Calculator User's Manual

Updated: January 15, 2018

Introduction

Grounded Solutions Network created the Inclusionary Housing (IH) Calculator to help advocates, policymakers and other interested stakeholders understand the economic issues involved in designing an inclusionary housing policy.  The IH Calculator is a simple on-line development pro forma which allows users to model a real or hypothetical development project and then add affordable housing requirements in combination with different development incentives.  In this way users can get a sense of what might be economically reasonable for a given jurisdiction trying to set inclusionary housing requirements and offer developers meaningful incentives.

This manual provides a general introduction on how to use the IH Calculator and provides guidance on basic real estate terms and key assumptions.  As with the Calculator itself, this manual is meant to provide general guidance and is not a replacement for professional financial feasibility analysis. 

What is the calculator useful for?

The Inclusionary Housing Calculator is both a teaching tool for illustrating the economic principles that are relevant to inclusionary housing, and a practical analytical tool for understanding the feasibility of requiring different types of community benefits (e.g., inclusionary housing) for a specific project.  The Calculator also provides users with a menu of different hypothetical project types to provide a starting place for understanding the feasibility of inclusionary requirements in the context of these prototypes. 

What should the calculator not be used for?

The Calculator should not be used a replacement for a detailed financial feasibility analysis prepared by a trained urban economist.  The Calculator can put users in the “ball park” of what might be economically reasonable for a specific project or policy, but it does not replace the need for careful background market analysis to thoroughly vet assumption, nor does it provide the in-depth training needed to integrate those assumptions into a development pro forma. 

What methodology does the calculator use?

The IH Calculator is built off of a “static” pro forma, meaning that it takes a look at a single point in time in the future at stabilized occupancy for rental developments and at the completion of initial sales for for-sale developments.  The calculator is not a multi-year cash flow, which is another type of pro forma often used by developers, investors and real estate development consultants.   A cash flow model is likely to be more accurate but it is much more complex to  set up. 

Who should use the calculator?

Anyone who's interested in testing some assumptions on a development prototype to see if an inclusionary affordable housing requirement would work can use the calculator.  This includes city or county staffers, housing advocates, elected or appointed officials, and any average citizens interested in trying to increase the supply of affordable housing in their communities. 

Which inputs make the most difference?

There are just a few inputs that make the greatest difference to the bottom line results of the Calculator:
  1. Average per square foot hard construction costs.  Usually between 60 and 70 percent of development costs can be attributed to materials and labor, so this assumption drives most of the cost side of the equation.
  2. Average rental rates or sales prices.  Average monthly rental rates for rental projects and average sale prices for for-sale projects are the most important assumptions on the revenues side of the equation.
  3. Capitalization rates.  For rental projects, even small changes in the “cap rate” can make a big difference in terms of the profit calculation since this variable is used to translate net operating income in stabilized year into total project value. 

Getting better data to refine the estimates

The best source of data is usually a recent development pro forma for a comparable project to the one that is being tested using the calculator.  Developers sometimes share these with cities or counties as part of development negotiations if the local jurisdiction is involved in the transaction through a land sale, the provision of subsidy or some other type of public involvement.  Otherwise it can be hard to get developer pro formas since many developers consider these proprietary.  If consultant feasibility studies are available, these can also be a helpful source of information about both cost and revenue assumptions. 

When to seek professional advice?

When communities are unsure how to structure a new inclusionary housing policy or rework a policy that isn't yielding results, Grounded Solutyions recommends that communities seek professional advice from an urban economist specializing in this type of analysis.  Typically, it's best to issue a request for proposals (RFP) to get the best thinking and most competitive price from a number of consultants interested in doing this type of study.   

Inputs

Project

Description

You can enter a name for the project or a brief description of the type of project that you are modeling. This text will be used to identify the project in the list of saved projects and will appear on your output reports.

Base Units

Enter the number of residential housing units in your project. For most projects this is just the total number of all units in the building – including both market rate and any affordable units.

For projects that include a ‘density bonus’ this is the number of units before the bonus. You can add bonus units by adjusting the ‘density bonus’ slider under incentives. That will increase the number of units to a total that is higher than the number of ‘base units’ entered here.

There is no typical number of units but there are typical numbers of units per acre. Detached single family homes can be as low as 1 or 2 units per acre, while high rise buildings can include more than 100 units per acre.

The Lincoln Institute for Land Policy has a helpful tool, Visualizing Density, that illustrates the number of housing units per acre for many common housing types. (datatoolkits.lincolninst.edu/subcenters/visualizing-density/tour/t4.aspx)

Make sure that the number of housing units (Base Units) is appropriate for the size of the parcel. The calculator shows the units per acre in an info box in the right panel.

If you set the Site Area to 1 acre, it is easier to understand the density of your project because whatever you include for the number of units is also the number of units per acre.

Site Area

Enter the size of the parcel of land that the project will be built on.

If you are unsure of the parcel size, you might want to assume a 1 acre site. Make sure that the number of housing units (Base Units) is appropriate for the size of the parcel.

The Lincoln Institute for Land Policy has a helpful tool, Visualizing Density, that illustrates the number of housing units per acre for many common housing types. (datatoolkits.lincolninst.edu/subcenters/visualizing-density/tour/t4.aspx)

Parking Ratio

The parking ratio is the number of parking spaces per housing unit.

The calculator asks for the cost of building parking spaces under Development Costs. In addition, under Incentives there is a slider to lower the parking ratio by a given percentage.

Some buildings will have as many as 2 parking spaces per housing unit but, increasingly. builders are including fewer parking spaces. Because parking spaces are expensive, particularly in higher density buildings, lower parking ratios can dramatically reduce the cost of a building and make it more profitable.

Common Area

This is the portion of Building Dedicated to Common Area. Space within a residential building is generally put into two categories: individual units and common areas. Common areas include hallways, lobbies, community rooms and other common spaces not inside of individual residential units. Common areas are measured by the total percentage of a building’s square footage, which meets this description.


A typical common area range for most residential buildings in the US is from 10 to 20%.

Recently developed projects in the local area are the best place to look. These projects will help you to understand what common area percentage to use. In some type of buildings, larger community spaces are more popular. In areas where land is expensive, developers try to maximize the amount of space they can rent or sell in the form of individual residential units.

Commercial Space

The calculator is built to model residential buildings but, in urban areas, many residential buildings include ground floor commercial (often retail space). It may be easier to understand the project economics if you assume no commercial space but for modeling real projects, we offer the option to include some commercial space and commercial rent. However, in order to keep the calculations simple enough to explain, we assume that any commercial space costs as much to build as residential space. This may not be a realistic assumption so it works best when the share of commercial space is small.

Commercial Rent

Enter the rent per square foot per month for commercial tenants, if there are any. If there is no Commercial Space, this won't make any difference.

You can find commercial rents by speaking with a commercial real estate broker. In some communities, it is more common to talk about commercial rent per foot per year. In those cases, you will have to divide by 12 before entering the rent into the calculator.

Other Rental Income

Enter any other expected rental income (per month) such as income from parking or storage space rental. If you are modeling a real project, you can adjust this number to match the total revenue that the developer is expecting. If you are not modeling a particular project, it may be simpler to leave this at $0.

Unit Mix

You can drag the circular handles in the Unit Mix pie chart to adjust the mix unit sizes in a project. The calculator tracks the percentage of units of each type. If you change the number of units it will keep the same mix.

Different developments will commonly have different unit mixes. For example, a single family home subdivision will tend to have 2, 3 and 4 bedroom units while an urban mid-rise apartment building may be mostly studio and 1 bedroom units.

Unit Specifications

Average unit size is measured by square feet per unit. Units within a building can vary by type (studio, one-bedroom, two-bedroom, etc.) and by size. This combination of unit sizes is called a unit mix. You can adjust adjust the number of units by type and size and also change the average unit size.

Average unit sizes for a building vary because of market preferences and locations. In general, you can assume:

o 500-750 square feet for a studio unit,

o 600-850 square feet for a one-bedroom unit,

o 750-1,000 square feet for a two-bedroom unit, and

o 1,000 square feet and more for three- and four-bedroom units.

Websites like Trulia.com and Zillow.com provide listings of currently renting or selling units in your local area. These listings can help find average unit sizes. The best source of information is usually a developer or market analyst. They will have current information on what types of units are most popular in the local market.

Average Market Rent

The average rental rate is measured per unit per month. The average is based off of the detailed unit mix listed under Unit Specifications.

You can adjust the average either by changing the Average Rental Rate Slider or by changing either the rents for each type of unit or the number of units of each type under Unit Specifications.

There is no typical average rental rate. Market conditions differ from place to place. The rental rates used in the Calculator are for actual developments in three market scenarios:

• strong (ex. San Francisco, New York City),

• mixed (ex. Denver, Salt Lake City, Chicago), and

• weak (ex. Detroit, Cleveland).

The best source of rental rate information is usually a developer or market analyst. These individuals often have current information on trends and comparable projects. Websites like Trulia.com and Zillow.com can also provide listings of current market rents in your local

Data Sources:

• Trulia provides for-sale and rental housing market data in an accessible and easy to use format. Trulia data should be used with caution as it is not always current or comprehensive. (trulia.com)

• Zillow provides estimates of housing market data for free through an easy to use on-line format. Like Trulia, it should be used with caution as the data is not always current or reliable. (zillow.com)

• HUD collects rental housing data for both small and large markets. When other sources are not available, HUD’s 50% percentile rent estimates are a good place to start.(www.huduser.org/portal/datasets/50per.html)

• Real also provides current rental housing market data based on their proprietary database of large professionally managed apartment complexes in major US markets. (www.realanswers.biz/real-research.html)

• NAHB/Wells Fargo Home Price Index provides for-sale and rental housing market data in an accessible and easy to use format. This index should be used with caution as the data is not always current or comprehensive. (www.nahb.org/en/research/housing-economics/housing-indexes/housing-market-index.aspx)

Average Sales Price

The average Sale Price is measured per unit. The average is based off of the detailed unit mix listed under Unit Specifications.

You can adjust the average either by changing the Average Sale Price slider or by changing either the rents for each type of unit or the number of units of each type under Unit Specifications.

There is no typical average sale price for either detached units or units in a condo building. Market conditions differ across the country. The sale prices used in the Calculator are for actual developments in three market scenarios:

• strong (ex. San Francisco, New York City)

• mixed (ex. Denver, Salt Lake City, Chicago), and

• weak (ex. Detroit, Cleveland).

As with rental rates, the best source of information is usually a developer or market analyst. These individuals often have current information on trends and comparable projects. Websites like Trulia.com and Zillow.com can also provide listings of current market sales in your local area.

Realtors can also sometimes have a sense of what sale prices are in a given location. Realtors based these estimates on their experience and access to Multiple Listing Service (MLS) data.

Revenue Data Sources:

• Trulia provides for-sale and rental housing market data in an accessible and easy to use format. Trulia data should be used with caution as it is not always current or comprehensive. (trulia.com)

• Zillow provides estimates of housing market data for free through an easy to use on-line format. Like Trulia, it should be used with caution as the data is not always current or reliable. (zillow.com)

• DataQuick collects for-sale market data for most major markets. In some cases this data is available for free through DQ News. (www.corelogic.com/landing-pages/dataquick.aspx)

• NAHB/Wells Fargo Home Price Index provides for-sale and rental housing market data in an accessible and easy to use format. This index should be used with caution as the data is not always current or comprehensive. (www.nahb.org/en/research/housing-economics/housing-indexes/housing-market-index.aspx)

Affordability

Area Median Income

The Area Median Income is a standard measure of the incomes in each community in the United States. You can find the AMI for your area on the website of the US Department of Housing and Urban Development (HUD): (www.huduser.org/portal/datasets/il/il15/index.htm).

Local housing and community development departments also publish an annual update of AMI levels. These updates are always the best source if available, as the AMI targets might be adjusted according to local housing needs.

This input will be the same for every project in a metro area. You should be able to set it once and never change it until HUD publishes a new AMI the following year.

Homebuyer Mortgage Rate

Enter the interest rate that buyers of Below Market Rate affordable homes in the project will expect to pay on their first mortgage loans. This is used to calculate the maximum affordable purchase price.

Regional mortgage rate averages are available at BankRate.com. Some cities have adopted rules for pricing affordable homes which include specific assumptions that should be used here.

Property Taxes

Enter the annual property tax rate in the jurisdiction. This is used to calculate the maximum affordable purchase price for Below Market Rate units.

The local property tax assessor (or any local homeowner’s tax bill) is the best source for the local tax rate. The national average for residential property taxes is 1.38%. The Tax Foundation publishes averages for each state. (taxfoundation.org/how-high-are-property-taxes-your-state) Responsive image

Insurance

Enter the annual cost of homeowner’s insurance as a percent of the value of the home. The calculator assumes that homeowners insurance costs 0.35% of purchase price. Most users will not need to adjust that assumption.

Some cities have adopted rules for pricing affordable homes which include specific assumptions that should be used here.

HOA and Other Costs

Enter the monthly cost of Home Owners Association (HOA) dues or charges, if any. These charges are common for condominium or planned unit development projects.

In 2015 the average HOA fee was $331 but the amount varies quite a bit by type of project and even between different regions.

Trulia tracks average HOA fees in different parts of the country. (www.trulia.com/blog/trends/hoa-fees)

Affordability Standard

The affordability standard is the percentage of a person’s total income available for all housing costs. Total housing costs include rent, mortgage payments, utilities, and other housing costs.

For rental housing, the national standard is 30%. This means that a housing unit is considered “affordable” when the occupants pay no more than 30% of their total income on housing costs. For ownership housing (and occasionally in some rental housing programs), the standard is sometimes adjusted up to 33% or 35%.

Local housing and community development departments are the best places for affordability standards. Note, standards can differ between affordable housing programs. Standards are usually available in program documents or from program staff.

Assumed Downpayment

Enter the assumed level of a homebuyer’s down payment. This number is used to estimate the maximum affordable purchase price for below market rate homeownership units.

This is typically 3 or 5%.

Some cities have adopted rules for pricing affordable homes which include specific assumptions that should be used here.

Affordability Levels

Inclusionary Below Market Rate units are generally restricted for sale or rent to only households that earn less than some target income. The income targets are set as percentages of Area Median Income. Different programs target different income levels. The lower the income level targeted, the more deeply discounted the rent or sales price will be.

The most common targets are 30%, 50%, 60%, 80%, 100%, and 120% of Area Median Income. The calculator adjusts the income targets to reflect different household sizes that are expected to occupy each unit size. The calculator assumes 1 person per bedroom plus one. As a result a 3 bedroom unit will rent for more than a 1 bedroom unit even when both are targeting 80% of AMI.

The calculator shows the actual income corresponding to each income level. (Make sure to update the Area Median Income above to the AMI for your area.)

Note, in less expensive markets it is important to be careful not to set affordability targets that are so high that ‘below market’ units are actually priced at or above market rate. Even if they are slightly below market, they may be hard to sell or lease.

Affordable Units Breakdown

Most inclusionary housing programs target all of their affordable units to households at or below a single income limit. However, the calculator allows for including affordable units priced at up to three different target income levels. This allows modeling more complex policy alternatives where some units are more deeply subsidized than others. We recommend sticking to a single income target for simplicity. Programs with multiple income targets can be much more difficult to administer.

Incentives

Developers often receive incentives to include a certain percentage of affordable housing units. The Calculator allows users to adjust the following types of incentives:

Density Bonus

Density bonuses let developers build more market-rate units in the same building than standard planning and zoning rules allow. The density bonus is the most common type of incentive. Density bonuses allow usually between 10% and 25% more units.

Tax Abatement

Some jurisdictions provide annual abatement (or forgiveness) of property taxes per rental unit. The abatement increases the amount of income that the property generates which can then be turned into value. This abatement varies by jurisdiction but is usually no more than $1,000 per unit per year.

Streamlined Processing

Cities will speed up planning and permit processing in exchange for including affordable housing. This streamlining can save between 1-12 months for a developer. While many jurisdictions offer streamlined processing, these programs don’t always translate to real savings to developers.

Fee Reduction

Cities can provide a per unit dollar savings to developer for including affordable housing. These savings take the form of reduced local development and impact fees. These savings can be up to $10K per unit.

Parking Reduction

Many cities require developers build a certain number of parking spaces per unit, known as a parking ratio. Cities will reduce this parking ratio for a developer if they include a certain amount of affordable housing. This reduction of the parking ratio is usually between 10% and 25%.

Cash Incentive

Some jurisdictions provide a direct cash incentive or grant to help offset the costs of building inclusionary units. Cash incentives are usually only used in areas where no other incentive is workable or meaningful. This cash` incentive is usually no more than $10,000 per affordable unit.

Development Cost

Construction Costs

Construction hard costs are measured in dollars per gross square foot. These costs are one of the most important numbers for a developer. In most cities and for most projects, construction hard costs make up between 60 and 70 percent of total development costs.

Construction hard costs include all construction material, labor, and general contractor overhead. General contractor overhead are hard costs not used in construction (like a temporary office space, or equipment rental.) An extra 15% is often included as a contingency to account for costs above what was estimated.

A “gross” square foot means the total space of all residential units and common area in a building including hallways and other circulation space. Some sources will list construction hard costs per net square foot (NSF). The NSF of a building includes only the space inside the residential units and excludes hallways, and other common areas.

These hard costs do not include expenses like architectural fees or permitting costs. These costs are included in the input for Soft Costs.

Construction costs differ between locations and are not always related to land cost. For instance, some cities, like Detroit, have low land costs but high labor and construction costs. Construction costs also depend on building type. Buildings built with wood-frames are much cheaper than those built with steel-frames. However, steel frames are required for taller buildings for reasons of fires safety.

The following table provides some representative per square foot costs from RS Means: Responsive image

Detailed construction cost data can be purchased through RSMeans.com. Yet, RS Means estimates can often be very different from the actual costs for real projects. To estimate the cost of construction it is best to find the costs for several projects of similar location, design, and construction type.

Note that the calculator breaks out the cost of constructing parking from the cost of constructing the residential structures. When looking up construction costs in other sources pay attention to whether parking is included. If it is included, you may need to remove parking costs from the total construction cost and enter the result here.

Land Cost

Often the hardest single assumption to get is the cost of land. Unlike other assumptions, there are fewer good sources of data on land. Speculation in the land markets also makes it difficult to get reliable information.

Land costs are measured in dollars per acre. These costs are determined by factors like: how many stories you can build on an acre (zoned density), how much demand there is for land, and landowner expectations.

There is no one typical land cost, even for similar zoned parcels in the same city. In cities like San Francisco or New York, there is a high demand for land and land costs can be as high as $10-$25M per acre. In cities where there is less demand for land, land prices might be $500,000 or less per acre.

The best data is often from companies who buy and sell land. These companies include real estate brokers and appraisers familiar with the local market. Data is also available in real estate market reports called “comps.” These reports written by professional consultants, list land sales of similar types of properties.

Data can also be found in a study of land prices by state published by The Lincoln Institute for Land Policy. (datatoolkits.lincolninst.edu/subcenters/land-values/land-prices-by-state.asp)

Cost Per Parking Space

Parking costs are measured by dollars per parking space. The IH Calculator breaks parking costs out by space to allow for the easy changes of the parking ratio. The parking ratio is the number of parking spaces compared to the number of units in the building. Some cities require a specific parking ratio to ensure enough parking for residents. However, developers have an incentive to reduce the number of parking spaces because of the high cost to build. In some cases, developers incorporate the cost of building structured parking into the per square foot Construction Costs.

Parking is one of the biggest costs involved in building multifamily buildings. Parking costs grow in areas where surface parking isn’t possible or desirable. There are several different types of parking in residential and mixed-use buildings including:

o Above-grade parking garages ($20-$35K per space);

o Below-grade or underground parking ($35-$45K per space); and

o The cheapest option, Surface parking ($1,000 per space depending on the site and the landscaping involved).

Like construction hard costs, parking space cost estimates can be purchased through RSMeans.com The best way to get information, though, is to look at similar recent developments with the same type of parking.

Be careful not to double count construction costs for parking. Parking construction costs should be entered here and not included in the hard construction cost input above.

Sales and Marketing Costs

Enter the sales commission and other marketing costs as a percent of the sales price of the property. This will typically be 3-5% of the price. Enter 0% if sales costs have already been included in soft costs.

Other Soft Costs

Most costs that are not related to materials and labor are referred to as soft costs. Soft costs are measured as a percentage of total hard costs. Soft costs include:

o architectural and engineering costs;

o legal and insurance fees;

o planning approval fees;

o environmental clearance and building permits (also called entitlements);

o development impact fees; and

o Other professional consulting fees or costs not connected to the physical building of the project.

Soft costs range from 20 to 30 percent of hard costs. This range depends on how complicated the project is to design and build and how long the entitlements (planning and permits) process takes.

Developer "pro formas" are a good source for soft costs. Local real estate experts and city planning staff familiar with local development conditions can also help.

Note that the Calculator separately itemizes financing costs, sales and marketing costs, and development impact fees. These costs are often included in soft costs. If you find a source for soft cost information, check to see whether it includes these items, and if it does, subtract them out and enter them separately in those fields.

Other Development Costs

Use this input for any other cost of development that might be separately itemized. For example, some jurisdictions require developers to make significant improvements to the area as part of the project. These improvements include things like new sewers, streets, or sidewalks, which can be very expensive. Since these requirements vary by jurisdiction it’s difficult to estimate a range of costs.

Residential Impact Fees

Impact fees, sometimes called Development Charges or Development Fees, are measured in dollars per unit. Impact fees are sometimes used to cover the costs the increase of local public services needed for the new development.

In more expensive cities, $10,000 per unit and more is typical. In other cities, fees are relatively insignificant or may not exist.

A summary of a jurisdiction’s development fees can often be found online. This summary is often on the Planning or Housing & Community Development department website. Local developers are also sometimes a good source of information based on recent projects that they’ve built.

The Brookings Institution also has published this report on residential impact fees. (www.brookings.edu/~/media/research/files/reports/2003/6/metropolitanpolicy-nelson/nelsonimpactfees.pdf)

Condo Wrap Insurance

Condominium Wrap Insurance is measured by dollars per unit. This insurance is only for ownership projects. Developers of for-sale condominiums buy “wrap insurance” that covers any potential risks and liabilities during the construction and sale of all the units. Once the units are sold, a homeowners association (HOA) is usually responsible for paying insurance costs.

Costs vary according to how risky the particular development is and how long the initial sales period is likely to take.

The best sources for wrap insurance are developers and insurance brokers that specialize in wrap insurance. They will be able to provide how much wrap insurance will cost for a given development type and location.

Read more about wrap insurance here: www.ccim.com/cire-magazine/articles/its-wrap/?gmSsoPc=1

Operating Cost

Rental Vacancy Rate

Enter the expected share of units that will be vacant in a typical month after the building has been fully leased up. Even a well-managed building with high demand will have some vacancy rate because of the time it takes to fill vacancies. Where demand is high, vacancy rates may be 5% while in softer locations they may be 10% or higher.

Rental Operating Cost

Enter the percentage of annual revenue that a rental property owner must spend to manage and operate the building. This cost will include things like utilities, trash, security, property management, maintenance, insurance, and taxes but should not include mortgage payments.

These costs generally run somewhere between 30 and 50% of income. The difference between different cost assumptions can make a big difference to feasibility.

A 2015 National Apartment Association survey found that the average operating cost for properties less than 5 years old was 35% of income.

Financing

Often projects require multiple sources to finance and create profit for a project. This layering of sources is complex and can be difficult to understand.

This section describes several of the main methods used to finance and make profit on a development. To simplify the pro forma analysis, the Calculator assumes a single source of debt (i.e. loans) and also a single source of equity (i.e. existing developer or investor funding).

Construction Loan Interest Rate

The construction loan interest rate is what a developer pays on the loan that they take out to build the project.

Interest rates fluctuate depending on conditions in the national economy. These conditions include the Federal Reserve prime rate, local market conditions, and lender underwriting standards. We’ve seen interest rates anywhere from 4.5% to 8% in recent years, with 4% to 5% being typical in strong market settings in 2015.

Local developers and lending institutions (i.e. banks) will have access to the latest information on construction loan interest rates.

Loan to Cost Ratio

Loan to cost ratio is the percent of total development costs that the developer pays for by taking out a loan. The rest of the money used is equity (ether the developer’s own capital or equity from an investor). Some analysts also refer to this as the Loan to Value (LTV) ratio.

A developer would like to get this number as close to 100% as possible. A ratio of 100% would mean that they were able to borrow all of the cost of developing the project and didn’t have to invest any of their own money (or any equity from investors). Higher ratios (closer to 100%) will result in higher rates of return because the more a developer can borrow the less equity they need to invest. Lenders, on the other hand, prefer to keep the loan to cost ratio well below 100% to provide a safety cushion in case things go wrong.

Typical loan to cost ratios range from 60% to 80%. The ratio can vary due to market conditions, lender underwriting standards, and developer creditworthiness.

Local developers and lending institutions will have access to the latest information on loan to cost ratios for construction loans.

Period of Initial Loan

The period of initial loan is the number of months over which the developer must pay interest on the loan. Generally, the period is the same as the time that it takes to build the project. The longer a project takes to build, the more interest a developer must plan to pay on their construction loan.

Anywhere from a year to three years for most developments would be typical. More complicated projects could have longer loan periods.

Local developers, lenders, and sometimes planning department staff are the best sources of guidance for this assumption.

Initial Construction Loan Fee

Loan fee or Points is a one-time fee that the developer must pay at the start of the loan. Loan fee or Points are measured as a percentage of the total loan amount.

Points of anywhere from 1% to 2.5% of the total loan are typical. In some markets, fees may be higher along with interest rates. Points will also depend on the creditworthiness of each developer. Creditworthiness is an analysis by a lender of the likelihood a developer will not be able to pay back a loan. A lower creditworthiness would mean a higher Points.

Local developers and lending institutions will have access to the latest information on fees/points.

Average Outstanding Balance

Developers typically draw down on construction loans gradually over the period of construction so they don’t have to pay interest on the full amount at the start. They only pay interest on what they have drawn down at any point. In the first months of construction they owe very little and in the last months they owe nearly the whole loan amount. In order to calculate the total amount of interest paid by the project, we need to know roughly how much of the loan is owned on average each month.

Another way to think of this is, at the middle point in the construction period, how much of the construction loan will have been drawn down. The higher the Average Outstanding Balance, the more the total cost of construction loan interest.

50% to 60% is typical in most cases. Smaller projects with a shorter time frame might have much higher average outstanding balances. This higher balance is because there is less time to draw down the loan.

As with the other assumptions in this category, developers and lending institutions will be the best source of information.

Permanent Loan Interest Rate

Enter the interest rate for the financing on the property after the completion of construction. Often this is lower than the construction interest rate because it is a less risky loan. This input is used in the calculation of the Internal Rate of Return (IRR).

Permanent Loan Term

Enter the number of years for repayment of the permanent loan. Generally this is 20, 25 or 30 years. Longer loan terms result in lower monthly payments. This input is used in the calculation of the Internal Rate of Return (IRR).

Profitability

Measure of Profitability

The calculator includes several alternative calculations that each measure the extent to which the project is profitable. There is no one single measure that truly captures everything that a developer cares about. However, in order to make comparisons possible the calculator asks users to choose a single measure to consider. Each of the measures are described below.

Profit Percent of Cost

Return on Cost is a simple measure of the rough profitability of development. I t compares the value of the project after completion to the cost of development.

For example if a project is “worth” $10 million but it only cost $9 million to develop there is a profit of $1 million. The profit of $1 million is 11% of the $9 million cost which means that the developer earned 11% “return on cost.”

One advantage of the Return on Cost measure is that is can be used to compare the relative profitability of rental and ownership projects.

Yield on Cost

Yield on cost is a profitability metric used to compare the profitability of rental properties. It measures the annual Net Operating Income relative to the cost to develop a project. The formula is simply NOI divided by Total Development cost.

For example if a project cost $9 million to develop and has an annual Net Operating Income (NOI) of $450,000 then the Yield on Cost is 5% (450,000/9,000,000).

This is also a very rough measure, but for rental property owners who intend to hold a property, Yield on Cost provides a better measure of profitability than Return on Cost.

IRR

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Residual Land Value

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Required Profit

This is the ‘hurdle rate’ for the return on cost calculation.

Required profit is the profit needed as a percentage of total costs to undertake a project. Below that required profit percentage, developers are unlikely to move forward with a project.

The typical range for required profit is 10%-20%. This range is based on a review of consultant reports and developer pro formas from across the country. In riskier markets, developers and their investors may expect higher profit margins. In stronger markets, lower profit goals are acceptable because higher demand for housing means investors face less risk. The less risk, the lower return an investor will demand.

The best sources for local profit data are real estate experts, market analysts, and local planning and community development staff. They often have an idea of what profit expectations are in the local marketplace.

Individual developers also are a good source of information. But they are sometimes not motivated to share this information.

Required Yield On Cost

This is the ‘hurdle rate’ for the Yield on cost calculation.

Required yield is the yield needed to undertake a project. Below that required percentage, developers are unlikely to move forward with a project.

The typical range for required profit is 4% to 9%. In riskier markets, developers and their investors may expect higher yields. In stronger markets, lower profit goals are acceptable because higher demand for housing means investors face less risk. The less risk, the lower return an investor will demand.

The best sources for local profit data are real estate experts, market analysts, and local planning and community development staff. They often have an idea of what profit expectations are in the local marketplace.

Individual developers also are a good source of information. But they are sometimes not motivated to share this information.

Cap Rate

The capitalization rate, or “cap rate”, is the ratio between the net operating income (total income minus operating expenses) and the project's value. Cap rates are used to calculate the value of a rental property and is reflected as a single percentage figure. Lower cap rates result in higher values.

Cap rates differ between different project types and markets and depending on the level of risk. Nationally, the average cap rate for apartment buildings in 2014 was around 5.5%, according to Integra Realty Resources. (www.irr.com/_FileLibrary/Publication/16/IRR_Viewpoint_2015.pdf)

The range was from 4% to 8% for newly built Class A properties. Stronger markets like San Francisco or New York have lower cap rates, and weaker markets like Detroit or Buffalo have higher cap rates. When in doubt, start with the national average and then make adjustments as needed. Responsive image

Cap rate data can sometimes be hard to find, and there is often as much art as science involved in setting appropriate cap rates. Integra Realty Resources is a good place to start.

You should also look at local reports from real estate brokers and market analysts to supplement this data. Different brokerage firms will provide alternative estimates of prevailing cap rates. This variation is due to their sources of transaction data and understanding of the market.