Multifamily Annual Rent Adjustments that Exclude Fixed Debt Service Can Have Lower Long Term Rents than Those that Include Debt Service.

In looking at multifamily rent increases it's important to note that many projects, including FHA financed projects, have fixed long term debt. 

So for projects with fixed debt service, if the rent increases, either the rent increase is paying for higher expenses or higher profits. 

I constructed the tables in a PDF file HERE and below to show how this might play out.  

First I used as reference data a recently published graphic by the National Apartment Association that attempts to show where $1 of rent money goes.

I consolidated some of their categories and arrived at this breakdown:
51% to expenses
9% to profit
40% to debt service

Next I assumed a 3% annual increase covering a 10 year period and a starting rent of $1,000. (HUD's related Operating Cost Adjustment Factor [OCAF] for Oregon since 1999 has a median annual increase of less than 3%).

In the first scenario, the 3% annual increase is applied to ALL categories: Debt service, profit, and expenses. 

In the second scenario the 3% annual adjustment does NOT apply to fixed debt service. Expenses, including profit, were all increased by 3% annually. 

Observations
In the first scenario rent increased to $1,305, a 30.5% increase. 
In the second scenario, rent increased to $1,183 a 18.3% increase. 

In the first scenario profit increased per unit by $149, from $90 to $239. 
That's an increase of 166%
In the second scenario it increased  by $27, from  $90 to $117.  
That's an increase of 30.5%.

In the first scenario, the profit to rent ratio more than doubled from 9% to 18.3%. 
In the second scenario it increased modestly from 9% to 9.9%.

In both examples expenses, excluding profit, increased by $155 (30.5%), from $510 to $665. 

Bottom line: 
Restricting annual rent increases to exclude fixed debt service from the calculation reduces the needed rate of rent increases, particularly for projects with high ratios of debt service to rent. 
Public agencies financing affordable rental homes policies should insure that project debt service is not variable or short duration and that refinances and prepayments require public agency approval AND are factored into rent increase review procedures.



Originally created and posted on the Oregon Housing Blog.