3_ 333. 333 33 3333 33 333 3333333 33333 3,-1.2;‘353 ~ go . 9L2. Mr- ‘. a :3 31 5' t ‘2 WI 103 w .53" :1.‘ $ 7’s. 1. ‘I “3 F“, v i '53 . ' “a 'y , :2" e a 9 \a'O'J.‘ .J‘J. . I' .zz'dl"! r-m . J ~-a.. .,.3~ olfl‘ I...)J O u.’ not! 5: u; ..f ‘ ' 'k“. ‘2‘- l > 3?“ lath-gs ~'\‘W"-" ‘0 "' .‘. . .kViu I.‘ 1‘: - I v_ § i Vf’ « .° 1 i 5 ‘1' f‘; 9 at? v ’ v\\~ ‘ O . O. 9.. 1‘! " a“ Kr '. 4&5" \ 1n .— .. V "V AW”: ' v. .‘. 1‘ ‘ I a. r—w. :5; 'I LL- l’f" ‘2 .. E.§<.;"\.Q' ‘3 z . "‘1' l v: I V “i w H“ ‘l:.“ ABSTRACT CREATING THE MODERATE INCOME HOUSING INVESTMENT UNDER SECTION 221(d)4 OF THE NATIONAL HOUSING ACT BY Thomas Erroll Bradley The purpose of this research project is to create a housing investment under Section 22l(d)4 of the National Housing Act, as amended. Notwithstanding the present Federal moratorium on subsidy funds for low and moderate income housing, Section 22l(d)4 is currently funded and affords developers the opportunity to develop new rental housing which can be syndicated. The housing investment is created through the formulation of a hypothetical housing development upon a site near the city of Saginaw, Michigan. The housing market is analyzed to determine the demand for market rate rental housing, a suitable site is selected within the market area and the project economics are structured such that the project is economically feasible and provides the developer and the investors with reasonable returns. The author concludes that profitable housing investments can be structured under Section 221(d)4 and that developers would be prudent to consider housing developments under this federal housing program. CREATING THE MODERATE INCOME HOUSING INVESTMENT UNDER SECTION 221(d)4 OF THE NATIONAL HOUSING ACT By Thomas Erroll Bradley A THESIS Submitted to Michigan State University in partial fulfillment of the requirements for the degree of MASTER OF SCIENCE School of Packaging 1974 Copyright by THOMAS ERROLL BRADLEY I974 To my parents whose inspiration and assistance has made this work possible. ii ACKNOWLEDGMENT I wish to express my sincere gratitude to Mr. Roosevelt Ridgeway, of the Ridgeway Development Corporation, for providing basic information regarding the housing site used and to Mr. Hallison H. Young, Esq. of the law firm of Patmon, Young and Kirk Professional Corporation, for his consultation regarding the maze of federal income tax laws. iii TABLE OF CONTENTS INTRODUCTION ........................... 1 Chapter I. MARKET ANALYSIS ...................... 3 II. PROJECT DESCRIPTION .................... 9 III. MORTGAGE AND INTERIM FINANCING ............... 13 IV. ECONOMIC FEASIBILITY .................... 14 V. STRUCTURING THE SYNDICATE ................. 18 VI. CONCLUSION ......................... 3l BIBLIOGRAPHY ........................... 32 APPENDIX A ............................ 34 Comparable Property #1 Comparable Property #2 APPENDIX B . . . ......................... 36 Michigan State Housing Development Authority Simplified Feasibility Formula iv a... O ...| o ‘0 co N 0'! 01 -b O.) N O O O O O O 0 LIST OF TABLES POPULATIONS, EMPLOYMENT AND CONSTRUCTION TRENDS ........ 4 HOUSING COMPOSITION AND OCCUPANCY CHARACTERISTICS ....... 5 RENTER OCCUPANCY CHARACTERISTICS ............... 7 RENTAL RATES AND UNIT MIX ................... 8 DEVELOPERS WORKING CAPITAL REQUIREMENTS ............ l3 PROJECTION OF DEVELOPMENT EXPENSES .............. 16 PROJECTION OF ANNUAL OPERATIONG EXPENSES ........... l7 PROJECTION OF INCOME AND CASH FLOW .............. 20 PROJECTION OF INCOME TAX LOSS, DISTRIBUTION AND CASH GENERATED PER UNIT OF INVESTMENT ............. 26 STATEMENT OF CASH REQUIREMENTS AND SOURCES OF FUNDS TO MEET CASH REQUIREMENTS ................ 30 LIST OF ILLUSTRATIONS l. Site Location Map ....................... lO 2. Site Photographs ........................ ll vi INTRODUCTION The purpose of this research project is to create a housing investment under Section 221(d)4 of the National Housing Act of 1968. There is a wide spread interest in the housing industry today in developing housing under FHA housing programs. However, developers feel that they must shift from developing new subsidized housing to new unsubsidized housing, due to the federal government's shift in preference from subsi- dized housing programs. Section 221(d)4 provides a developer with an excellent opportunity to produce new unsubsidized housing through creating an investment which can be syndicated. Section 221(d)4 of the National Housing Act of 1968 is a FHA insured market rate housing program. Under this program FHA provides mortgage insurance of up to 90% of the estimated replacement cost of a housing project. Both the mortgagee and the mortgagor must be approved by FHA and the project must meet all FHA design standards, as well as other governmental requirements. Only profit motivated mortgagors are acceptable by FHA.1 A limited partnership is utilized as our investment vehicle and the limited partnership will own 100% of the housing project developed herein. Under this type of ownership, FHA disallows the typical cash builder's profit based upon the estimated construction cost in favor of a 1U.S., Department of Housing and Urban Development, Digest of: Insurable Loans and Summaries 9f_0ther Federal Housing Administration Programs (Washington, D.C.: Government Printing Office,71970), pp. 59-60. I 2 Builder Sponsors Profit and Risk Allowance,2 and requires a 10% equity investment on the part of the developer.3 However, through the principle of "financial leverage" it is possible to create a housing investment which, when syndicated, produces an excellent return to the developer as well as provides a handsome return to project investors. This analysis of creating a housing investment was derived through the preparation of a model housing development, called the Village Green, upon a site located in the Saginaw, Michigan area. Saginaw, Michigan was chosen as the location of this study because of ease of access and the rapidly expanding suburban region to its north. The key development determinants utilized were: (1) the housing market was analyzed to determine the demand for market rate housing, (2) a suitable site4 was selected within the market area, and (3) the project economics were structured such that the project is economically feasible and provides the developer and investors a reasonable return. 2The Builder Sponsors Profit and Risk Allowance is a credit allowed the developer in lieu of a cash profit. 3U.S., Department of Housing and Urban Development, Digest 9: Insurable Loans, pp. 59-60. 4A suitable housing site is considered to be a housing site which is served by those utilities and community facilities necessary to create a viable housing environment. CHAPTER I MARKET ANALYSIS The following analysis of the Saginaw market area was compiled to determine the demand for market rate rental multifamily housing. The Saginaw Standard Metropolitan Sample Area is considered to be the same as the Saginaw market area. Saginaw, Michigan is the home of several General Motors foundries and manufacturing plants as well as support facilities, which form the economic base of Saginaw and provide employment and security for a major- ity of the county's current residents. It is evident from Table 1 that, in comparison with the State of Michigan as a whole, the market area has experienced a higher increase between 1960 and 1970 in the areas of population, labor force, nonfarm employment, and occupied dwelling units. Population increase 28,991 (15.2% increase) Employment increase 87,300 (27.6% increase) Occupied dwelling units 52,870 to 63,143 (19.4% increase) Saginaw appears to be a growing community with an increasing population due to increasing job opportunities. The Saginaw County areas, as shown in Table 2, experienced a very strong increase in duplex and multifamily housing units in comparison to single family houses and mobile home units. Duplex and multifamily housing units increased by 3,381 units between 1960 and 1970 or 46.3%. POPULATION, EMPLOYMENT AND CONSTRUCTION TRENDS 4 TABLE 1 Saginaw Year Saginaw SMSA Michigan Population 1960 98.265 190,752 7,823,194 1970 91.849 219,743 8,875,083 Absolute increase (6,416 28,991 1,051,889 Percent increase (6.5% 15.2% 13.4% Employment 1960 68,400 2,959,000 1970 87,300 3,618,700 Absolute increase 18,900 Percent increase 27.6% 22.3% Nonfarm Employment 1960 62,500 2.665.200 1970 78,000 3,272,700 Absolute increase 15,500 Percent increase 24.8% 22.8% Occupied Dwelling_Units 1960 28,563 52,870 2,239,079 1970 28,309 63,143 2.653.059 Absolute increase {254 10,273 413,980 Percent increase .9% 19.4% 18.5% SOURCES: U.S. Department of Commerce, Bureau of the Census, General Population Characteristics, August, 1971, pp. 59, 61, 335; Detailed Characteristics, November, 1972, pp. 824, 829; Housin Charac- teristics for States, Cities and Counties, Vol. I, August, 972. PP. 7-8 (Washington, D.C.: Government Printing Office). 5 TABLE 2 ‘ HOUSING COMPOSITION AND OCCUPANCY CHARACTERISTICS Absolute Percent Change Per 1960 1970 Change Change Total Market SAGINAN COUNTY Total Units 55,899 65,629 9,730 17.4% Single Family 47,978 53,665 5,687 11.9% (4%) Duplex and Multifamily 7,307 10,688 3,381 46.3% 3% Mobile Homes 614 1,276 662 107.8% 1% Total Occupied 52,870 63,143 10,273 19.4% Owner Occupied 41,121 49,095 7,974 19.4% 0% Renter Occupied 11,749 14,048 2,299 19.6% 0% SAGINAH Total Units 29,918 29,767 (151; (.5% Single Family 23,062 21,634 (1,428 (6.2% (4%) Duplex and Multifamily 6,852 8.144 1,262 18.4% 4% Mobile Homes 4 19 15 37.5% 0% Total Occupied 28,563 28,309 (254) (.9%) Owner Occupied 19,603 19,162 446) (2.3%) (.9%) Renter Occupied 8,955 9,147 192 2.1% .9% REMAINDER OF COUNTY Total Units 25,981 35,862 9,881 38% Single Family 24,916 32,031 7,115 28.6% 7% Duplex and Multifamily 455 2,574 2,199 465.7% 5% Mobile Homes 610 1,257 647 106% 1% Total Occupied 24,307 34,834 10,527 43.3% Owner Occupied 21,513 29,933 8,420 39.1% (2.6%) Renter Occupied 2,794 4,901 2,107 75.4% 2.6% SOURCE: Michigan State Housing Development Authority, "Feasi- bility Analysis, MSHDA No. 188, Waterside," Michigan State Housing Development Authority, 1972. 6 Compared to the total number of housing units, duplexes and multifamily units increased by 3% while single family homes decreased by 4% and mobile homes increased by 1%. The City of Saginaw experienced a 4% decrease in single family homes, a 4% increase in multifamily homes and no change in mobile homes over the same period. In the county outside the City of Saginaw, duplexes and multi- family units gained 5% of the housing market between 1960 and 1970 while single family units decreased by 7% with a 1% increase in mobile homes. The percentage Of owner occupied units compared to renter occupied units did not change between 1960 and 1970 in the county as a whole. However, there seems to have been a slight decrease in owner occupied units for both the City of Saginaw and the out-county area in favor of rental units. These Observations are strong indicators that duplex and multi- family are increasing at a faster rate than single family housing units, particularly outside the City of Saginaw. Renter households, as indicated in Table 3, consist of 23.7% of the total households in the market area. In the City of Saginaw the number of renter households is 9,077 units as compared with 4,207 outside the City of Saginaw. The vacancy rate in the City of Saginaw is 7.1% as compared with 4% outside the City of Saginaw. From Table 3 it is evident that although 32% of the renter households are located outside the City of Saginaw, there is a marked difference in rental rates. The median rent outside Saginaw is $109 or $22 higher than the median rent in Saginaw. The rental rates outside .Nm _~a_1.aupeLo mcwuepaa Seaseaasow ..o. a .eaumcremaxv =am.go.z .¢~ .»a 3 ._o> .aavucaou ace .m33mvo ”mu mum Lou morvmeOHuabmzu mcwmsoz .mzmzmu 039 $0 zmmksm .mULmEEOU $0 Hewsvsmnmn :m 2 .mumzcm um» 3°33 New pea: =a_uaz No. 3 333 am.m we. Rm. mN case use com” 3m. w 33m.3 am.m~ cmo.~ u¢.m opm am.» - amp” am. a, eom.. am.m3 New ae.m3 ~m~.3 3433 - ONP» n3.mp muo.~ um.c_ Ame mm.~p mmm._ 333» - co.» NON mmm.~ um.p_ mom ma.- mmo.~ am» - om» uo.o~ mmo.~ mm. m_ Sum 3m.~m e~o.~ as” - om» Rm.m Pm¢._ 33. m omm No. «3 .m~.3 mm” - oe» xw.m mac as. m cm, as. N mew cc» gag“ mam; um mph u_ 3mm um. m awn “cam :mau oz «cum uuagpcoo vmvmvuwmm N~.m 33w 33 $33 x_.~ mam mama au=a0a> Laucaa nu.m~ ¢w~.m3 amp ~o~.e Nam Aso.m eavqsuuo conga“ up man 33o. COP no.3 me mung eucaua> Laezo 333 «34.33 umm mum.m~ gem 4mm.~_ eavaauuo Laezo 530.4m mmo.m~ Fem.m~ wave: e33a=ooo Payee unwogmn sonszz ucwusmn‘ smaEsz pcmugmai sonszz emg< poxgmz mmg< pmxgmz zmcnmmm peach mo swucwmsmm munhwamuhuuz <: s. ‘5 F. E s. . _§ Saginaw River 2 U Carrollton Township Scale 1" = 1 3/4 M1165 \ Fig. 1.--Site Location Map 11 W or! 'fivwm nu -' l (a) North View (b) Northwest View Fig. 1.--Site Photographsa aPhotographs by Thomas E. Bradley. 12 Public facilities are provided by Carrollton Township which includes excellent educational facilities within three-quarters of a mile of the project site. Two neighborhood and one regional shopping centers are located within a two mile radius of the project site. In order to control the noise pollution created by heavy traffic along I-676, it will be necessary to construct an earth berm along the west boundary of the project site. Since the site is presently zoned agricultural, rezoning to multi- family is required. Land control was acquired for twelve months through a $2,000 option with a renewal clause providing for an additional six months upon the payment of an additional $2,000. CHAPTER III MORTGAGE AND INTERIM FINANCING The initial working capital to develop the Village Green is to be provided by the developer and is considered as his financial investment. Table 5 is a projection of anticipated expenses befOre initial mortgage loan closing. TABLE 5 DEVELOPERS WORKING CAPITAL REQUIREMENTS Land Carrying Expense $ 4,000 Soil Tests 1,000 Survey 1,000 Legal Expenses 5,000 Architect's Fee 5,000 FHA Commitment Fee 8,366 Office Overhead 20,000 Total Working Capital Requirement $ 44,366 The developer's investment represents his maximum financial risk in undertaking the development of the Village Green other than construc- tion risks. Interim construction financing and permanent mortgage financing are assumed to be acquired from a private mortgage source and insured by FHA under Section 221(d)4 of the National Housing Act. 13 CHAPTER IV ECONOMIC FEASIBILITY To insure the economic soundness of the Village Green, Economic Feasibility5 was determined through the use of the fOllowing fOrmula which was derived from the Development Expense Schedule and the Develop- ment Cost Schedule of the Michigan State Housing Develpment Authority6 (See Appendix 8). Where x = total development costs y = total number of units 2 = gross income = gross expenses 2 = [x (.01 + .004 tax rate + .9 debt service factor) + ($400 + sewer and water charge) y + $3,100]/.905 By substituting the gross annual income from Table 4 into our feasibility equation, we obtain the following: $388,440 = [x (.01 + .0004 tax rate + .9 debt service factor) + ($400 + sewer and water charge) y + $3,100]/.905 It is assumed that at the time of mortgage financing the FHA interest rate will be 7 3/4% and that the term of the mortgage loan 5Economic Feasibility is the economic state of a housing develop- ment such that there is sufficient capital to construct the project and sufficient income to successfully operate the development with an economic return to the owners. 6Michigan State Housing Development Authority, "Users Guide to MSHDA Feasibility and Economic Analysis Program," Michigan State Housing Development Authority, January, 1973, pp. 14, 15, 16, 19. 14 15 will be forty years; therefore, a debt service factor of .08569767 will be utilized. The tax rate in Carrollton Township is $39 per $1,000 of assessed value and water and sewer charges are $50 per unit per year.8 After substituting these values into the feasibility equation and solving for x, we determine the total development cost of the Village Green to be $2,734,782. Tables 6 and 7 were developed under the guide of the Development Expense Schedule and the Development Cost Schedule of the Michigan State Housing Authority and set forth the projection of development expenses and the projection of annual operating expenses. 7The debt service factor is the ratio of the annual mortgage payment to the original face value of the mortgage loan at a given interest rate. The debt service factor utilized is actually for 8 1/4% to include 1/2 of 1% for annual mortgage insurance premium. 8Mr. George Arron, Carrollton Township, Saginaw, Michigan, June, 1973. 16 TABLE 6 PROJECTION OF DEVELOPMENT EXPENSES Land: Cost of land $ 150,000 Landscaping and land improvements 225,000 Buildings: $ 375,000 Structural 1,693,362 Architect's Fee 75,000 Bond Premium 12,000 $ 1,780,362 Other Costs and Expenses Allocable to Land and Buildings: Builder Sponsor Profit and Risk Allowance 238,617 General Requirements 57,551 Builder's Overhead 29,639 Title and Recording Expense 8,000 Insurance during Construction 5,470 FHA Inspection Fee 12,307 FHA Examination Fee 7,384 jg; 3 358.968 Total Land and Buildings $ 2,514,330 Other Costs Incurred Prior to Final Mortgage Close: Interest 95,376 Property Taxes 5,470 FHA Mortgage Insurance 12,307 Financing Fee 49,226 Legal Expenses 15,000 FNMA/GNMA a 23.033 Operating Expenses ,0 ____ 3 260,452 Total Cash Requirements 1 2,774,782_ aThis item has been added to meet operating deficits occuring in the first two years of operation. 17 TABLE 7 PROJECTION OF ANNUAL OPERATING EXPENSES Real Estate Tax $ 42,664 Maintenance 30,450 Fuel 17,250 Management 17,478 Water and Sewer 7,500 Insurance 4,500 Administration 3,000 Comon Electricity 2,250 Legal 1,500 Audit 1,600 Miscellaneous 2,550 Operating Reserve -0- Replacement Reserve 10,939 Debt Service and Mortgage Insurance 210,929 Cash Flow Available for Distribution 16,408 Vacancy 19,422 Total Annual Expenses $ 388,440 CHAPTER V STRUCTURING THE SYNDICATE The investment vehicle which is utilized in syndicating Village Green is a limited partnership. This arrangement very closely resembles a corporation in terms of the liability of its members with one excep- tion, the limited partners (investors) have no liability beyond their capital contribution to the partnership, to a third party, and no voice in the management of the partnership. However, the managing (general) partner enjoys the right to the management of the project and is exposed to unlimited personal liability.9 Although there is no cash profit to the developer from the mortgage proceeds, it is possible to generate a profit through the sale of the project to a limited partnership in which the investors take a position as limited partners, while the developer assumes the position as the managing general partner. Under this limited partnership arrangement, the partnership is exempt from taxation as a corporation, thus, losses from the project can be treated as ordinary personal income for tax purposes, in relation to each partner's pro rata share of the partnership interest.10 In the 9Len Young Smith and G. Gale Roberson, Business Law (2d ed.; St. Paul, Minn.: West Publishing Co., 1966), pp. 726-727. Under current FHA procedures there is no personal liability of members of limited dividend mortgagor on the mortgagor note. 10Internal Revenue Code Section 701, Section 704(A) and Section 18 706(A). 19 early years of the forty year mortgage the interest payments are rela- tively high as compared to payments to principal, this interest expense when combined with depreciation taken on a double declining balance results in a taxable income loss to the project. Thus, a return is realized by each partner not only from direct payments from the project but also from a reduced federal income tax expense resulting from off- setting other personal income with project operating losses. Table 8 is a complete analysis of the income and expense projections of the Village Green from construction to year 22 and is utilized as the basis of establishing a sales price and value of the partnership interest to the limited partners (investors) and the net return to the developer. The syndicate is to consist of one general partner and ten limited partners. The partnership interests are as follows: General Partner 5%, Limited Partners 95% (ten equal shares). Table 9 is a projection of the cash generated over the first twenty-two years of operation of the Village Green based upon the 9.5% interest of a typical investor considered to be in the 50% income bracket. The total cash generated is a result of an investor's pro rata share of cash distributions plus income tax savings resulting from the investor using his pro rata share of the project's taxable income losses to offset the payment of income taxes on other income. The cash generated is positive in years 1 to 22 but in year 23 the cash generated becomes negative and increases geometrically each year negatively until the mortgage loan is fully amortized, thus it is advisable that the project be sold in year 22 to avoid an increasing tax liability with insufficient cash flow from the project to meet this liability. Rent at Full Occupancy Less 5% Vacancy Allowance Rental Income 20 TABLE 8 Interest Earned on Funds Reserved for Replacementa Total FHA Mortgage Insurance Property Taxes Income Interest Depreciation Operating Expenses Amortization Total Taxable Income (loss) Add: Depreciationb Cash Flow from Operations Expense Less: Mortgage Principal Payment Replacement Reserve Interest on Funds in Replacement Total Additional Cash Requirements Net Cash Flow (deficit) Add: Reserve Funds Provided by Mortgage Partners Contribution Cash Flow Available for Distribution Cumulative Cash Flow Available for Distribution Cumulative Taxable Income (loss) Mortgage Balance at End of Year PROJECTION OF INCOME AND CASH FLOW lst Yr. -0- -0- -0- -0- -0- 12.307 5,470 95.307 -0- 20.000 107,299 240,382 (240,382) -0- (240,382) -0- -0- -0- -0- 220.382 20.000 -0- -0- (240.382) 2.461.304 2nd Yr. 349.602 17 480 337???? 262 332.384 12.284 42.664 190.102 150.864 88.078 -0- 483,992 (151,508) 150.864 744 9.543 10.939 262 20.744 -0- 20,000 -0- -0- (391.990) 2.451.761 3rd Yr. 388.440 19 422 369.018 819 369.837 12.235 42.664 188.391 140.908 88.078 -0- 472.276 (102,439) 140.908 38.469 10.303 10.939 819 22,061 -0- -0- 16,408 16.408 (494.429) 2,441,458 4th Yr. 388,440 19,422 369,018 1,429 370.447 12.181 42.664 187,616 131.644 88.078 -0- 462.183 (91,736) 131.644 39.908 11.132 10.939 1,429 23.500 -0- -0- 16.408 32,816 (586.165) 2.430.326 21 TABLE 8 (cont'd.) 5th Yr. 6th Yr. 388.440 388.440 19,422 19.422 369.018 369.018 2,062 2,727 371.080 371.745 12.124 12.063 42,664 42,664 186.779 185.870 123.017 114.978 88.078 88,078 -0- -0- 452,662 443,653 (81,582) (71,908) 123.017 114.978 41.435 43.070 12.026 12.996 10.939 10.939 2,062 2,727 25.027 26.662 -0- -0- -0- -0- 16,408 16.408 49.224 65.632 (667.747) (739,655) 2.418.300 2.405.304 7th Yr. 388.440 19,422 369.018 3,426 372.444 42.664 184.891 107.490 88.078 -0- 435.117 (62,673) 107.490 44.817 14.044 10.939 3.426 28.409 -0- -0- 16,408 82.040 (802.328) 2,391,260 8th Yr. 388.440 19,422 369.018 4,161 373.179 11.923 42.664 100.509 88.078 88.078 -0- 429.016 (53.837) 100.509 46.472 15.164 10.939 4,161 30.264 -0- -0- 16.408 98,448 (856,165) 2,376,096 9th Yr. 388.440 19,422 369.018 4,933 373.951 11.844 42.664 182.700 94.000 88.078 -0- 419.286 (45.335) 94.000 48.665 16.385 10.939 4,933 32.257 -0- -0- 16.408 114.856 (901.500) 2.359.711 10th Yr. 22 TABLE 8 (cont'd.) 11th Yr. 388.440 19,422 369.018 5,745 374.763 11.758 42.664 181.469 87.930 88.078 -0- 411.899 (37,136) 87.930 50.794 17.702 10.939 5,745 34.386 -0- -0- 16.408 131.264 (938.636) 2,342,009 388.440 19,422 369,018 __§_z_§2_9_ 375.617 11.667 42.664 180.141 82.267 88.078 -0- 404.817 (29,200) 82.267 53.067 19.121 10.939 6.5.99. 36.659 -0- -0- 16.408 147.672 (967.836) 2 9 322 ’888 12th Yr. 388.440 19,422 369.018 262 369,280 11.568 42.664 178.705 76.982 88.078 -0- 397.997 (28,717) 76.982 48,265 20.656 10.939 262 31.857 -0- -0- 16.408 164.080 (996,553) 2,302,232 13th Yr. 388.440 19 422 369.018 819 369.837 11.460 42,664 177,148 72.049 88.078 -0- 391.399 (21,562) 72.049 50.487 22.321 10.939 819 34.079 -0- -0- 16.408 180.488 2,279.911 23 TABLE 8 (cont'd.) 14th Yr. 15th Yr. 16th Yr. 17th Yr. 18th Yr. 388,440 388,440 388,440 388.440 388.440 19,422 19,422 19,422 19.422 19,422 369.018 369.018 369.018 369.018 369.018 1,429 2,062 2,727 3,426 4,161 370.447 371.080 371.745 372.444 373.179 11.344 11.221 11.086 10.940 10.783 42.664 42.664 42.664 42.664 42.664 175.476 173.668 171.710 169.594 167.308 67.440 63.143 59,125 54.372 51.865 88.078 88.078 88,078 88.078 88.078 -0- -O- -O- -0- -0- 383.002 378.774 372.663 365.648 360,698 (14,555) (7,694) (918) 6,796 12,481 67.440 63.143 69.125 54.372 51.865 52.885 55.449 58.207 61.168 64.346 24.109 26,040 28.133 30.395 32.838 10.939 10.939 10,939 10.939 10.939 1,429 2.062 2,727 3,426 4,161 36,477 39.041 41.799 44.760 47.938 -0- -O- -O- -O- ~0- -O- -O- -O- ~O- -0- 16.408 16,408 16,408 16.408 16.408 196,896 213,304 229,712 246,120 262,528 (1,032,670) (1,040,364) (1.041.282) (1,034,486) (1,022,005) 2.255.802 2.229.762 2.201.629 2.171.234 2.138.396 24 TABLE 8 (cont'd.) TOTAL YEARS 19th Yr. 20th Yr. 21st Yr. 22nd Yr. 1 - 22 388.440 388.440 388.440 388.440 8.118.402 19,422 19,422 19,422 19,422 405.920 369.018 369.018 369.018 369.018 7.712.482 4,933 5,745 6,599 262 64,588 373.951 374.763 375.617 369.280 7.777.070 10.611 10.429 10.229 10.017 252.066 42.664 42.664 42.664 42.667 901.414 164.846 162.180 159.299 156.192 3.803.234 48.585 45.521 42.693 39.973 1.755.355 88.078 88.078 88.078 88.078 1.869.638 -O- -O- -O- -0- 107,299 354.784 348.872 342.963 336.925 8.689.006 19,167 25,891 32.654 32.355 (911,936) 48.585 45.521 42.693 39.973 1.755.355 67,752 71,412 75,347 72,328 844,905 35.472 38.320 41.410 44.722 482.823 10.939 10.939 10.939 10.939 229.719 4,933 5,745 6,599 262 64,588 51.344 55.004 58.939 55.923 777.130 -0- -O- -O- -O- -O- -O- ~O- -O- -O- -0- 16.408 16.408 16,408 16.408 328.160 278.936 295.344 311.752 328,160 (1,002,838) (976,947) (944,293) (911,839) 2.102.923 2.064.603 2.023.202 1.978.480 25 TABLE 8 (cont'd.) aIt is assumed that the funds for replacement reserve are invested each month at the rate of 5% per annum and that at the end of year 11 and year 21 the entire reserve is expended. This expenditure is not reflected in the operating expenses for the respective years. bDepreciation is computed upon a double declining balance assuming a 33 1/3 year life for buildings and a 20 year life for land improvements. 26 TABLE 9 PROJECTION OF INCOME TAx LOSS, DISTRIBUTION AND CASH GENERATED PER UNIT 0F INVESTMENTa Estimated Taxable Federal Income Income % Cash Year Distribution Loss Of Savings, Generated 1 22.836 11.418 11.418 2 14.403 7.201 7.201 3 1.559 9.732 4.866 6.425 4 1,559 8,715 4,357 5.916 5 1.559 7.750 3.875 5.434 6 1.559 6.831 3.415 4.974 7 1.559 5.954 2,977 3.426 8 1.559 5.115 2,557 4.116 9 1.559 4.307 2,016 3.575 10 1.559 3,528 1,764 3.323 11 1.559 2.774 1,387 2.946 12 1,559 2,728 1,364 2,923 13 1.559 2.048 1,024 2.583 14 1,559 1.383 692 2.251 15 1,559 731 366 1.925 16 1,559 87 43 1.602 17 1,559 (646) (323) 1,236 18 1,559 (1,186) (543) 1,016 19 1,559 (1,821) (911) 648 20 1,559 (2,459) (1,230) 329 21 1.559 (3,102) (1,551) 8 22 1,559 (3,074) (1,537) 22 Total 31.180 86,634 43.317 74.497 aTax preference items have not been considered. 27 The limited partners are allowed a return of 20% from the project based upon their equity in the project. To determine the investment required by an investor to achieve a 20% return on equity the "Inwood method"11 or internal rate of return of an investment was used, where the internal rate of return is the rate of discount that equals the present value of the future cash receipt to the cost of the project.12 Expressed as: n -a = 2 at (T+ 1‘) t t = 0 Where -a = the initial investment or present value r = rate of return t 8 number of years of ownership at 8 annual cash generated Thus, the value of the investment to a typical investor can be computed by summarizing the discounted value of the cash generated to arrive at their present value. A special case exists in year 22 in that upon the sale of the project, capital gains tax must be paid and is considered to be a negative payment in that year. Assuming the sale of the project and liquidation of the partnership for approximately $1 over the mortgage per unit of investment at the end of year 22, the capital gains tax per unit of investment for a 50% tax bracket investor is computed as 30% of 11Paul F. Wendt and Alan R. Cerf, Real Estate Investment Analysis and Taxation (New York: McGraw-Hill Book Company, 1969), p. 23. 12James C.T. Mao, Quantitative Analysis 0: Financial Decesions (London: The Macmillan Company, 1969), pp. 192-195. 28 the sum of the tax losses, the cash distribution and the proceeds of the sale of the project minus the initial investment as outlined below.13 Tax losses $ 86,634 Cash distribution 31,180 Proceeds of sale 1 $ 117.815 Less investments (-a) Capital gain 117,815 - (1a) Capital gain tax .3[117,815 - (-a)] Less proceeds of sale 1 Cash needed to pay .3[117,815 -*(4a)] — l The initial investment for a typical 50% investor is found to be: -a - 113519.. 2.291. 6.425 5 916 5,434 1.2 1.44 * T?728'+ ‘270736’* 2.48832 + 4 974 + 4,536 + 116 3 575 I 4 2.98598 3.58318 4.299817 + 5.5515978 + 6 323 2 946 2 923 2 583 '6—1. '91 '7 '3' '6' * 7543 0'08 * "8 .‘9‘1‘6’1 I ”TA—‘0 . 699 32 I 2,251 1.925 1,602 1 236 12.83918 + 15740702'+ 18.488 + 227186111‘+ 1,016 648 329 8 26.62333 + 3T?94799‘+ 38T33759’+ 4670051'+ -[.3(117.815 - (a) - 1],+ 22 55.20614 _ 28,863 + .[.3[117.815 -(-a)] - 1] + 22 'a ‘ 55.20614 13Mr. Hallison H. Young, Esq., Patmon, Young and Kirk, Attorneys, Detroit, Michigan, June, 1973. Internal Revenue Code Section 741. 29 -55.20614a = 1,593,415 -[.3[117,815 - (-a)] -1] + 22 -55.20614a = 1,593,415 -[35.344.5 - .3(-a) -1] + 22 -55.20614a = 1,593,415 - 37,344.5 - .3a + 1 + 22 -54.90614 = 1,556,093.5 -a = $28,341 -a(10) = $283,410 The value of one unit of investment is therefore $28,341. The total value of the investment and the sale prive to ten investors is $283,410. The fee which the developer can charge the partnership for his efforts in creating the housing investment is the difference between all of the cash which is available to the partnership and the total cash which is required to complete the project. Table 10 is a statement of the total cash available to the partnership and the total cash require- ments. 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