Written by: Kenon Chen, EVP, Strategy and Growth, Clear Capital; and Emanuel Santa-Donato, SVP, Financial Products and Partnerships, Tomo Mortgage
With housing supply — especially affordable housing supply — near historical lows, more and more communities have turned to shared equity programs as a solution to maintain affordable housing stock for residents. Shared equity programs are growing across the country, and lenders and appraisers should understand the nuances of these programs to ensure accurate valuations.
What is shared equity?
Shared equity, in a nutshell, means that the appreciation of the property is shared between a program manager and all future owner-occupants of the property, and not just the owner-occupant at any given point in time. This structure creates perpetually affordable housing stock.
For example, a home in a shared equity program is sold at a below-market price, affordable to those making less than 80% of the Area Median Income. In turn, when it comes time to sell the home, that owner can’t realize any more appreciation beyond 2% per year. Anything in excess becomes “shared equity” and is passed on to future owner-occupants as the house will continue to transact below market price.
There are two main types of shared equity programs:
- Community Land Trusts: These are nonprofits that own land and sell their homes as leaseholds with ground rents to further enhance affordability. In these cases, a ground lease memorializes the shared equity program.
- Inclusionary Housing: Typically administered by housing authorities or municipalities, inclusionary housing policies require for-profit developers to create a percentage of units sold below market value. These are typically sold to lower-income homebuyers and the appreciation is capped through a deed restriction to maintain affordability.
Shared equity and valuation methodologies
Shared equity properties may have significant differences between sale price and market value, posing challenges for appraisers evaluating a shared equity property as well as when evaluating market rate properties in proximity to shared equity sales.
When the subject property is a shared equity property
A lender should specify in the appraisal order whether the subject property is a shared equity property. If it is not highlighted by the lender, the appraiser should review the income and resale restrictions in the purchase contract, and notify the lender before completing the order that it is a shared equity property. The contract will also likely reference a second document, either a deed restriction or a ground lease.
When appraising a shared equity property, you should first develop an independent assessment of the fair market value of the property to assist in determining the property’s leasehold value. A few things to watch out for:
- The contract price may be considerably below fair market value and should not influence the appraised value.
- To first establish a fee simple market value of the subject, it is important to use sales of homes outside the shared equity program.
- Fannie Mae’s guidelines for Appraising Community Land Trust Properties contain a more in-depth methodology for appraising homes specifically in community land trusts.
From a lender’s perspective, it may be acceptable for appraisers to develop the fair market value of a shared equity property. Lenders have their own set of guidelines on whether to use the market value or contract price to calculate Loan-to-Value (LTV) in the shared equity context. The lender is first looking for an assessment of what the property can be sold for on the open market without any restrictions.
When the subject property is not a shared equity property, but recent sales might be
Shared equity sales below market value should not affect the future appraised values of nearby properties. Appraisers are on the front lines of combating the incorrect narrative that shared equity programs in communities bring down home values. Tomo is working with dozens of shared equity programs and all build good, sound, market-quality housing and we see this argument as totally false.
As an appraiser, how can you help? Don’t include shared equity sales as comps (some may be on the MLS!) for any fair market value analysis. Here is how to identify them:
- Outliers — Do extra diligence on outliers. These shared equity properties can transact as low as 50% of market value.
- Leasehold — Applicable to community land trust properties, these sales will be indicated as leasehold rather than fee simple.
- Verify with publicly recorded documents. In most cases, the ground lease or deed restriction will be recorded at the county clerk’s office. These records are public and often available online.
Best practices for lenders selecting and working with a valuation provider
While there are a growing number of shared equity programs across the country, these transactions are less common than other types of housing. Selecting the right valuation provider is key. Here are some best practices for selecting and working with the right partner:
- Mission alignment — Shared equity programs are a solution to a common problem: housing affordability. Selecting a provider that shares a common vision of being a part of the solution, helps ensure priority of working through challenges together.
- Communication — Early and ongoing communication of the requirements and expectations is important. Geographic focus, property type, and expected fees are great conversations to have before the first order, so proper coverage and appraiser selection are in sync.
- Learn and iterate —More often than not, lessons will be learned on each assignment. Don’t let those learnings stay with the last appraisal. Carry them forward so the next appraiser can benefit from better information upfront.
Shared equity programs are a growing segment across the country and play a needed role in maintaining affordability. While their presence adds some nuance to appraisal methodology, key industry players like Clear Capital and Tomo are equipped to navigate this challenge. We agree that the proper appraisal methodologies will maintain market-rate home values in the community and stand to support the shared equity movement.
