September 18, 2015
Why Credit Rating Agencies Exist
Robert Rhee has posted Why Credit Rating Agencies Exist to SSRN. The abstract reads,
Although credit rating agencies exist and are important to the capital markets, there remains a question of why they should exist. Two standard theories are that rating agencies correct a problem of information asymmetry and that they de facto regulate investments. These theories do not fully answer the question. This paper suggests an alternative explanation. While rating agencies produce little new information, they sort information available in the credit market. This sorting function is needed due to the large volume of information in the credit market. Sorting facilitates better credit analysis and investment selection, but bond investors or a cooperative of them cannot easily replicate this function. Outside of their information intermediary and regulatory roles, rating agencies serve a useful market purpose even if credit ratings inherently provide little new information. This alternative explanation has policy implications for the regulation of the industry.
I do not think that there is much new in this short paper, but it does summarize recent research on the function of rating agencies. Rhee’s takeaway is that, “given their dominant public function, rating agencies should be subject to greater regulatory scrutiny and supervision qualitatively on levels similar to the regulation of auditors and securities exchanges.” (15) Amen to that.
September 18, 2015 | Permalink | No Comments
Friday’s Government Reports
- The Government Accountability Office (GAO) has released a report, Affordable Rental Housing, which points out that there are initiatives on the state, local and federal level which address this issue, however they are not always well coordinated, often overlap, and there is “incomplete information to assess performance.” Without sufficient information, the GAO argues it is impossible for Congress or other agencies to set appropriate spending priorities and assess performance. GOA’s recommendation is for the U.S. Department of Housing and Urban Development to work with state and local entities to develop a coordinated assessment and reporting structure.
- Also from the GAO, Pay for Success: Collaboration Among Federal Agencies Would be Helpful as Governments Explore New Financing Mechanisms is a report which describes Social Impact Bonds (SIBs). SIBs are a mechanism by which investors pay for social outcomes and receive an agreed upon return based on the success of the program or as GAO put it, “contracting for social outcomes.” According to the GAO SIBs can be useful in reducing the cost of providing social services while improving success. While the use of SIBs has been limited so far the Office of Management and Budget has been encouraging Federal Agencies to test their potential effectiveness. This GAO report analyzes SIBs that have already been piloted, for example the Department of Labor awarded $24 Million in grants in 2013 to reduce recidivism in New York and Massachusetts. One fear is that SIBs could create perverse incentives. SIBs could eventually be used to finance affordable housing development.
September 18, 2015 | Permalink | No Comments
September 17, 2015
Valuing Rental Property
Money quoted me in Here’s How Much You Should Pay for a Rental Property. It opens,
Q: I want to invest in a rental property. Is there a formula I can use to determine the value of a building based on the rent it takes in?
A: One useful calculation to use is the capitalization (or “cap”) rate, which is the ratio of net rental income to the purchase price of the property, says Brooklyn Law School professor David Reiss.
Start with your gross rental income, which is simply the total of one year’s worth of rents for all of the units combined. Subtract 5% or so to account for occasional vacancies throughout the year. It’s safest to use existing rents, but you can conservatively increase the amounts if you are planning to improve the units and raise rents.
Then add up the yearly operating expenses — property taxes, insurance, utilities, plus at least 5% of gross income for a maintenance/repair fund — and subtract that from the annual income. To get your cap rate, divide that number (the net operating income) by the purchase rate.
Run the Numbers
Let’s say you’re buying a five-family house and anticipate gross annual income of $100,000. If you calculate your total annual operating expenses at $30,000, you end up with $70,000 in net operating income. For a property that cost, let’s say, $1 million, that equates to a 7% cap rate.
But is 7% a worthwhile return on your investment for the work and risk of being a property owner and a landlord?
“But if you’re talking about a rundown building, in an borderline neighborhood, with a several vacant units that you’re planning to fill after you undertake major improvements, you might reasonably hold out for a 20% cap rate,” he explains, because you’ll have renovation costs on the expense side, perhaps a higher vacancy rate while you fix it up — and you’re taking a bigger risk with your money.
Using a Mortgage
Also, the cap rate assumes a cash purchase. When you take a mortgage to buy an investment property, lenders will likely demand a down payment of 25% or more, says Reiss.
So in that case, he suggests also calculating your return on upfront costs.
In our example, if you invest $300,000 in upfront costs (down payment plus other initial expenses like closing costs and renovations) and expect to earn $20,000 a year (after $50,000 annual mortgage payments), that’s just under a 7% annual return on your money.
Again, you need to consider the relative risk of the particular investment property to determine whether that payback rate is high enough. Look at several properties to get a better feel for how the risks and rewards compare.
September 17, 2015 | Permalink | No Comments
Thursday’s Advocacy & Think Tank Round-up
- Corelogic’s Second Quarter U.S. Equity Report indicated that over three-quarters-of -a-million properties regained equity, while 4.4 million remain in negative equity over the same period. Aggregate negative equity fell $28 billion from $338 billion to $309 billion. According to Corelogic this reduction is caused both by foreclosure completions and home price appreciation.
- According to a study by the National Association of Realtors (NAR) new home construction is trailing job growth in major metro areas. NAR sees this as the primary reason for the affordability crisis now gripping the nation in many of the same areas.
- The National Fair Housing Alliance (NFHA) has filed a complaint with the U.S. Department of Housing and Urban Development (HUD) against certain real estate agencies and individual realtors who are alleged to have treated black and latino buyers in Jackson Mississippi in drastically different ways than they treated equally qualified white buyers. According to the NFHA complaint white buyers were shown a wider variety of homes while black and latino purchasers were largely steer into majority minority neighborhoods.
- The NHFA, in a related vein, also released a study entitled Where You Live Matters – 2015 Fair Housing Trends Report which draws a stark parallel between the historic lack of investment in communities of color and the racial disparities in educational, social, and economic outcomes that have resulted.
- NYU’s Furman Center has released a Brief entitled Black and Latino Segregation and Socioeconomic Outcomes which finds that the burgeoning Latino population in the U.S. is largely “inheriting the segregated urban structures experienced by African Americans.” This segregation seems to lead to reduced socioeconomic prospects when compared with whites, including lower earnings, more violent crime, less access to credit and lower homeownership rates.
September 17, 2015 | Permalink | No Comments
September 16, 2015
Does Historic Preservation Destroy Affordable Housing?
The Real Estate Board of New York released a report about Rent Regulated Units in Landmark Districts. The report opens,
This analysis was conducted to examine the frequent assertion that landmarking helps preserve existing affordable housing. It is based on data that recently became publicly available that provides a snapshot of the number of rent-stabilized units in 2007 and again in 2014.
Contrary to statements made by advocates, affordable housing is not preserved at higher levels in NYC’s historic districts. The data shows that properties located within New York City’s historic districts showed a greater net loss of rent regulated apartments than those located in non-landmarked parts of the City.
FINDINGS
An analysis of the data found that, from 2007 to 2014, the decline in the number of rent regulated apartments located within New York City’s landmarked properties was four times higher than in non-landmarked parts of the City.
Citywide, landmarked properties showed a much greater decrease in the number of rent stabilized units (-22.5%) than non-landmarked properties (-5.1%). At the end of this seven year period, there was a net loss of nearly 10,000 rent-stabilized units in landmarked districts in the City.
The Manhattan and Brooklyn numbers are particularly startling. Manhattan landmarked properties lost 24.5% of their rent-stabilized units compared to a loss of 11.5% in nonlandmarked properties. And Brooklyn landmarked properties lost 27.1% of their rent-stabilized units compared to 3.4% in non-landmarked properties.
The historic districts that had the highest net loss of rent stabilized units were Greenwich Village (-1432 units) and the Upper West Side/Central Park West (-2730 units). Combined, these two historic districts showed a decrease of 30% in rent stabilized units during this seven-year period. (1, footnotes and references omitted)
This study has been criticized for conflating causation with correlation. I think the criticism is warranted. The relevant question appears to be whether landmarking causes an increase or decrease in the number of rent stabilized units. The REBNY study does nothing to demonstrate causation.
Intuitively, it would seem that residents of hot neighborhoods like Greenwich Village would both seek to keep out new, large developments (which landmarking would achieve) and see higher and higher rents over time (which would lead to a reduction in rent-regulated units through a variety of mechanisms). It is not obvious how landmarking itself would lead to a reduction in rent stabilized units.
It is a shame that the REBNY study is so flawed. It raises important questions, but just leaves us more confused than before. There are serious arguments that historic preservation reduces affordable housing overall. If REBNY wants to take a meaningful position in this debate, it should produce a serious study.
September 16, 2015 | Permalink | No Comments
September 15, 2015
Gentrification and Displacement
Miriam Zuk et al. have posted a Federal Reserve Bank of San Francisco Working Paper, Gentrification, Displacement and The Role of Public Investment: A Literature Review. The paper opens,
The United States’ metropolitan areas’ ever-changing economies, demographics, and morphologies have fostered opportunity for some and hardship for others. These differential experiences “land” in place, and specifically in neighborhoods. Generally, three dynamic processes can be identified as important determinants of neighborhood change: movement of people, public policies and investments, and flows of private capital. These influences are by no means mutually exclusive – in fact they are very much mutually dependent – and they each are mediated by conceptions of race, class, place, and scale. How scholars approach the study of neighborhood change and the relative emphasis that they place on these three influences shapes the questions asked and attendant interventions proposed.
These catalysts result in a range of transformations – physical, demographic, political, economic – along upward, downward, or flat trajectories. In urban studies and policy, scholars have devoted volumes to analyzing neighborhood decline and subsequent revitalization at the hands of government, market, and individual interventions. One particular category of neighborhood change is gentrification, definitions and impacts of which have been debated for at least fifty years. Central to these debates is confronting and documenting the differential impacts on incumbent and new residents, and questions of who bears the burden and who reaps the benefits of changes. Few studies have addressed the role of public investment, and more specifically transit investment, in gentrification. Moreover, little has been written about how transit investment may spur neighborhood disinvestment and decline. Yet, at a time when so many U.S. regions are considering how best to accommodate future growth via public investment, developing a better understanding of its relationship with neighborhood change is critical to crafting more effective public policy.
This literature review will document the vast bodies of scholarship that have sought to examine these issues. First, we contextualize the concept and study of neighborhood change. Second, we delve into the literature on neighborhood decline and ascent (gentrification). The third section examines the role of public investment, specifically transit investment, on neighborhood change. Next, we examine the range of studies that have tried to define and measure one of gentrification’s most pronounced negative impacts: displacement. After describing the evolution of urban simulation models and their ability to incorporate racial and income transition, we conclude with an examination of gentrification and displacement assessment tools. (2, footnote omitted)
Because gentrification is such a contested topic both within and without the academy, this literature review is very useful. Notwithstanding the fact that the results of many of the studies mentioned are mixed, the authors were able to identify certain findings that emerge from the literature. These include,
- Neighborhoods change slowly, but over time are becoming more segregated by income, due in part to macro-level increases in income inequality.
- Racial segregation harms life chances and persists due to patterns of in-migration, “tipping points,” and other processes; however, racial integration is increasing, particularly in growing cities.
- Despite severe data and analytic challenges in measuring the extent of displacement, most studies agree that gentrification at a minimum leads to exclusionary displacement and may push out some renters as well. (44-45)
As hot cities like New York and San Francisco struggle with their changing housing markets, policy makers should make decisions based on the best available research on gentrification and displacement. This literature review provides a guide.
September 15, 2015 | Permalink | No Comments
