Benefit-cost analysis (BCA) and its housing applications: Three examples from the production, consumption and

government perspectivesBy: Andy Carswell, Joe Laquatra, Patryk Babiarz

Housing Education and Research AssociationOctober 12, 2015

Definition of BCA

• Choice between mutually exclusive projects/alternatives that provides the greatest value return relative to the costs.

• You would want the final best available option to be positive.

• May be public or private projects

BCA in the classroom• Economics

• Environmental economics

• Law

• Public policy/ public administration

• Real estate (?)

Our field’s own flirtation with BCA• Scott Maynes and the

“Maynes model”• A series of consumer

possibilities related to a decision choice (maximax, minimax, BOMP, highest expected value)

• Objective and subjective costs and benefits involved

• Probabilities assigned to each particular event occurring

ActionsPossible Outcomes I II III IV V VIProbabilities 0.2 0.8 0.4 0.6 0.7 0.3

Objective Costs Rent or mortgage PI (13,800.00)$ (15,000.00)$ (6,324.84)$ (6,324.84)$ (6,085.68)$ (6,085.68)$

Property tax $0 $0 (1,725.00)$ (1,725.00)$ (2,240.00)$ (2,240.00)$ Property insurance/renter's insurance (300.00)$ (300.00)$ (575.00)$ (575.00)$ (560.00)$ (560.00)$

Maint/Repair (1,560.00)$ (1,560.00)$ (1,800.00)$ (1,800.00)$ (2,100.00)$ (2,100.00)$ Closing Costs $0 $0 (4,416.00)$ (4,416.00)$ (4,300.80)$ (4,300.80)$

Opportunity cost of security deposit or down payment (5.75)$ (5.75)$ (23.00)$ (23.00)$ (22.40)$ (22.40)$

Objective Benefits Equity Build-up $0 $0 $1,944.23 $1,944.23 $1,926.60 $1,926.60

Tax Savings A. Interest $0 $0 1,226.57$ 1,226.57$ 1,164.54$ 1,164.54$

B. Property Tax $0 $0 483.00$ 483.00$ 627.20$ 627.20$ Anticipate appreciation $0 $0 575.00$ 287.50$ 560.00$ 280.00$

TOTAL OBJECTIVE Cost and Benefits (15,665.75)$ (16,865.75)$ (10,635.04)$ (10,922.54)$ (11,030.54)$ (11,310.54)$

Subjective Benefits (Security, freedom,etc) (100.00)$ (200.00)$ 250.00$ 100.00$ 500.00$ 200.00$

Subjective costs (Risk, lack of mobility, etc.) 100.00$ 50.00$ (500.00)$ (1,000.00)$ (250.00)$ (2,000.00)$ TOTAL SUBJECTIVE -$ (150.00)$ (250.00)$ (900.00)$ 250.00$ (1,800.00)$ NET UTILITY (15,665.75)$ (17,015.75)$ (10,885.04)$ (11,822.54)$ (10,780.54)$ (13,110.54)$

UTILITY

C - CondoA - Rent apartment B - Suburban House

Why not housing?

The producer scenario

BCA housing scenario #1: The builder ponders use of a temporary seller buydown

mortgage• Successful local builder faces

a difficult financial situation• Buyer realizes that (s)he has

market leverage, but not a very high income

• Local lender willing to do creative financing option, but needs some risk mitigation

• There are options to make all three parties happy

Benefit-Cost Analysis of Buydown Scenario for Builder/Seller

Up-Front Cost to Lender ($2,993)

Holding Costs Foregone

Construction Loan Costs $ 6,000

Utilities $ 814

Outside Maintenance/ Property Management $ 250

Pest Control $ 150

Property Taxes $ 1,125

Total Foregone Holding Costs $ 8,339

Net Benefit(Cost) of Doing Buydown $5,346

Translation in the end for BCA scenario #1

• EVERYBODY’S HAPPY!• Through proactive BCA:

Buyer got into a home exercising market leverage

Lender able to facilitate a sale without losing money

Builder able to sell home in down market without reducing home price

The consumer scenario

BCA housing scenario #2: The resident ponders an energy-efficiency improvement

• Resident in older homes considers making a major upgrade to save L-T energy costs

• High up-front costs• Lower monthly energy costs• Various ratios and measures help

determine if the upgrades are viable• Constrained by household’s timetable

for remaining in the home• Also hampered by “shortsightedness”

of current standard ratios and measures and their unwillingness to incorporate house price gains

The data/ratios which help drive our EE improvement decisions

• Life-cycle costs = purchase and installation costs, maintenance and repair costs, replacement costs, and energy costs

• Net benefit/savings = difference between the economic lifetime dollar energy savings and economic lifetime dollar costs of an energy-efficient home

• Savings/investment ratio = the ratio of the present value savings to the present value costs of an energy conservation measure

• Payback period = elapsed time between the point of initial investment and the point at which accumulated savings, net of accumulated costs, are sufficient to offset the initial investment cost

Potential limiting factors when arriving at ratios and measures

• There is almost certainly an immediate equity influence (+) on a home price after upgrades

• There may also be a house price premium attached to degree of energy-efficiency

• Also, there may be a year-to-year equity premium over and above regular house price appreciation rates

Sample HERS form

Application of energy efficiency features and analytical tools

Variables Values Values After Retrofit

Discount Rate 10%

Months Left in House 120

Purchase and Installation Costs $7,500

Salvage Value N/A

Maintenance/Repair Costs $20 $10 $10

Replacement Costs N/A

Energy Costs $265 $140 $125

Life-Cycle Costs $25,500

Net Benefit /Savings $2,716

Savings-To-Investment Ratio 1.36

Payback Time Analysis 55.56

Variables Values Values after Retrofit

Discount Rate 10%

Months Left in House 120

Purchase and Installation Costs $7,500

Salvage Value $1,500

Maintenance/Repair Costs $20 $10 $10

Replacement Costs $3,000 $ -

Energy Costs $265 $140 $125

Energy-Efficiency Equity Kicker $2,700

HERS Rating Kicker @ HERS Score of 80 $1,200

Life-Cycle Costs $25,500

Net Benefit /Savings $6,616

Savings-To-Investment Ratio 1.88

Payback Time Analysis 26.67

Impact analysis of energy efficiency analytical tool results after factoring in house price growth

So what sort of tricky consumer situation does this apply?

• Home valued at $200K• Buyer contemplating $5K

energy upgrade• Saving $100 per month in

energy costs• HERS rating of 90• Appraiser estimates 2% equity

push• AVM suggests $100 premium

per HERS point beyond the baseline

• Time horizon of 4 years before moving

Just focusing on the payback period portion of the equation…

Under traditional method of measurement:Payback period = 58 monthsThus, the improvement is not undertaken

Under housing equity incorporated method of measurement:Payback period = right away, since $5K equity gain is instantly realized through upgrades

Cost to the buyer of not doing the upgrade:PV of sum of cash flows in added savings from lower energy costs = $4,258

The government scenario

BCA housing scenario #3: Local government considers funding early intervention homeless program called

“Housing First”

The “Housing First” approach to homelessness prevention

• Housing is a basic human right.• People facing homelessness should have immediate

access to permanent, independent housing.• Issues that led to a person becoming homeless are

best addressed from a foundation of stable housing.• Case worker dedicated to handling social service

aspects of Housing First clients.• Similar to a preventative maintenance approach.

Emergency Room Costs

Hospital Overnights

Incarceration Costs

Sheltering Costs

Detox/Substance Abuse Costs

Inpatient Medical or Psych (Non-Medicaid)

Medicaid Costs

Mental Health Overnights

Outpatient Medical (Non-Medicaid)

Booking Costs/Police Contacts

Ambulance Costs

Prescription Drug Costs

Hirsch and Glasse

r 2008

Mondello et al 2007

Home & Healthy for G

ood

Perlman and Parvensky 2006

Mercer Housin

g First Demo

Culhane, Metra

ux and

Hadley 2002

Larimer et al 2009

Corporation 2008

Martinez and Burt 2

006Previous BCA

Studies

References• Carswell, A.T., & Babiarz, P. (in press). Benefit-cost analysis and optimization modeling for a seller/builder buydown mortgage.

Journal of Real Estate Practice and Education. • Gladwell, M. (2006). Million-dollar Murray. The New Yorker, 13, 96. • Gramlich, E. M. (1981). Benefit-cost analysis of government programs. Prentice Hall.

• Guess, G. M., & Farnham, P. G. (2011). Cases in public policy analysis. Georgetown University Press.

• Laquatra, J. (1986). Housing market capitalization of thermal integrity, Energy Economics, 8(3); 134-138.

• Laquatra, J. (2003). The value of energy efficiency. Home Energy, 20(6): 30-32.

• Laquatra, J., & Carswell, A.T. (2015, in press). Re-assessing the economic and analytical tools of measuring and optimizing energy efficiency. Housing and Society.

• Maynes, E. S. (1976). Decision-making for consumers: An introduction to consumer economics. New York: Macmillan. • Tsemberis, S. (2010). Housing First: ending homelessness, promoting recovery and reducing costs. How to house the homeless, 37-

56.

• Zerbe, Jr., A., & Bellas, A.S. (2006). A primer for benefit-cost analysis. Northampton, MA: Edward Elgar Publishing.