They say diamonds are forever. The same can be said about market studies—at least for most affordable housing developments. The long-term implications of decisions made based upon market study data can be a make or break for a project. Thus, extreme care must be taken to procure the most in-depth study possible and to pay close attention to the results. I advocate a “hurt me” market analysis. I know developers who work hard to get a market study to support a project. Instead I suggest the opposite tack. We want to see all of the ugliness, warts, and imperfections that are revealed by the process of deep-dive research on a market.
One of the first areas where mistakes are often made is in defining the market area for a specific project. We want to see this area shrunk to realistic proportions. It really doesn’t matter whether the community is large or small, people just aren’t going to drive long distances to work nor are they inclined to relocate within the larger expanse of a market area. For example, in a rural community with a population of 7,000, it’s generally unrealistic to think that someone in a town of 2,500 just 10 miles away will relocate and move to the larger community. Thus, the market area for a new project in that community of 7,000 should be restricted to the city limits for study purposes. Likewise, in a larger market of several hundreds of thousands or even millions of people, the market area should probably be defined to include the immediate neighborhood as well as those corridors to major employers where residents might work. But expecting that a resident will drive more than three to five miles is probably too aggressive of an assumption.
Another pitfall to be avoided is the belief that homeowners can be converted to renters, particularly for senior projects. We’ve been involved with developments in rural communities where we thought we could attract seniors living on farmsteads to move into town and occupy a new apartment at a very affordable rental rate. Do you know how hard it is to convince an older person to move at all—much less from a home they’ve owned for decades? And often, the value of their property causes the senior citizen to be overqualified. Some traction can be gained converting homeowners to renters, but this is a dangerous strategy if a property is dependent upon a conversion of this type.
What is the denominator? Ultimately, we’re looking for the eligible renter pool and what percentage of that pool we need to capture to fill our project. The eligible renter pool becomes the denominator for this analysis. Thus determining the eligible renter pool becomes the real challenge. We need to identify the maximum income level a renter can earn to qualify for the property, and we also need to know the minimum income level using 30% to 35% of monthly income as a rule of thumb. I’ve seen market studies that don’t establish a floor on income, which assumes that renters who earn nothing still qualify for the project. Unless there are project-based Sec. 8 vouchers, this is a flawed approach and unrealistically expands the renter pool.
The professionally prepared market study will identify the proper rent levels for a prospective affordable housing development. Here’s a common trap of which to beware: Our product will be the newest and the nicest in the market. By extension, this means that we should also command the highest rents as well. Or does it? There certainly is some truth to this notion, and in a larger market (100,000 population and larger), being toward the top end of the market is less problematic. But in a town of 20,000 people with market-rate rents topping out at $650, do we really want to bring our low-income housing tax credit (LIHTC) project online at $675 or $700? In a case like this, it’s better to find a way to bring our rents down to at least 10% to 15% below market. This may cause us to abandon a proposed project if we can’t bring the rents down, but it’s better than creating a long-term disaster.
One final area for caution is with the supply analysis. Often a market study will focus on substandard housing in the area. And a developer may believe this presents an opportunity to fill the new project. The problem comes in the rent differential that exists between a ramshackle single-family house and the rate for new LIHTC product. If a substandard single-family home is being rented for $250 per month and LIHTC rent on a new project is $495, it’s going to be tough to convince someone living on a fixed income that it’s worth paying another $245 for better quality housing. The advice here is to look very carefully at this differential, and if it’s more than $75 to $100, don’t count on filling a property with renters from this housing stock.
Market studies are a treasure trove of data and can help guide the successful development of an affordable property. It’s important to make certain to pay attention to what the data is really revealing and not use it to check a box and rubber-stamp the project.
R. Lee Harris, CRE, CPM, is president and CEO of Cohen-Esrey, LLC, an Overland Park, Kan.-based family of companies involved in affordable housing development, market-rate apartment acquisitions, construction, syndication, and property management. He can be reached at email@example.com.