Thursday, March 29, 2018

Where Will We Put All Those Fourplexes?

After my initial foray into the citywide fourplex proposal, I began to take a closer look at my own surroundings.  And as much as I want to exercise caution I became quite surprised at how little of north Minneapolis is zoned for multifamily housing compared to how much this part of the city could use such development.

For instance, from my place on 26th and Penn up to 30th Avenue North (which is only three blocks because the 2800 and 2900 blocks get jumbled together here), there are at least twenty-three city- or county-owned vacant parcels of land.  All of them are zoned R1 residential, so without a variance only single-family homes can be built.

Penn Avenue North is a community corridor.  It already has a mix of multi-family and single-family homes along the route, especially in this three-block stretch.  North Minneapolis has bled density and needs to add more people back to our community.  In fact, you can't rightly call Penn a commercial corridor because there isn't enough of a population to drive much commerce here.  When Metro Transit surveys their ridership to see where its ridership is most dependent on busing as their primary mode of transportation, Penn's route (the 19) and its tributaries and parallels (the 5, 22, 14, among others) consistently come out near the top.

When you talk about areas that need density, we're it.  When you talk about building housing for those without cars, the northside is not some trendy place where young college grads use the Uber to Lyft their Car2Go or whatever the kids are doing nowadays.  People are riding the bus to do their laundry and grocery shopping because that's what they need to get by.

So looking at this zoning proposal in terms of racial equity and access to an affordable infrastructure of housing and transit, corridors like Penn and Lyndale, Emerson and Fremont Avenues North absolutely have to be the cornerstone of how communities can benefit.  Because the next carless micro-unit building for college grads making sixty grand is not going to cut it.

With that in mind, my next round of number crunching was centered around this query: Were it not for the R1 zoning restriction throughout much of north Minneapolis, would we see an influx of multifamily investment?  Or as some council members have posited, would that investment be focused in other areas even at the expense of existing housing stock?

Some of what I found seemed to support my predispositions and other data was more than a bit surprising.

Before delving too deeply into the statistics, here are a few of the presumptions I made:
  1. Rental rates for a 2-3 bedroom/1-2 bathroom unit in a fourplex is going to cost more in south and northeast Minneapolis than north.  (This was not a presumption, as I searched online rental listings and spoke with a few property owners to validate what I saw in those searches.  In any case, not a huge surprise.)
  2. Property taxes in other parts of town are higher than over north.  (Again, backed up by some research and even a cursory knowledge of our city's tax base.)
  3. Insurance, vacancy rates, and maintenance may cost more in north Minneapolis.
  4. The type of building and quality of construction should be the same in north as anywhere else.
  5. The type of financing and the interest rates for these properties should remain the same citywide.
So let's say a developer buys an existing yet cheaper home on the lower end of the housing market in south Minneapolis for $200,000 with the intention of tearing it down to construct a fourplex.  Then there's $15-25,000 in demolition fees.  We'll round that up to the $25,000 price tag for the sake of this exercise.  And then maybe the construction costs of $125,000 per unit go to something more like $150k.  Now we have a $600,000 new build and our total entry cost is $825k.

These units seem to be renting for anywhere from $1,800 to $2,300 per month in parts of south and northeast Minneapolis, so we'll call it an even two grand.  That's $96,000 per structure in rental income per year.  Most mortgage companies would just take 25% off the top for the sake of calculating a qualifying income.  We're going to be a little more precise.  Taxes might wind up at $12,000 per year and I'll ballpark insurance at $2,500.  Could be a fair amount more depending on what gets covered though.  Then we take off 10% ($9,600) each for vacancy/maintenance and lawn care/snow removal.  That net profit comes to $62,300.

So if you started with $825,000 of your own money, made $62,300 each year off of that investment, and sunk the entirety of those proceeds back into repaying yourself, you'd break even in thirteen years and three months.  After that, everything is pure profit.  But of course people who spend their time thinking about the best way to spend eight hundred G's to turn a profit don't do that with their own money, goodness no.  So that investment comes from a down payment and a small business or multifamily real estate loan.

One such loan may offer terms at 5.5% interest with a 25-year amortization and a 20% down payment.  So in this case, now we're only using $165,000 of our own money and borrowing the rest.  That comes out to a $4,053 monthly principal/interest payment, and cuts the profit down to just under $14,000 per year.  It doesn't fundamentally alter the time it takes to break even on the out-of-pocket investment, and it takes significantly less cash to get started.

Now let's compare that to building on a city-owned vacant parcel on Penn Avenue North.  We'll assume the city in its benevolence will give the land away for free and there are no demolition costs.  So the up-front investment is only needed to build that $600,000 fourplex.  Rent here seems to be about $1,200 per month on these units.  So we're bringing in $57,600 per year in gross rent.  Taxes are going to be lower, but insurance could be higher, so we'll put that at $6,000 per year in taxes and $3,000 for insurance.  We take out the same 20% in vacancy/maintenance/snow/lawn costs and that leaves a net profit of $37,080 each year.

And that, dear readers, means it takes sixteen years and two months to recoup the $600,000 investment.  The $825,000 demo/new construction makes its money back almost three years faster.  That's not too far off, but if this model is even somewhat accurate it will still be more cost effective to tear down existing houses elsewhere instead of building in north Minneapolis.

But what if we only used a 20%/$120,000 down payment?  The same financing terms come to a principal/interest payment of $35,364 per year.  Which means after collecting $37,080 in rent after the other expenses, we get an annual return of just over $1,700.  Now I'm no business expert, but one question I like to ask about investing is "Will I make money before I am dead?"  If the answer is no, my next question would be "Am I building a fourplex or buying life insurance?"

Let me be the first to admit that these numbers are HIGHLY anecdotal.  I really want someone like CURA or other industry leaders to put together their own projections.  But the foundation of this exercise remains the same.  You cannot deny the disparities in rental rates across the city, yet we should expect the same quality of housing and the same financing terms citywide.  Which means there absolutely will be a price point at which acquisition, demolition, and new construction makes more financial sense than simply building new with no other costs.

I find it unacceptable that we would simply say that any single-family home in certain neighborhoods that is for sale at an affordable price point would now be at risk to be bought out by a developer against whom the average homebuyer cannot compete.  I find it equally untenable to create a citywide change in policy that benefits the rest of Minneapolis but passes over north entirely.  If our city council and mayor agree, then there are two conceivable responses.  Either identify that danger zone and subsidize development outside of it, or limit the zoning change to existing land only.

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