Fast Company put up a story that won't go away.  This sloppy clickbait piece does not help the cause of building housing at a price that working people can afford.

Here is the FastCompany piece: It costs $20,000 but it is nicer than yours

Here is a local piece From Arts Atlanta that puts the cost of building two of the $20K houses at  $135,000

So what's the deal?  The folks running the Rural Studio in Auburn University's Architecture Program set a goal of producing a house with a mortgage payment that someone living on Social Security in Hale County Alabama could afford.  That's how they arrived at $20,000 as the price of the house.  The target price.  The aspirational price. The price they hope to someday achieve.  They have not done it yet.  Not once.  It would be good to refrain from giving people the impression that they have delivered the house for $20,000, if in fact they have not. Link to the Rural Studio 20K House

What they have managed to do is generate a lot of press that give the casual reader the mistaken idea that the 20K House actually only costs $20K and the Fast Company piece is just the latest bit of lousy fact checking to reinforce that misconception.  Their idea is a well-intentioned one with a couple of important missing pieces. The Rural Studio site breaks their aspirational $20,000 number down into $12,000 for materials and $8,000 for contracted labor and profit.  Houses and mobile homes for that matter in Hale County need a municipal sewer connection or septic tank and a municipal water connection or well.  The cost of drilling a proper cased well, installing a pump , and building a septic system in Hale county is between $12,000 and $15,000. So even if $8,000 is enough to cover a builders labor cost, workmans' comp. insurance, general liability insurance, office overhead, and profit on the house (and it isn't) the project is $12,000 over the aspirational $20K budget if the homeowner does not have to pay for the land it will sit on.

An important lesson to teach young Architects in any studio course is that you should not leave large numbers out of a building budget.  Math is unforgiving and cannot be erased with good intentions or a lot of PR.  Maybe there is no such thing as bad publicity.  If that is true, I guess the Rural Studio Folks won't mind this blog post.

The Regional Plan Association (RPA) recently prepared a report describing how real estate finance is structured and the unintended consequences of that structure impacting neighborhoods and the economic health of communities.

For smaller increments of development, the debt financing can be delivered in the form of off the shelf FHA, Fannie Mae, or Freddie Mac 30 year mortgages for buildings of 1 to 4 residential units.

If the project is 5 units or more, the small developer typically goes to a small local bank and takes out a commercial construction loan which will require a 25 - 30% down payment and a personal guaranty.  Once the building is completed and has a couple years of operating history, the developer can take out a nonrecourse loan which does not require a personal guaranty and pays of the construction loan.

As the RPA Report explains, small developers who want to build modest mixed use buildings on their town's Main Street or provide Missing Middle buildings are not able to access the favorable financing available to the developers of large single use suburban apartment complexes.  The largest single source of federally insured financing for apartments is the HUD 221(d)(4) Loan Program.  In 2015 $2.9 billion in loans were issued under this program.  It is the largest single loan program for apartments in the US.  If a project meets the underwriting requirements of the program the terms are pretty great:

• The down payment is only 16.5%.
• The term of the loan is 40 years.
• The loan starts out as a construction loan and is converted to a permanent mortgage without any additional fees.
• There is no personal guaranty required.

The 221(d)(4) Loan Program has focused upon single use apartment projects and there are some serious issues that come up if you try to use the program to finance a mixed use building or series of buildings.  The underwriting standards have specific restrictions upon how much commercial space is allowed in the building and how much commercial income can be considered in the rents the project will collect.

These restrictions are listed in the RPA Report as:

• a 10% Cap on Gross Income Derived from Commercial.
• a cap of 15% of the Gross Leasable Area of the building devoted to Commercial Use.

A typical two story Main Street mixed use building has close to 50% of it's building area devoted to commercial use, so you can see the problem.  That building can't use HUD 221(d)(4) financing.  The appraisers certified by HUD and FHA to review 221(d)(4) applications are residential appraisers, so they have a hard time figuring out what the value of a building containing something other than residential apartments.

HUD recently released the 2016 Multifamily Accelerated Processing  (MAP) Guide on January 29, 2016.  This is the rule book HUD issues periodically to the banks that are certified to sell loans under the various HUD programs 221(d)(4), 220, and 223.  There have been some changes made to the rules following public comments over the last couple years on the issue of bringing HUD's loan programs in line with HUD's policy of supporting walkable mixed use neighborhoods.

• The 10% Cap on Gross Income Derived from Commercial has been raised to 15%.
• The 15% Cap on Gross Leasable Area of the building devoted to Commercial Use has been raised to 25%.

So if you want to build a four story mixed use building and devote the ground floor to commercial use, you can use the HUD 221(d)(4) loan program, (since one floor out of four would get you 25% of the gross leasable area of the building).  Unfortunately, the most income you can show on your pro forma to qualify for the loan from that ground floor commercial tenant is 15% of the building's total income.  What HUD is saying here is, "Okay, you can build it, but we are not going to count much income from it."

I suspect that the reason this new crop of rules is such an unfortunate half-measure is that the folks at HUD who periodically edit the rule book have been so focused upon single use apartment complexes in the suburbs for so long that they have a hard time understanding how a two or three story mixed use building on Main Street actually work.  At this rate, it may be a long time before small developers have access to the same financing as big outfits building apartment complexes on the edge of town.

If a picture is worth a thousand words, then the right diagram is worth at least ten thousand.  I am very grateful  Jim Heid of Urban Green has boiled down the difference between Large and Master Planned Development and Small and Incremental Development into the series of excellent diagrams above.

I recently had a conversation with a bright guy in a Masters in Real Estate Development program at a serious university.  He was wondering if a Real Estate Investment Trust (REIT) would be a good vehicle for people in a local community to be able to invest in small projects in their neighborhood.  Just to set things straight, a REIT would not be a good vehicle for this as a REIT has to have a lot of property under management to justify their existence and overhead, so the structure would be way beyond the scale of small projects in a specific neighborhood.  Investors would own shares in an outfit that owns a large portfolio of a specific type of real estate.

-But the conversation reminded me of Jim Heid's diagram.  The kind of  local in the neighborhood projects my grad student friend was describing belong in the lower left quadrant of Jim's diagram, the Small and Incremental/Entrepreneurial and Bootstrapped territory.  Ownership of real estate by a REIT belongs up in the Corporate and Institutional/Large and Master Planned upper right quadrant.  We might want to bring established tried and true tools scaled for the upper right quadrant to bear on projects in the lower left, but often the scale is just...off.  I think we can call that a Quadrant Foul.

Rethinking the development business model for Small Developers will continues to uncover habits that may serve folks doing large project well that need to be substantially retooled to work in small projects, or they may just need to be set aside as because they are not fit to the purpose.