Management and Capital of Mid-Sized Rental Property...