Printer Friendly



The housing sector is one of the most important parts of every economy, whether it in a developed or developing environment. Its importance comes from the fact that a house is a concern of every individual and family. In addition, the housing sector has several economic advantages including offering job opportunities, serving related industries, and fulfilling the social function of the society. In most countries the housing sector witnesses prosperity as well as depression periods according to the political and economic trends of that particular country. The housing sector may be categorized as follows:

* Private and public housing

* Single family and multi-family housing

* Owner-occupied and renter occupied housing

However, the private housing unit attract the most concern, because it is related to finding a shelter to live in, know as a dwelling unit. The demand for private housing units comes from several parties, such as newly formed families, families and individuals needing to improve their present dwelling units, and those waiting to replace the dilapidated units. The supply for the housing sector comes from:

* households who arrange the construction of their own family housing units.

* speculative builders and/or developers of both single-family and multi-family units.

* the government projects.

Based upon supply and demand the price of a house is supposed to be set at a fair price. However, in most countries, especially in the developing countries, the price may be unaffordable for many buyers in spite of their desires and urgent needs. In addition, most of the developing countries witness a significant shortage of housing units constructed to accepted standards, a fact that may be discovered by comparing the demand for housing units and the supply under normal conditions. This situation may lead to many families having no place to live or living in sub-standard units. As a result, most governments use subsidized housing programs in one way or another in order to increase the supply of the needed housing units. However, the equilibrium of the housing units market may be different from one environment to another any consequently the characteristics of the housing sector are different.

In a developed environment such as the U.S.A., the financial institutions play a critical role in determining the supply of housing units [Fair (1)] and the correlation between the cost of financing and housing supply is very high [Alrcelus and Meltzer (2)]. In the developed countries, due to the role of the financial institutions, there is less need for subsidized housing compare to developing countries, while in developing countries the need for subsidized housing is very high and the shortage of housing units is very significant. This is due to a number of reasons:

* the lack of the organized private financing institutions, especially those related to financing the housing sector.

* the low rate of return from construction firms, especially for projects related to low income families.

* the increasing cost of construction.

* the high cost of financing for long-term housing loans.

* the lack of raw materials for building houses.

In developing countries which are facing continual increases in both cost of financing and cost of construction, more direct programs are usually carried out, such as distribution of housing to law-income families, granting of funds to be allocated for building housing units and granting of interest-free housing loans. However, the above programs and sources of funds fluctuate according to the availability of public sources of funds and changing of policies and priorities. Accordingly, the question always arises as to whether or not to keep the subsidized housing programs going, and whether to create self-perpetuating channels of subsidized housing units, instead of implementing programs that become exhausted. In addition, most subsidized housing programs consider only demographic elements and social benefits, and are rarely financially evaluated as to their feasibility as other business projects are evaluated before implementation, for instance industrial [UNIDO (3) and agricultural projects [Gittinger (4)]. Therefore, there is a need to explore the issue of financing subsidized housing programs by suggesting several self-continuing means and institutions which may be used for this purpose. There is also a need to discuss the investment evaluation techniques which may be used by such institutions by adopting the capital budget techniques to the subsidized housing projects.

Purpose of this study: This study is aimed at discussing the possible methods of financing subsidized housing in the developing countries, and to explain the investment analysis techniques which may be considered in such methods. In more details this study is intended to accomplish the following:

* to explore the cost of financing subsidized housing programs, taking into account the time value of cash inflows.

* to state what possible means and institutions may be considered in financing subsidized housing program in a developing environment which contains a substantial low-income population.

* to suggest the relevant capital investment formulas that would evaluate the financial feasibility of the subsidize programs, and assure self-continuity of the suggested institutions, as well as keeping the cost of financing at a minimum level.

* to state the relevant capital investment formulas which may be used by international business firms to implement subsidized housing programs in developing countries.

Cost of Subsidized Housing Interest Factors to be kept in Mind: Subsidized Housing means reducing the cost of purchasing a housing unit below what the market would otherwise dictate. The reduction of the cost may be varied in its extent and conditions. Considering its extent, the reduction ranges from 100 per cent (in case of distribution of free houses) down to just one per cent. The subsidy may cover all or a part of the principal amount and/or the interest cost, a deduction in the down payment, or an extension of the number of years of the principal amortization. Accordingly, the extent of the subsidy for housing may be defined as the difference between regular prices, market interest rate and housing sale conditions determined by the free market and the stated respective prices, interest rate and sales conditions for subsidized housing units. The difference between the two prices, known as the subsidized margin, is usually financed by allocated public funds. The subsidized margin has a financing cost which is a percentage of the market interest rate and/or the principal amount. Therefore, there is need to discuss the interest rate factor and its role in financing subsidized housing programs. Concerning the related institutions of subsidized housing the above four components may be considered as follows:

* To cover annual expenses, the greater the efficiency in running the activities to the related institutions, the less are the administrative expenses needed, Generally, one per cent to two per cent is the average cost of the total funds for the administrative expenses. However, the related institutions may need to invest a part of their assets in market securities, in order to generate annual returns to cover a part of the annual expenses.

* To cover the risk and bad loans, in spite of the fact that housing loans are secured by properties which are the same built or bought houses, there is a significant rate of a default risk of not paying the installments at the times dues, since the repayments are due monthly, which may be hard to maintain for most of the beneficiaries who have no regular income. Therefore, a percentage of the total granted loans should be deducted to cover possible losses in this regrade. However, other risks such as future increasing interest rate should not be considered in the case of financing subsidized housing.

* To meet the cost of capital or funds, generally the cost of capital may be determined based upon the structure of the liabilities and owner equity of the institution. However, in case of the related housing institutions which are owned by the public and financed through free or low interest long-term loans, the cost of capital is expected to be at a minimum rate.

* To cover the inflation rate; currently, most of the countries witness a continuous increasing rate of inflation. This situation creates a real problem for long-term money market, especially for housing loans [Lessard and Modigliani, 1975], which have long-maturity periods ranging from 10 to 25 years. To consider the inflation rate which increase the interest rate to a high nominal interest rate is not an easy task. However, several methods may be used, such as:

* a fixed premium rate may be added to the actual interest for all periods.

* a variable rate which is connected with the national price index may be stated and added annually to the monthly repayments.

* an interest rate adjusted to the average market rate which reflect the inflation rate among other factors.

The subsidized housing cost which is considered as the subsidized margin may cover one or more of the above four components, or may be extended to the principal amount according to various subsidized programs, as indicated in Table 1. However, it should be noted here that the interest rate may be considered as the discount rate when considering the present value of cash flows of subsidized housing projects.

Investment Analysis of Subsidized Housing Means : The possible means and channels of financing subsidized housing projects are different from one country to another, and from one housing project to another. Many factors should be considered in preferring the services of one institution over another, factors such as the purposes of the housing programs, the economic ability and social class of beneficiaries, and the desired extension of subsidized margin. Traditionally, public specialized institutions are the main methods of financing subsidized housing, either through direct financing such as granting loans for beneficiaries, or through carrying out specific projects to build for distribution to the beneficiaries. However, various institutions and means may be used to finance the subsidized housing projects in different countries and environments. These institution may be classified into three groups as follows:

* public institution such as public construction institutions and municipalities.

* cooperative institutions such as cooperative banks, cooperative construction firms and supply cooperatives for building materials.

* private business firms such as international and local construction firms and financial firms.

Housing Bank: The specialized housing bank is one of the most relevant channels which may be used to finance subsidized housing in a developing environment. Such a bank concentrates on granting long-term loans directly for customers who are seeking to build their own houses and/or to finance buying new houses. In this regard, several options may be given to a public housing bank. For example;

First option: A bank with a portion of its assets to be invested in market securities while the remainder is allocated for housing loans, and having a public grant as owners equity may be operated according to the following:

Formula 1: The annual cash inflow for a fiscal year (collected installments) from previous loans + Market securities returns [greater than or equal to] the annual cash outflow (newly granted loans + bad loans and administrative expenses).

The above formula uses a fiscal year basis. The present value of cash flows, cost of capital and inflation rates are ignored as a way of subsidizing the housing sector.

Second option: A bank with all assets allocated for housing loans, having low interest liability loans, and a pubic grant as owners equity may be operated according to the following investment formula:

Formula 2: The annual cash inflow for a fiscal year (collected installments) > the annual cash outflow (newly granted loans + annual cost of loans + bad loans + administrative expenses).

Cooperative Housing Bank: A cooperative housing bank is the second important channel of financing subsidized housing units. The cooperative housing bank deals only with housing cooperative societies. In most developing countries the housing cooperative sector represents a significant part of the total housing sector. The cooperative housing societies work and deal with the cooperative housing bank according to international and national cooperative principles and regulations. Accordingly, a cooperative housing bank with assets allocated for housing loans, liabilities which include current accounts for cooperative societies and low-interest long-term loans, and members capital shares as owners equity maybe operated according to the following:

Formula 3: Annual cash inflow for a fiscal year (collected installments) [greater than or equal to] annual cash outflow (newly granted loans + bad loans + annual expenses + annual interest) + 6 per cent of capital shares value.

The above formula is stated on a fiscal year basis and ignores the present value of cash flows and the inflation rate. However, if the present value of the cash flows should be considered the discount rate may be calculated as follows:

Formula 4: The discount rate = a percentage (1-2 per cent) to cover annual expenses and bad loans + a percentage to cover the social cost (amount to be allocated for social services) + (interest liability rate X the ratio of long-term liabilities to total assets) + 6per cent X capital shares value + total granted loans value.

Supply Buying Cooperative for Building Materials: Obtaining the relevant building materials at fair process considered: a significant problem facing the housing sector in developing countries, especially most of the housing units are constructed under the supervision of their owners and not by specialized construction companies. A family that wants to have a house has to hire many small contractors and supervise all processes of building the home, and it has to buy all of the relevant building materials from scattered market places. Therefore, establishing a supply cooperative for building materials is considered a significant means of financing subsidized housing units through offering the materials at low prices, in addition to many technical and construction services. The difference between the market price and the cooperative final price is considered to be the subsidized margin. The supply cooperative may be owned by individuals who already have licenses for building and may stay as owner-members to finish the building of their houses. Then they can sell their proportionate share to new qualified individuals or to the cooperative itself. The supply cooperative may be operated based on the following:

Formula 5: The net cash flow (sales - cost of goods sold + annual expenses) [greater than or equal to] {6 per cent of capital + 25 per cent of income for reserves + 10 per cent of income for social services} + the recovered price ratio (patronage dividends + annual sales)

The Local Construction Business Firm: a construction business firm may be used directly as a means to subsidize the housing sector. This is accomplished by offering the firm special subsidies, which will supposedly be passed on to the final beneficiaries. The special subsidies range from tax exemptions, importing privileges for building materials and facilitation of credit including direct grants of free or low-interest loans. Granting low-interest loans to the specialized construction firms is a common mean of subsidizing business firms in serving the housing sector. However, governments and public institutions that grant such loans are expected to impose special conditions with regard to prices, cost and conditions of financing, and types of implemented housing units as well as the qualifications of the beneficiaries. In this case, the construction business firm may be operated according to the following:

Formula 6: The present value of cash inflows for all periods of the subsidized project [greater than or equal to] present value of cash outflows discounted based on a reduced rate {cost of capital rate - the subsidized rate (the average market interest rate - the granted interest rate x percentage of the granted loan value to the total assets)}.

The International Construction Firm: Due to the lack of experience in construction as well as lack of needed equipment and building materials in most developing countries, international construction firms may be invited to participate in carrying out special housing projects. Then the question arises about the possibility of participating in implementation of the subsidized housing projects and dealing directly with final beneficiaries. In this case, formula No. 6 may be considered with adjustments related to the difference between international and local interest rates. Therefore, an international construction firm who receives subsidized loans may be operated according to the following:

Formula 7: The present values of cash inflows for all periods of a Housing project [greater than or equal to] present value of cash outflows discounted based on a reduced rate {expected rate of return from the related projects -the subsidized interest rate (international market interest rate - granted loan interest rate) X the ratio of the granted loan to the total investments for a project.

The Public Institution: Two groups of public institutions may be involved in subsidizing the housing sector: First, specialized public construction firms which are part of the public sector and are designated to build houses in order to resell or rent these houses to the individuals; and second, the public institutions such as municipalities and housing ministries. In case of a public construction firm, the investment formula may be as follows:

Formula No. 8: The present value of cash inflows for the expected whole life of the firm [greater than or equal to] the present value of outflows discounted based on a minimum rate including a percentage to cover expenses and bad loans + a percentage to cover the expected inflation rate.

The cost of capital rate as a part of the discount rate may be ignored as a part of the subsidized margin. In the case of the municipalities, the investment evaluation formula may be as follows:

Formula No. 9: The present value of cash inflows for all periods of a project [greater than or equal to] cash outflows which are discounted based on a minimum rate including a percentage to cover housing project expenses, a part of the municipality expenditures and the expected inflation rate.

Non-profit institutions such as social charities may be involved in subsidizing the housing sector, especially for low income families and social welfare beneficiaries. These institutions may build special housing complexes through business construction firms in order to sell them at special prices to qualified beneficiaries under special programs. The subsidized margin, as the difference between market and special prices, may include the cost of financing and a part of the principal amount. In this case, the above special programs may be operated according to the following:

Formula No. 10: The total cash inflows for a program (collected installments + allocated subsidized funds) [greater than or equal to] total cash outflows for the sane program. Finally, Table 2 summarizes the above suggested institutions and their investment bases of financing the subsidized housing programs.


The financing of the housing sector has special characteristics, such as a long maturity, monthly repayment of the housing loans, and an increasing cost of the housing units. These characteristics significantly affect the amount of housing supply, which raises the final cost of housing to an unaffordable level for many potential buyers. Therefore, countries allover the world try to subsidize the housing sector using various means. Directly allocated funds are one of the most effective and commonly used means, especially to subsidize low-income family houses. However, the funds allocated for housing in a country fluctuate from one period to another and spent in most cases without considering the financial feasibility of such projects as long as the social targets are fulfilled.

The subsidized housing programs may be offered through public firms, cooperative, local business and international business firms. Accordingly, the suggested investment formula are relevant to the above institutions according to the purpose of the subsidized programs, and the available funds. Generally, a fiscal year basis formula is relevant to financial institutions which are subsidized by public funds. A project basis formula using present value of cash flows is a relevant technique to be used by local and international construction firms, while a life project basis is a relevant technique to be considered by public construction firm. Finally, it should be noted that the suggested institutions and the investment formulas may be applicable to most developing countries in order to fulfill the social and economic objectives of subsidizing housing sector. However, differences concerning to the philosophy, objectives, related laws and regulations should be considered from one country to another in each of the above mentioned institutions.


(1) Fair, R. C. "Disequilibrium in Housing Models" Journal of Finance (May 1972)

(2) Alrcelus, F. and A.H. Meltzer, The Markets for Housing and Housing Services", Journal of Money, Credit and Banking (February 1973).

(3) UNIDO, Manual For Preparation of Industrial Feasibility Studies (Vienna, United Nations Industrial Development Organization) 1986

(4) Gittinger, Price Economic Analysis of Agricultural Projects (The John Hopkins University Press) 1982


i) Lessard, D. and F. Modigliani "Inflation and Housing Market: Problem and Potential Solutions" in New Mortgage Designs for Stable Housing in an Inflationary Environment (Federal Reserve Bank of Boston conference Series No. 14) January 1975.

ii) Seiders, D. F. "The President's Commission on Housing; Perspectives on Mortgage Finance" Housing Finance Review (October 1982) 323-348.

iii) Segal, M. A. and B. M. Bird "The New Low-Income Housing Credit, "The Tax Adviser (July 1988).


Dean of Faculty of Commerce and Economics

Birzeit University

P. O. Box 14 Birzeit

West Bank - sia ISRAEL

Institutions          Bases

Housing Banks         * fiscal year basis
                      * subsidized margin includes a part of cost of
Cooperative Banks     * a fiscal year basis
                      * subsidized margin includes a part of cost of
                      * cooperative principles to be considered
Supply Cooperatives   * a fiscal year basis
                      * the subsidized margin includes recovered price
                        ratio (patronage)
                      * cooperative principles to be considered
Local Construction    * a project basic
Firms                 * the present value to be considered
                      * subsidized margin includes low discount rate
International         * a project basic
Construction Firms    * present value to be considered
                      * subsidized margin includes low discount rate
                        (international rate-granted rate)
Public Institutions   * a whole life firm project basis
                      * a zero net present value basis
                      * subsidized margin includes cost of capital
Non-Profit Firms      * a project basis
                      * subsidized margin includes cost of capital and a
                        part of the principal
                      * subsidized funds are exhausted
COPYRIGHT 2018 Reprinted with permission from JFMA. Copyright reserved with JFMA.
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 2018 Gale, Cengage Learning. All rights reserved.

Article Details
Printer friendly Cite/link Email Feedback
Author:Sabri, Nidal Rashid
Publication:Journal of Financial Management & Analysis
Article Type:Report
Geographic Code:0DEVE
Date:Jan 1, 2018

Terms of use | Privacy policy | Copyright © 2020 Farlex, Inc. | Feedback | For webmasters