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Ways to Recapture Subsidy
in Affordable Housing

Limiting Speculation in the Resale of Affordable Housing That Was Developed With Significant Subsidy

Nonprofit developers typically use significant amounts of public subsidy in order to make their housing units affordable. The idea, however, is to provide long term housing solutions for low-income families and not to provide "get rich quick" scheme for shrewd home buyers. For this reason, such developers are often interested in putting in place some kind subsidy recapture mechanism to discourage speculation. To be practical the subsidy recapture mechanism should be relatively straightforward and understandable to the buyer. It should also be relatively easy to administer. Here are four ideas:

SUBSIDY RECAPTURE

The buyer signs a promissory note for the value of the subsidy, which may include the value of public benefits like fee waivers, density bonuses, free land, staff time, etc., as well as any cash subsidy.  The buyer executes a mortgage to secure payment of the promissory note. The mechanism ensures that the property is not sold without your knowledge and repayment of the loan.  The mechanism is self-enforcing because them mortgage is recorded in the Public Record and any buyer of the property would have to deal with it if they hoped to get clean title.
  • This type of promissory note would not add to monthly payments to be made by the homebuyer. The note carries a below market interest rate and would requires no monthly payment. It just sits there earning interest. The interest and original loan amount would be due and payable ONLY upon sale or transfer of the home or if the home buyer fails to use the property as their primary residence. Optionally, repayment can be required if the property is refinanced. Another option could be a provision for waiving some or all of the interest in order to protect the home owner's equity if there is little or no appreciation during their term of ownership.
  • The silent second mortgage mechanism maintains the affordability of the property to the initial owner while discouraging that owner from immediately selling the property and obtaining a windfall.
  • This type of mortgage can be structured so that the principal balance is forgiven if the homeowner remained in the home for a set period of time (for example, ten years). Or it could be structured so that a certain percentage of the principal (for example, 10%) would be forgiven each year that the homeowner remained in the home until the entire principal was forgiven.
  • It's very easy for the owner and the administrating agency to forget about these loans. For that reason it may be a good idea to make an annual statement to the borrowers advising them of their loan balance every January.
  • One problem with this approach is that in an inflationary market you doesn't earn enough interest to subsidize a new unit when the loan is repaid.

EQUITY SHARING

With equity sharing -- usually it's really a shared appreciation mortgage or SAM -- the local agency receives a share of the sales price when the home is sold. The SAM essentially indexes the value of the subsidy to the local housing market. A $20,000 subsidy that represents 20% of a typical $100,000 home today is always worth 20% of that home's value. If the home's value inflates to $300,000, the value of the subsidy grows to $60,000. This hopefully enables the local agency to help another home buyer buy into the market in the future.

SAMs tend to work well in strong real estate markets and during inflationary periods. They do not perform very well in deflationary periods -- no recapture mechanism does. SAMS are complex to explain and administer. There are lots of potential pitfalls, including the handling of deferred maintenance, credit for improvements and sham (below market) sales. And if the local market goes wild, your share of the appreciation will probably be insufficient to help a new household become a home owner.

"RECORDABLE REGULATORY AGREEMENT"

The "recorded regulatory agreement" operates differently than a silent second mortgage. Essentially, it is a recorded agreement that provides that the initial owner and all subsequent owners, in return for a highly subsidized initial purchase price, are required to resell the property only to a qualified low income buyer at an artificially low price (usually the original purchase price plus some small yearly percentage increase and any capital improvements). Often such regulatory agreements will also grant the subsidizing governmental entity an option to purchase the property at the preset resale price if the owner claims that they cannot find a qualified buyer.

The major advantage of the regulatory agreement is that it provides a continuing subsidy to future generations. However, it has several serious drawbacks. Primarily, it imposes a significant ongoing administrative responsibility on the enforcing governmental entity. Owners, including second and third owners, will constantly need to know the price at which they can sell their property and the income limits of potential buyers. The enforcing governmental entity must be constantly monitoring so that it can respond to such inquiries. There is also a continuing educational requirement as second and third owners are often largely unaware of the purpose of the original affordability program. Additionally, while an affordable home with a forgivable second mortgage can be resold by any real estate agent, most real estate agents will not handle transactions involving regulatory agreements due to the restrictions on the sales price and the potential buyers. Finally, the artificially low resale prices can have a depressing affect on market rate resale prices in the subdivision which can make the subsidy program unpopular.


COMMUNITY LAND TRUST

The Community Land Trust may be a better approach when you want to create permanently affordable housing stock rather than simply recapturing subsidy. A Community Land Trust is an organization that buys property in the community and then leases it back on long term basis (e.g. 99 years) to low income residents. The leaseholds can be bought and sold but the price is based their value as housing and not upon speculative considerations. The reason for this is that the persons occupying the housing it do not own the underlying "fee" ownership interest. Leaseholds can also be inherited. It is a tool that can be used to fight gentrification since the residents would pay taxes based only the assessed value of their leasehold interest and not on the constantly escalating value of underlying "fee" ownership interest.  There might be problems in getting developers to build houses on such property since the projected appraised value for the completed unit may be too low to support financing for the cost of construction.