Two Extremes of Residential Segregation (Part 2 of 3)
In the second part of this three-part blog series, we lay out some potential policy recommendations that could bring investment to areas of disinvestment. (You can read our more lengthy paper for Harvard’s Joint Center for Housing Policy’s April symposium in its full glory here.)
For many people, their home is their primary means of building wealth, and homeowners of color are most likely to face stagnant or declining home values as evidenced by our colleague’s recent post on the black and brown homeownership experience. If we care about Chicago’s glaring wealth divide, this matters. Second, if we care about inclusion, we need to address the very real barriers to people with options selecting a community in which the likelihood of their home losing value is high.
When property values are low, movement in the real estate market slows to a crawl and makes it less likely that traditional lending products will meet would-be buyers’ needs. [1] This is complicated by phenomenon known as appraisal redlining, in which appraisers systematically undervalue property in low-income areas. It’s been documented that “the appraisal industry has had relatively little experience with, and simply does not know how to value property in, non-white communities.” The combination of low real estate value along with poorly executed appraisals often results in a virtual standstill of market activity, as would-be investors and homeowners cannot get the credit they need to reinvest in the community.
The appraisal industry doesn't know how to value property in non-white communities.
We are interested in strategies to combat these challenges. To address the phenomenon known as the appraisal gap—in which the costs associated with rehabbing or constructing units is higher than the appraised value of the property itself—Chicago and Detroit have tried tactics to make up for this market failure and jumpstart reinvestment.
In Detroit in 2014, of 3,500 single-family home sales, 87 percent were cash sales—a number that does not even include homes sold in foreclosure auction. Conventional home loans are nearly impossible to come by due to the combined challenge of low land values and high rehab costs resulting from deferred maintenance. To combat this, the Detroit Home Mortgage Program allows buyers who qualify to borrow against the “true value”—replacement value—of a home rather than the appraised value. This program addresses the appraisal gap by offering two mortgages: One for the appraised value of a home and a second mortgage to cover the gap between the appraised value and the sale price of the home or the cost of renovations needed.
In Chicago, appraisal gap issues and lack of access to credit are less rampant overall than Detroit’s, but just as severe where they do exist. In the South side neighborhood of Englewood, for instance, 87 percent of 2012 home purchases in one census tract were cash, compared to 23 percent cash citywide. In 2009, values dropped so precipitously that nearly a quarter of sales in high-foreclosure areas were paid in cash for under $20,000. Cash buying is most prominent in high foreclosure areas, and it tends to signify the collapse of a more traditional homebuyer market in favor of one dominated by investors.
Basing lending so heavily on property values lead these areas to experience what Cook County Land Bank Authority President Rob Rose calls a self-fulfilling prophecy in the both the run-up and rundown of a housing bubble, as “irrationally exuberant” values build on themselves in a run-up and, when values disappear, collapse just as definitively. Several Chicago-based Community Development Finance Institutions (CDFIs) with strong track records have all designed products that allow would-be investors and owners to borrow based on ability to repay the loan instead of collateral value. Products like these, which can reach up to 140 percent of loan to value, work to establish value in areas that have experienced significant losses.
The City of Chicago recently announced a $2 million pilot for local contractors and developers to rehab vacant homes in disinvested areas called the Chicago Neighborhood Rebuild Pilot Program. Partially intended as a jobs program for out-of-work young adults, it is also intended to increase homeownership and property values in areas where both are below the citywide average. The Chicago Community Loan Fund, which administers the program, is able to reach 120 percent loan to value, and has recruited a loan loss reserve/first loss capital fund to provide the credit enhancement these markets demand. [2] While its current iteration is supported by one-time surplus funds from unclaimed property tax rebates, we are interested in exploring sources to expand it in similar markets across the city.
While CDFIs in the Chicago area have worked hard to fill the gaps caused by traditional lending criteria, we advocate for its expansion to any community reaching certain criteria. This expanded criteria would undoubtedly reach into large swaths of south suburban Cook County as well as city neighborhoods. Criteria could include percentage of foreclosures, percent of mortgage activity compared to overall transactions, etc. Could traditional lenders could provide credit enhancement and count the loans in their Community Reinvestment Act portfolio? We’ll be exploring this question.
A nascent proposal for a national Neighborhood Homes Tax Credit would provide a substantial boost to this framework. Modeled after the Low Income Housing and New Markets Tax Credits, the Neighborhood Homes Tax Credit would focus on homeownership for disinvested areas suffering from appraisal gaps, with the credit bridging the financing gap between the cost of construction or rehabilitation and the sales price of the home. The proposal is not yet a bill, but has substantial support from groups such as NeighborWorks and the National Association of Affordable Housing Lenders. Notwithstanding valid criticism of over-reliance on tax credits versus directly allocating benefits, their use and proliferation is pragmatic rather than an almost certainly doomed fight for direct allocations for investment in struggling areas. When the President threatens to “send in the Feds” to Chicago, we wish it were actually a promise to do so with the kind of investment that would make the Neighborhood Homes Tax Credit unnecessary. Until then, we support its development and passage.
Revised lending criteria and improved appraisals would positively impact a large portion of the Chicago region’s disinvested areas, making them more likely to be places that allow homeowners to build wealth and attract investment and inclusion.
Research Assistant Andres Villatoro contributed to this research. Read Part 1 and Part 3 of this series.
[1] We refer in this post to individual homebuyers in particular. For corporate investors, a bottomed-out real estate market is ideal due to low prices and high inventory in close proximity, and cash sales are not a barrier. While responsible investor ownership of formerly single family homes is certainly an improvement over buildings sitting vacant, community-based groups with which we work would prefer actual homeowners in single-family homes. We therefore refer to the barriers and needs of these individuals in this section.
[2] The Chicago Community Loan Fund’s Neighborhood Investor Lending Program lends 90 percent Loan to Cost and maxes out at 120 percent Loan to Value. Both features are non-conventional and allow more distressed properties to be financed. For example, if a property cost $30,000 to acquire and $70,000 to rehab and thus had a total development cost of $100,000, CCLF could make a loan of $90,000 as long as the appraisal was at least $75,000, resulting in 120 percent Loan to Value. The $15,000 gap in this scenario would stop most lenders from making this loan. CCLF’s balance sheet and loan loss reserves that they have recruited for this purpose allow them to finance the deal, but if they had more at-risk capital on hand, they could finance properties with larger appraisal gaps. A 140 percent Loan to Value in this scenario would represent a property appraising at approximately $64,000 ($26,000 gap).