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                      Angela M. Christy
                      Faegre & Benson LLP
                      2200 Wells Fargo Center
                      90 South Seventh Street
                      Minneapolis, MN 55402
                     Maintaining Long-Term Affordability in For-Sale Housing

I.         General.

         Traditionally, providing affordability for single-family homes involved a subsidy to a
first-time homeowner either through a “write-down” of the purchase price or a low- or
no-interest rate loan. These subsidies may have required the beneficiaries to repay them if
they sold their homes before a fixed-period (such as five or ten years). As home values have
appreciated dramatically each year, many housing organizations have realized that these
programs have provided affordability to a very limited number of people. In effect, the
initial primary beneficiaries receive a windfall when they sell their homes and capture all of
the appreciated value (even if they must pay back the original subsidy). At this point the
home is no longer affordable because of the dramatic increase in price, the housing
organization may or may not have recovered the original subsidy, and the subsidized land
owner has made a substantial profit. While this may not be a terrible result (there has been
an increase in housing stock and somebody who otherwise would not have been able to has
experienced the American Dream), many housing organizations recognize the potential
unfairness in this system and have explored options to maintain long-term affordability. The
real estate law of each state has a major impact on the available options to preserve long-term

II.        Strategies.

        Generally, subsidy providers need to pick one of two strategies: mortgage controls or
resale restrictions (or as one commentator describes them “attaching to the cash or attaching
to the unit”1). Mortgage controls (also referred to as leverage controls) allow housing
organizations to recapture their subsidy upon sale of the subsidized house and recycle the
recaptured dollars to subsidize a different property and new owner. Using resale restrictions,
on the other hand, is a strategy that “attaches to the unit” because it attempts to keep a
particular property affordable for a long period if not permanently. The following sections
will briefly describe various methods used in each of these two strategies and a few
advantages and disadvantages of each.

III.       Mortgage Controls (or “Attaching to the Cash”).

           A.      Methods.

                   1.       “Soft-Second” Mortgage. This is a second mortgage loan to help
                            finance an affordable house. Typically a “soft second” loan would bear
                            zero or one percent interest, although it could be structured to bear a
                            market interest rate and require low or no payments until its final

    Jeanne Goldie Gura, “Preserving Affordable Homeownership Opportunities in Rapidly Escalating Real Estate
    Markets”, 11 Journal Affordable Housing and Community Development Law (2001).

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                      maturity. These loans may be for as long as 30-40 years, but generally
                      require payment in full if the house is sold.

                2.    “Shared Appreciation” Mortgage. This type of mortgage is very
                      similar to the Soft-Second Mortgage except that in addition to principal
                      and interest, the borrower must pay to the lender a fixed percentage of
                      the property’s appreciation. As explained below, any method involving
                      splitting the appreciation creates certain complexities.

                3.    Soft-Second Mortgage with Resale “Incentive”. This type of mortgage
                      is like a Soft-Second or Shared Appreciation Mortgage, but has a “due-
                      on-sale” clause that excludes sales to qualified low-income buyers, i.e.
                      it would permit certain low-income persons to buy the house and
                      assume the mortgage. Accrued interest may be forgiven on the sale to
                      a qualified buyer (See Exhibit A).

         B.     Advantages. Mortgage controls have the following advantages:

                1.    Traditional Legal Documentation. These methods involve more
                      traditional legal documentation, which in turn makes them more
                      acceptable than resale restrictions to first-mortgage lenders;

                2.    Ease of Administration. There is less need to monitor the property
                      when using a mortgage – upon any sale a prudent lender will insist that
                      the second mortgage be paid off or subordinated (otherwise it would be
                      a superior lien to the new lender’s mortgage). While this is generally
                      true, a mortgage may contain maintenance and other obligations on the
                      land owner and the housing organization may want to monitor

                3.    Ease of Enforceability. Mortgage foreclosure procedures are well
                      defined. Procedures for enforcing covenants, restriction and options
                      are more time consuming and expensive.

                4.    Less Concern with Enforceability. As discussed below, resale
                      restrictions are subject to challenges as restraints on alienation and may
                      be subject to the rule against perpetuities, and will be extinguished in
                      Minnesota by the “30-year rule” (Minn. Stat. Sec. 500.20). Mortgages
                      alleviate, if not eliminate, these concerns.

                5.    Ease of Subordination. Soft-Second Mortgages can easily be
                      subordinated on resale or refinancing. Subordination of re-sale
                      restrictions may be more complicated.

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           C.       Disadvantages. Programs using mortgage controls have the following

                    1.        Limited Assistance. During time of rapid appreciation in home values,
                              housing subsidies tend to generate huge windfalls for a limited number
                              of participants. This seems especially unfair when the appreciation
                              may have resulted in large part because of the subsidies, e.g. problem
                              properties have been rehabilitated or there has been very thoughtful,
                              painstaking governmental planning. In addition, the homeowner would
                              not have been able to afford the house initially without the subsidy.

                    2.        Lack of Property Control. Although a second mortgage could place
                              maintenance and other obligations on the property owner, it would be
                              administratively costly to monitor compliance. More importantly, it
                              will be very difficult to find a first lender that will allow the housing
                              organization as second mortgage holder to exercise any meaningful
                              remedies if the first mortgage is not in default.

                    3.        Tax Issues for Owner. The tax treatment of forgiven interest or
                              forgiven mortgages is uncertain. The forgiveness is either a reduction
                              in basis or income.

IV.        Resale Restrictions (or “Attaching to the Unit”)

      This strategy strives to keep the house itself “affordable”2 for the long-term, if not

           A.       Methods.

                    1.        Restrictions on Resale. These restrictions generally prohibit selling the
                              subsidized property to anyone other than an “eligible” buyer (typically
                              defined by the person’s income level). If these restrictions are
                              contained in the deed, the grantor will retain a possibility of reverter or
                              right of reentry. Otherwise, enforcement of the restrictions would be
                              limited to damages or attempting to use specific enforcement.

                    2.        Purchase Options. Purchase Options allow the housing organization to
                              repurchase the home in the future for a price that is fixed or based on a

     Housing that is “affordable” is traditionally defined as housing that costs less than 30% of the buyer’s income. By
    contrast, “affordable housing” does not have a consistent meaning, but often refers to housing that is affordable to
    persons with incomes at or below some percentage (often 50% or 60%) of the area’s median income. In the
    context of tax-exempt housing revenue bonds, a recent commission recommendation called for increasing the
    definition to 80% of area median income. Some affordable home ownership models define affordable based on a
    specific price or use income limits up to 110% of area median income.

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                      formula, and upon a date certain or some triggering event (such as the
                      desire of the homeowner to sell the house).

                3.    Rights of First Refusal. A right of first refusal allows the housing
                      organization to buy the property upon the same terms as a third-party
                      who has offered to buy the property from the current homeowner.

                4.    Community Land Trusts. A community land trust retains ownership of
                      land and enters into a ground lease with the affordable buyer. The
                      ground lease contains affordability restrictions and usually a purchase
                      option. (See Community Foundation Land Trust materials.)

         B.     Advantages.

                1.    Maintains Long-term Affordability. With resale restrictions, even with
                      rapidly increasing home prices, affordability isn’t lost on the first

                2.    More Beneficiaries. Because of the resale restrictions, the subsidy will
                      benefit more low- to moderate-income persons instead of just the first

                3.    Less Destabilization of Neighborhoods. Homeowner doesn’t have as
                      large a financial incentive to “cash-out” and leave neighborhood.

         C.     Disadvantages.

                1.    Administrative costs. Most resale-restriction concepts, including
                      community land trusts, require active monitoring of property. This
                      requires a larger staff and a minimum number of properties to achieve
                      efficient economies of scale.

                2.    Disincentive for Home Improvement. The more the homeowner is
                      restricted from realizing appreciation, the less incentive there is to
                      maintain or improve property. Some shared appreciation programs
                      even prohibit home improvements or require pre-approval before
                      undertaking home improvements.

                3.    Complexity with respect to Sharing Appreciation. Housing
                      organizations must determine formulas for sharing appreciation with
                      homeowners. These formulas must consider the rate of return on
                      equity the homeowner will be allowed and how to calculate the
                      homeowner’s equity, especially with respect to home improvements.
                      As to home improvements, the housing organization must decide how

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                          much appreciation due to home improvements it will allow the
                          homeowner to capture. This will include determining what types of
                          home improvements will be eligible for increasing the homeowner’s

                 4.       Enforceability issues.3

                          (a)      30 Year Act. Minnesota Statutes, Section 500.20 provides that
                                   “all private covenants, conditions, or restrictions created by
                                   which the title or use or real property is affected, cease to be
                                   valid and operative 30 years after the date” of the instrument
                                   creating the restrictions.4 There is an argument that if the
                                   restrictions are placed by a governmental entity for a public
                                   purpose that the restrictions would not be “private” and thus not
                                   subject to this act, although this is not clear under Minnesota
                                   law and a court could find that the government acting in a
                                   “proprietary” function would be creating “private” restrictions.
                                   See Keeter v. Town of Lake Lure, 141 S.E.2d 634, 643; 264
                                   N.C. 252.

                          (b)      Restraints on Alienation. Minnesota courts have stated that the
                                   rule against restraints on alienation generally voids restrictions
                                   on the sale or mortgage of real property. In re Anderson’s
                                   Estate, 126 N.W.2d 250, 251 (Minn. 1964). But Minnesota
                                   courts have not addressed the issue with respect to restrictions
                                   for affordable housing purposes and the trend in most states is to
                                   apply a reasonableness test with respect to restrictions. See
                                   Restatement (Second) of Property (Donative Transfers), Sec.

                          (c)      Bankruptcy Concerns. Purchase Options and Rights of First
                                   Refusal could be set-aside in a bankruptcy of the homeowner if
                                   they are found to be executory contracts.

                          (d)      Enforcement Mechanism. In general, a lawsuit will have to be
                                   commenced for non-compliance (with the possible exception of
                                   a land trust) which could be time consuming and expensive.
                                   Some courts may be reluctant to enforce affordability covenants.

  See Keeley and Manzo, Resale Restrictions and Leverage Controls, 1 J. Affordable Housing & Community
  Development Law 9 (1992) for a more detailed discussion of these enforceability concerns (other than the 30-Year
  There are some exceptions but they generally don’t apply in the housing affordability context.

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                       (e)     Rule Against Perpetuities. The law school favorite raises its
                               ugly head. This rule invalidates property interests that may not
                               vest within 21 years of a life in being. While it does not affect
                               rights of reentry or possibilities of reverters, this rule could
                               invalidate a right of first refusal unless by its terms it expires so
                               as not to violate the rule (e.g. within 21 years or less after the
                               death of the homeowner).

V.       Subsidies From Other Properties

         A.     Methods. A mixed-income development may impose a private transfer tax on
                market rate units that could be used to subsidize future sales or create new
                affordable units. The deed to the buyer contains a restriction similar to the

                The Unit conveyed by this deed is part of Common Interest Community
                Number ___, created in part with the intention of positively contributing to the
                [vitality, well-being and livability of] [preservation of affordable housing in]
                the local community. Accordingly, upon the voluntary sale or resale of fee
                title to the Unit, or any portion thereof (as evidenced by the delivery of a deed
                or contract for deed from the seller to the purchaser therefor), there shall be
                paid to ______________________ Foundation, a _________ non-profit
                corporation under Section 501(c)(3) of the Internal Revenue Code (the
                “Foundation”), a transfer fee to be used for reinvestment in the local
                community in accordance with the articles and bylaws of the Foundation.
                Such fee shall be paid by or on behalf of the seller in cash or other
                immediately available funds, in an amount equal to one quarter of one percent
                (0.25%) of the value of the consideration paid by the purchaser for the Unit
                (the “Transfer Fee”). Notwithstanding the foregoing, (i) there shall be no
                obligation to pay the Transfer Fee upon the foreclosure of a mortgage or a lien
                by the Association (as hereinafter defined) for assessments due the
                Association, cancellation of a contract for deed, or delivery of a deed in lieu of
                such foreclosure or cancellation, and (ii) a holder of a mortgage, or the
                Association holding an assessment lien on the Unit, who acquires title to the
                Unit through foreclosure or deed in lieu of foreclosure, shall have no
                obligation to pay the Transfer Fee upon the re-sale of the Unit. Additionally,
                the Transfer Fee shall not apply to the conveyance of an easement, or the
                granting of a mortgage or other lien on the Unit. Upon the presentation of
                written evidence reasonably satisfactory to the Foundation showing the
                amount of the consideration paid, the Foundation shall issue a written
                statement to any buyer or seller of the Unit stating the amount of the Transfer
                Fee, which such statement shall be binding on the Foundation, the buyer and
                the seller, unless a claim is made within six (6) months following recording of
                the deed, that state deed taxes were paid on consideration in excess of that

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                reported to the Foundation. By acceptance of this deed, Grantee(s) agree(s) to
                the terms hereof, which shall run with the land and be binding upon
                Grantee(s), his, her, its or their successors and assigns for a term ending on
                December 31, 2035, unless prior thereto or prior to any extension of said term,
                the Association elects by resolution of its members to renew said restrictive
                covenant for an additional ten (10) year term. Notwithstanding the foregoing,
                this deed restriction may be terminated by the Foundation, after which the
                foregoing restrictive covenant shall have no further force or effect. The
                Foundation shall have all rights and remedies at law or in equity to enforce
                payment of said Transfer Fee.

         B.     Advantages.

                1.     It puts the affordability burden on the higher income homeowners
                       rather than the purchasers of the affordable units.

                2.     This strategy continues to generate new dollars for affordability as
                       home prices rise.

         C.     Disadvantages.

                1.     Since this method is relatively new, it is difficult to predict how courts
                       will apply restrictions on covenants to a perpetual transfer fee. The
                       above example is limited to 30 years with a possible 10 year extension.
                       State laws regarding restraints or alienation must be examined.

                2.     The transfer fee must be combined with restrictions on the affordable
                       units to avoid windfalls in favor of the buyers of subsidized units.

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                                           EXHIBIT A

                                     PROMISSORY NOTE
                                          given by



                          [NAME OF HOUSING ORGANIZATION]

Dated: ______________, 2002                                      At: _____________, Minnesota

        FOR               VALUE             RECEIVED,              the             undersigned,
_____________________________________                    ______________________________,
__________________________ (marital status) (the “Borrower”), hereby promises to pay to the
order of [NAME OF HOUSING ORGANIZATION], a ____________________ (“Holder”)
or at such other place as the Holder may, from time to time, designate in writing, the principal
sum of __________________________________ and No/100 Dollars ($___________.00),
plus interest at the rate of ____% per annum. No monthly payment shall be due on this Note.
The entire principal balance plus interest of this Note is due and payable on December 31,
203__ or earlier in the event of default.

         This Note shall be due and payable in full immediately if:

         (a)    Borrower sells, assigns, conveys or otherwise transfers (whether by deed,
                contract for deed, lease or otherwise) of the House, except as permitted in the
                affordability requirements section of this Note below.

         (b)    Borrower fails to occupy the House as Borrower’s principal residence
                determined in the same manner that homestead tax treatment is determined under
                property tax laws (or any similar statute selected by Holder if the homestead
                property tax classification is eliminated).

        This Note is secured by, among other things, a Mortgage, dated the date hereof from
Borrower, as Mortgagor, to the Holder, as Mortgagee, (the "Mortgage") on property owned by
Borrower and legally described in the Mortgage (the "House"). All of the agreements,
conditions, covenants, provisions and stipulations contained in the Mortgage are hereby made a
part of this Note to the same extent and with the same force and effect as if they were fully set
forth herein. Time is of the essence hereof. In the event of any default in the payment of any
principal or other indebtedness due hereunder then the Holder may, at its right and option,

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declare immediately due and payable the principal balance of this Note, together with any
attorneys fees incurred by the Holder in collecting or enforcing payment thereof, whether suit
be brought or not, and all other sums due hereunder and payment thereof may be enforced and
recovered in whole or in part at any time by one or more of the remedies provided in any
document securing this Note, including any Mortgage.

        The Borrower and any guarantor, surety or endorser hereby waive demand, presentment,
notice of nonpayment, protest, notice of protest, notice of dishonor and diligence in collection
and agree that without any notice the Holder hereof may take and/or release additional security
herefor or the Holder hereof may, from time to time, release any part or parts of security
interests from Borrower in favor of Holder with or without consideration and that in any such
case the Borrower and any guarantor, surety or endorser shall remain liable to pay the unpaid
balance of the indebtedness evidenced hereby as so additionally secured, extended, renewed or
modified and notwithstanding any such release.

        The remedies of the Holder, as provided herein and in any document securing this Note
shall be cumulative and concurrent and may be pursued singly, successively or together, at the
sole discretion of the Holder, and may be exercised as often as occasion therefor shall occur.
The Holder may, in its discretion, waive any default hereunder and its consequences and rescind
any declaration of acceleration of principal; provided, however, that no action or inaction by the
Holder shall be deemed a waiver of any of the Holder's rights or remedies unless the Holder
specifically agrees in writing that such action or inaction shall constitute a waiver of its rights or
remedies. Any waiver shall only apply to the particular instance for which it was agreed. No
delay in exercising and no failure in exercising any right or remedy hereunder or afforded by
law shall be a waiver of or preclude the exercise of any right or remedy hereunder or provided
by law, whether on such occasion or any future occasion, nor shall such delay be construed as a
waiver of any default or acquiescence therein. The exercise or the beginning of the exercise of
one right or remedy shall not be deemed a waiver of the right to exercise at the same time or
thereafter any other right or remedy.

Affordability Requirements

        This Note may be assumed by a Qualified Purchaser. A Qualified Purchaser is a person
whose median family income is fifty percent (50%) or less of area median income adjusted for
family size who certifies that the House will be used as that person’s principal residence.
Certifications regarding the Qualified Purchaser’s income and intended occupancy of the House
must be submitted to the Holder on forms approved by Holder at least thirty (30) days prior to
any intended sale. If Holder confirms that the information confirms that the person is a
Qualified Purchaser, Holder shall approve assumption of this Note by the Qualified Purchaser.
[Upon assumption by a Qualified Purchaser, Holder shall forgive any accrued interest on this
Note.] If the House is sold or transferred to someone other than a Qualified Purchaser, Holder
may declare this Note immediately due and payable. Increases in income or changes in
household composition after purchase shall not cause of Qualified Purchaser to be considered
over-income for purposes of this paragraph.

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       In the event of Hardship, the Holder may in Holder’s discretion permit assumption of
this Note by someone other than a Qualified Purchaser. Hardship shall include disability, death,
dissolution which requires a sale of the House, loss of employment, and relocation by an
employer. In addition, if an increase in interest rates make it impossible for the Borrower to sell
the House to a Qualified Purchaser, Holder may in Holder’s discretion make an adjustment to
the maximum income level of a permitted purchaser to reflect the impact that the interest rate
increase has on monthly payments on a first mortgage with the same outstanding principal
balance as is owed by Borrower.

       Holder also agrees to subordinate the Mortgage securing this Note to any mortgage
made by or held by an institutional lender or investor in connection with any refinancing of any
prior mortgage on the House provided that the purpose of the refinancing is to acquire the
House, reduce the interest rate of the loan, reduce the term of the loan, or make a Qualified
Improvement to the House.

       A Qualified Improvement is a substantial structural or permanent fixed improvement
costing $5,000 or more.

       [The principal balance of this Note shall be forgiven _______________% per year
beginning on the ____th anniversary of this Note provided that the House continues to be
occupied by the Borrower or a Qualified Purchaser.]

       It is intended that this Note is made with reference to and shall be governed by and
construed in accordance with the laws of the State of Minnesota.

        IT IS HEREBY CERTIFIED AND RECITED that all conditions, acts and things
required to exist, to happen and to be performed precedent to or in the issuance of this Note do
exist, have happened and have been performed in regular and due form as required by law.

        IN WITNESS WHEREOF, the Borrower has caused this Note to be duly executed by
its authorized representative, all on the date and year first above written.



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