Sustainable Development and Mortgage Default

Multifamily properties with sustainability features have a significantly lower risk of mortgage default. That’s the conclusion of a May 2013 report by Professor Gary Pivo, which is available from Fannie Mae. The lengthy and self-explanatory title of the report is The Effect of Transportation, Location, and Affordability Related Sustainability Features on Mortgage Default Prediction and Risk in Multifamily Rental Housing.

Professor Pivo was able to access Fannie Mae’s database of multifamily loans. The study looked at 37,385 loans that ranged in age from brand new to 30 years old; the average loan age was 6 years. The default rate of properties in this study was a very low 0.86%. That means only a few hundred properties were in default.

The average location on the urban-rural spectrum was “metro city” — between the urban center and the urban outskirts. The average number of dwellings on each property was 95 (standard deviation was 125 dwellings) and the average construction date was 1968 (standard deviation was 26 years). Both of the latter two measurements had a large standard deviation, meaning the data values were spread over a wide range.

The study tested the portfolio of loans with seven sustainability variables. The variables were based on U.S. Census 2000 statistics for census tracts, census block groups, and other sources.

  1. Commute time: Commute time in minutes for those who work outside the home
  2. Rail commute: Do at least 30% of the residents take a subway or elevated train to work?
  3. Walk commute: The percentage of residents who walk to work
  4. Retail presence: Are there at least 16 retail establishments nearby?
  5. Affordability: Are some of the units required to be affordable?
  6. Freeway presence: Is the property located within 1,000 feet of a freeway?
  7. Park presence: Is the property located within 1 mile of a protected area?

The study controlled for characteristics of the loan, property, neighborhood and location, and regional and national economies — factors that typically have a strong effect on default rates.

Pivo added the seven sustainability variables to a model that has been used by other researchers to explore the why mortgage defaults happen. Pivo’s thinking was that conventional financial models and lending practices have not incorporated sustainability features. Yet, sustainability features have been associated with higher rates of return. If sustainability variables are added to the model, the model should become more accurate at predicting mortgage defaults.

This hypothesis turned out to be true. The addition of sustainability variables improved the accuracy of the model, according to four different “goodness of fit” tests.

The second hypothesis was that default risk was reduced by sustainability features (or conversely, risk was increased by unsustainable features). This also turned out to be true. The effect of the variables was substantial:

  1. Commute time: Every 10-minute increase in average commute time increased the risk of default by 45%.
  2. Rail commute: Where at least 30% of the residents took a subway or elevated train to work, the risk of default decreased by 64.4%. New York City was omitted from this calculation because it skewed the results.
  3. Walk commute: Every increase of 5 percentage points in the percent of residents who walk to work decreased the risk of default by 15%.
  4. Retail presence: Where there were at least 16 retail establishments nearby, the risk of default decreased by 34.4%.
  5. Affordability: For properties with some units required to be affordable, the risk of default decreased by 61.9%.
  6. Freeway presence: Where properties were located within 1,000 feet of a freeway, the risk of default increased by 59%.
  7. Park presence: Where properties were located within 1 mile of a protected area, the risk of default decreased by 32.5%.

A great advantage of the sustainability variables in this study is that all are based on existing datasets provided by the Census Bureau and other agencies. According to Pivo, “it would be relatively easy to build an online address-based lookup tool that any lender can use to obtain certain sustainability information on a given property.” Furthermore, because sustainability factors reduce default risk, the lender can give a property more favorable loans without increasing its risk exposure. Pivo suggests an online tool could provide the recommended loan adjustments for any given property.

Pivo concludes,

Multifamily lenders can mitigate risk by gearing their portfolios toward more sustainable properties. Moreover, and for society this may be even more important, lenders can offer favorable financial terms to more sustainable properties without increasing risk, or as Benjamin Franklin once said, they can “do well by doing good”.

Additional resources

Gary Pivo’s home page at the College of Architecture, Planning and Landscape Architecture at the University of Arizona.

Responsible Property Investing Center

Property Working Group of the UN Environment Programme Finance Initiative

Smart-growth publications on Business and Economic Development from the U.S. EPA’s Office of Sustainable Communities

Content on market trends from Better! Cities & Towns

Featured Topic: Value Capture from Reconnecting America

One response to “Sustainable Development and Mortgage Default

  1. Pingback: Study: Walkability Linked to Much Lower Risk of Default on Housing Loans |

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