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Valuation of Real Estate
By Frederika Bremer
10/14/12
There are three methods of valuing real estate. The Cost Approach is pretty simple and is used by your insurance agent for your fire insurance policy. It calculates how much it would cost to replace your house if it was totally destroyed by a fire. In the San Francisco Bay Area, the current replacement costs are over $200 per square foot. If your house is historic and you pay an extra premium you can have it replicated with all its special character defining elements like the wood multilite windows. That would mean that your insurance premium for, say, a modest 1,400 square foot two bedroom house would be based on a replacement cost of close to $300,000.
The second method of valuation is based on the sale of comparable properties in your neighborhood. If you look at comparable sales regionally, you will find that that same modest house would sell for about the a bit more if it were not in Vallejo. Property values in Oakland, a similarly challenged city, are currently based on $230 per square foot. If our example small 2 bedroom house was located in Oakland it would sell for around $320,000. Houses in view districts add over $100,000 to the price.
But in Vallejo where the real estate market is driven by investors, that same house is valued by the third method, the Income Capitalization approach. This means that the value is based on how much an investor can rent it for less all the costs except debt service. The highest rents are achievable through the Section 8 market, assisted and encouraged by the City of Vallejo policies and programs. For that same small Vallejo house, the HUD Housing Choice Vouchers set the value at about $1,200 a month. Management costs are minimal since rents are transferred electronically right into the investor’s bank account. Nor are there any marketing costs as the property can be listed on gosection8.com. The actual market value is determined through applying a magic number called the Capitalization Rate which averages about 0.07. So the valuation of that same house, based on HUD vouchers based on gross rents of about $15,000 less taxes, insurance and maintenance divided by the Cap rate would be about $170,000. If the home was not Federally subsidized, the same rental property would be about $120,000 since market rents are less than the HUD vouchers.
In Vallejo, many of our neighborhoods are less than 20% owner occupied. So all residential property in Vallejo is valued and sold as income property which then provides the Comparables that set the value of owner occupied properties. The City pursues HUD subsidies because they provide a 20% administrative fee. Given the over 2,000 Choice Vouchers, this adds up to about $36 million a year with over $7 million going directly into the Vallejo Housing Authority’s dedicated budget. The over 2,000 additional Project Based Vouchers (201 Maine and others) are negotiated directly by HUD in San Francisco. No one knows how many Choice Vouchers come into Vallejo from other cities but the sending jurisdiction is paid the administrative fee even though Vallejo bears the brunt of the social costs. So the overall value of real estate in Vallejo is driven by HUD’s subsidized housing and poverty programs.
Let’s do the math. Given the City of Vallejo’s economic strategy of relying on Federal subsidies, the overall valuation of real estate for the City’s tax base is about half what it would be if City staff pursued a strong middle class home ownership economic strategy. Many of the historic neighborhoods around the downtown are within an easy walk to the ferry terminal and many homes have spectacular views. Given that the market for housing in San Francisco is overheating, that same small two bedroom home in San Francisco would rent for over $3,000 per month and, if owner occupied, would sell for over $700,000. Capitalizing on Vallejo’s view districts, the overall valuation for tax purposes would increase. If Vallejo positioned itself in relationship to the San Francisco market which is feasible because of our ferry, Vallejo’s overall valuation for tax purposes would increase substantially and we could hire many more police officers. But we might not need them because as the middle class increases and the poverty class decreases, the requirements for public safety services would decline in tandem.
The effect of the City of Vallejo’s current economic strategies on the General Fund is catastrophic. The only real beneficiaries are the investors and those that administer the programs. The extremely low income families we purport to serve cannot move up and out of poverty if there are no jobs, failing schools and unsafe neighborhoods. If we really want more officers on the street and less crime, the first thing we need to do invert the investor/homeowner ratio so that we can build the middle class. If we really want to help the poor and disadvantaged, we need to stop herding them into places that will keep them from thriving.
We often hear that we need development….anything and anywhere…to fix our economic woes. The real estate developer’s favorite mantra is “retail follows roofs” which is the rule in the suburbs. But that has an unstated corollary. It only works for middle and higher class roofs. When the roofs cover low income rentals, surrounding retail can’t survive and it flees. So building the middle class would result in more commercial development and retail with an increase in the sales tax. And, as the middle class grows, firms needing a dependable workforce would follow. The General Fund would increase with the larger real estate tax base and sales taxes. With that increased tax revenue we could build more parks and recreation opportunities that might keep poor kids off the streets and reduce juvenile crime. This is not rocket science. Anyone who can balance their checkbook can figure it out. Odd that the experts in the City of Vallejo’s Economic Development Department can’t.
NEXT: Externalities or how to shift costs off your balance sheet and onto the taxpayer
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