Front Door Back Door exercise with TIF, Tax Credits and other grants

You work for a real estate development company that wants to construct an apartments building
for low income people in City X. Your task is to find a site for this project, and make sure that
the project meets the following three criteria:
1. All apartments in the building must have the same size, equal to 1,000 sf .
2. The monthly rent that a tenant pays for an apartment in the building is no more than 60% of
the income that the tenant obtains working 10 hours a day at the minimum wage $7.5/hour, for
25 days per month.
3. Because the main work location for low-income individuals in City X is the Central Business
District (CBD), the building must be located within 6 miles from the CBD – there is no public
transportation to the CDB from locations further away than 6 miles.
You start gathering data and find the following financial information for an affordable housing
development project with size equal to 60,000 square foot and non-land costs equal to
$7,000,000 ($6,000,000 for hard construction costs and $1,000,000 for soft costs):
 Lenders will allow you to borrow 60% of the total capital budget at an 8.5% interest rate
and a 25-year amortization.
 Equity investors will expect an 8.0% minimum cash on cash return
 Operating expenses are 40% of EGI

You assume that the information above remains valid for all potential sites under consideration.
However, vacancy rates and site land costs depend on the number of miles that the building is
from the DBC (henceforth “miles”). You will consider two possible areas for your development:
East side and West side. In both directions, there are available sites for development at the
following locations: 0, 1, 2, 3, 4, 5, 6, 7 and 8 miles from the CBD. In the East side, vacancy
rates and site land costs obey the following equations:
$ 9,000,000 7.071∗√ 1+ miles
site cost= ∧vacancy rate=
1+miles 200

In the West side, vacancy rates and site land costs obey the following equations:
$ 9,000,000
site cost= + 1,000,000∗miles
1+miles
7.071∗√ 1+ miles
vacancy rate= −0.02∗miles
100
Exercise 1: Assuming that hard and soft construction costs, mortgage conditions, and the
required equity dividend do not change with location and market area, build a Front Door
(feasibility) model that calculates the required monthly rent per apartment at all locations, both in
the East side and West side. Then, choose the location with the minimum possible required rent
per square foot and that meets conditions 1, 2 and 3 above.

Exercise 2: In Exercise 1 above, is the development project feasible at any location with a
60,000 sf rentable area?
Now suppose that after an initial spatial feasibility analysis, you come to the conclusion that the
project needs a larger rentable area to become feasible. You talk to your boss to consider a
120,000 sf development project instead. You argue that a larger rentable space will imply more
tenants and a lower monthly required rent per tenant. Your boss wants you to do a new feasibility
analysis considering a 120,000 sf rentable area instead. With this new assumption, what is the
optimal location for the affordable housing development project?

Exercise 3: Consider again Exercises 1 and 2 above. Now, you learn that a corporation is
interested in using its tax credits in your project. Tax credits will allow the corporation to
subtract the amount of the credit from the total they owe to the state, while for your real estate
development project it means that you get a capital injection at no cost, i.e., you do not have to
pay any return on capital to the corporation, nor giving back the principal to the corporation. The
corporation is willing to finance 20% of the total capital budget. The remaining will be split
between debt (60%) and equity (20%). With this new assumption, what is the optimal location
for the affordable housing development project? Do your simulations by considering two
rentable areas: 60,000 sf and 120,000 sf.

Exercise 5: Consider again Exercises 1, 2 and 3 above. Now you learn that City X has
implemented a new classification of scoring areas, and has chosen the East side as a scoring area.
Any affordable housing development in the East side is entitled to a 55% subsidy over the total
budget capital of the project. This subsidy together with the tax credit considered in Exercise 4
means that you do not need equity if you chose a location in the East, and that you can decrease
debt to 25% of total capital budget. The only requirement to get the City’s subsidy on top of the
tax credit is that the monthly rent cannot be higher than 30% of the tenant’s income. With this
new assumption, what is the optimal location for the affordable housing development project?
Do your simulations by considering the two rentable areas: 60,000 sf and 120,000 sf.