Written by Kenneth Munkacy
Cities across the United States are experiencing a housing disconnect. Even as new construction starts have added up to a multifamily building boom, a housing crunch remains in many U.S. cities, with many people unable to find or afford a place to live. A large segment of the apartment-seeking population does not qualify for subsidized housing, but also does not make enough for the market-rate rentals in its cities. The need for inexpensive housing, within close proximity to job centers, that caters to this working population of renters — and the opportunity for investors — is clear, and it is aptly referred to as workforce housing.
WHAT IS CAUSING THE CRUNCH
Over the past five years, several demographic, cultural and sociopolitical events converged to create a greater demand for rental housing and, in particular, housing that is economically accessible to more people.
Younger and older people both move toward rentals. Millennials face significant barriers to homeownership, with unprecedented student-loan debt, rising home prices and more rigorous mortgage requirements. Even though 80 percent of millennials would like to purchase a home, the ability to afford one remains an obstacle that could take one or two decades to overcome. At the same time, baby boomers are downsizing and looking for lower maintenance and more flexible living situations. The number of renters in their early 60s increased by 84 percent between 2006 and 2016, the most of any age group.
Effects of the global financial crisis linger. The repercussions of the housing market collapse from 2007 to 2009 are still being felt a decade later. At least 1.2 million Americans lost their homes during the recession, and for many of them, it affected their ability to finance in the future. Banks also responded to the subprime mortgage crisis by tightening their lending criteria, making it more difficult for some first-time buyers to obtain a mortgage.
Changes in federal tax structure. Affordable housing overseen by the U.S. Department of Housing and Urban Development aims to alleviate the cost burden on families who pay more than 30 percent of their household income on housing. HUD estimates more than 12 million renter and homeowner households now pay more than 50 percent of their annual incomes for housing. The Tax Cuts and Jobs Act enacted in late 2017 decreased low-income housing tax-credit prices, which are designed to entice private equity to invest in affordable-housing developments. Rising interest rates and development costs are also making it more challenging to finance these projects. The lack of new affordable housing is pushing renters in that category into the general pool of housing seekers. On the individual level, the federal tax reform bill also makes owning a home in certain markets less attractive because the deduction for state and local taxes has been capped. Without the incentive of that deduction, some higher-income renters are deciding to stay put instead of buying a house.
Luxury development may be entering a glut. Most of the new development over the past five years has been focused on new luxury towers in prime markets. The addition of hundreds of thousands of new high-end units is causing downward pressure on rents. Concessions in Manhattan and Brooklyn hit record highs, as an influx of new inventory converged with renters hitting a wall of what they are able to afford. More municipalities are also being asked to consider rent control measures, including Orange County, Calif., and Chicago.
THE OPPORTUNITY FOR WORKFORCE HOUSING
With younger and older people with lower and higher incomes all coming into the renter pool, people in the middle are being squeezed in the availability and affordability of apartments. According to CoStar, this “rentership society” is expected to grow by more than 7 million through 2025, and 80 percent of the renter demand, representing 4 million units, is from renters with incomes less than $75,000, the “renters by necessity.” This population makes up the lesser-known but increasingly important — and potentially lucrative for investors — workforce housing segment.
Workforce housing is distinct from affordable housing, targeting middle-income families and individuals with good-quality rental units that are in a lower rental class than the luxury class A and A+ new construction buildings. The class B and C multifamily buildings that comprise workforce housing offer good fundamentals for investors: steady demand, low vacancy rates, and the ability to incrementally raise rents with low capital expenditures on improvements.
One investment strategy is to focus on identifying growing submarkets that are short of housing that meets the needs of the middle — millennials who do not have the capital or desire to own a home, young families who are saving to buy, and baby boomers who are downsizing.
The multifamily sector continues to be a compelling investment for institutional investors, real estate investment companies and family offices, as the country sees a demand for affordable rental housing for middle-income families that are unable, or unwilling, to purchase a home.