Providing equity in affordable housing means compromising ó we want to provide as much equity as possible, so the owner will feel "vested" in the property and so the owner can develop some wealth. At the same time, we must limit equity so that the property stays affordable over the long term.
This compromise is accomplished through limiting the equity that an owner can accumulate. The amount of equity is set by a formula, which is usually in the organizationís Articles of Organization (if it is a co-op) or Declaration of Trust (for a condominium), or deed restriction (for a stand-alone home).
There is no one best formula. Different formulas work best in different situations. Following are some of the most common formulas used for equity limitation:
1. Equity is limited to one dollar forever. The rationale behind this is that since owners are really not accumulating significant equity anyway, they should not be fooled into thinking that they are. (ARCH does not support this type of formula)
2. Equity is limited to the amount invested, plus an allowance for inflation. The inflation is usually determined by the Consumer Price Index. A variant on this increases the value as invested by the development. The appreciation is often capped at 5% per year.
3. Equity is limited to the amount invested, plus an allowance for inflation, plus the value of improvements installed by the owner. This can get a bit tricky. First, the value of the improvements must be approved by the Board at the time of installation. The value must be set at market value, not the cost to the owner (purple shag carpet may be expensive but it does not increase the value of the unit). Second, improvements generally depreciate over time. This must be built in. In our experience, residents of limited equity cooperatives rarely make significant improvements, and this clause is often more trouble than it is worth. For limited equity condominiums, the level of vesting by the owner is greater and improvements are more frequent, so this is more important.
4. (Condos only) Equity is limited by a formula which may include the elements above, but also includes a factor for the mortgage principal reduction. This allows the owner to retain the amount corresponding to the amount he/she has paid down the mortgage. Note that without this, a condo owner may be forced to sell at a loss. For example, a $101,000 condo ($1,000 down for this example) is occupied for 10 years and the mortgage is paid down from $100,000 to $80,000. If equity is limited to the $1,000 down plus interest, the owner will be forced to sell for about $82,000.
Equity formulae for condominiums can get quite complicated. For further assistance contact ARCH.
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