Workforce Housing: Why Real Estate Investors Can’t Afford To Ignore It Anymore
Hard-working Americans who represent the burgeoning “workforce housing” sector – including teachers, firefighters, accountants and nurses – have fallen into a housing blind spot. But current market fundamentals and economic conditions are flipping this script. Record low unemployment, stagnant wage growth, and a glut of new upscale housing has compelled investors, developers and lenders alike to seek out new strategies that focus on this oft-ignored but booming “workforce housing” market.
This shift in focus favoring middle-class over luxury renters was one of the many topics of discussion at the recent Bisnow Multi-Family South Conference in Dallas, Texas. Commercial real estate thought leaders gathered to discuss recent economic headwinds, multi-family market fundamentals and housing trends that are having profound effects on multi-family development and investment.
Investor confidence remains bullish towards the apartments sector despite robust supply levels, climbing construction costs and natural cycle maturation. But these headwinds are not going unnoticed. Trinity Private Equity Group principal, Doug Gunn, addressed the elephant in the room, saying that the high levels of capital available are having the ill effect of raising prices and compressing returns for most current deals, particularly those catering to the luxury segment of the market. Attendees acknowledged that current conditions are only going to worsen as the growth stage of the cycle creeps toward a decline, making it imperative for industry leaders to get in front of the problem and deliver housing options that benefit all stakeholders involved.
As part of the “Finding Value in Class B and C Asset Classes” panel, we discussed the tactics borrowers and lenders should employ to take full advantage of the emerging market for lower-cost housing.
Why Pursue Workforce Housing?
Workforce housing has historically been ignored because it falls in a no-man’s land between government subsidized affordable housing on one end of the spectrum, and amenity-driven luxury residential units at the other extreme. Amenities in modest-priced apartment communities don’t scream ‘rent growth’ like luxury complexes, nor are they supported by subsidized sources of capital, so investors have many times gravitated away from these deals when they have more attractive options. The result: the number of occupied rental units priced below $800 fell by 1.2 million units between 2005 and 2016, while in contrast, overall supply of apartments more generally rented jumped by almost 6 million units. Meanwhile, 2017 saw the most multifamily completions on record, but developers still opted to deliver more upscale, Class A properties rather than address this gap in the middle. Workforce housing, therefore, represents a classic investment opportunity, offering a market featuring low supply and high demand.
This disconnect between the new supply being brought to market and market demand has needed strategic attention for years, but the financial incentive for investors is just now catching up to the unrelenting need. Realizing returns on Class A developments are being squeezed by overabundance of supply, slowed rent growth and rising interest rates. Therefore, investors have become motivated, pivoting towards more value-add opportunities that require less up-front capital and offer more stable cash flows. This year, over 40 percent of all real estate investment dollars raised by private equity funds were put towards value-add investments, further evidence of this once-niche sector’s ascent into buzzword and must-know territory.
How to Pursue Workforce Housing
Savvy investors understand in a market rife with supply, abundant capital and soaring property valuations, identifying undervalued existing assets is essential. This is particularly true when attempting to deliver solutions that address both the budget constraints and lifestyle needs of America’s working class – while being financially viable. Although investors and developers have previously favored Class A projects, driving up rental rates to counteract rising construction costs, the path to value in the current market lies in Class B and C properties. In these locations, value can be created through building and management improvements without driving rents beyond affordable levels for the units.
Bridge loan financing has become an attractive lending option as investors attempt to break into the market. Funds from bridge loans can be used to reposition assets through initial capital expenditures and value-adds such as new flooring, improved lighting, and updated appliances. In doing so, investors are able to change the desired tenant profile and boost rents, ultimately leading to sustained increases in revenue. This strategy requires a very small capital injection up front and holds little risk for lenders who are hesitant to finance projects with interest rates rising.
Bridge loans offer an avenue to refinancing or repositioning, ultimately with the end-goal of either holding or selling a property. Lenders help structure the loans so that they align with the client’s business plan, forecasting models, and competitor offerings, often offering to help with the initial capital expenditures to help prepare the new owners for a rapid transition from bridge capital to an agency (Fannie or Freddie) permanent loan.
Key Challenges for Owners and Investors
Developers must be wary of being overly ambitious or too conservative when crafting their business plans for workforce housing investments. Lenders suggest spending between $8,000 – $15,000 per unit in order to effectively drive up rents and attract desirable tenants. Spending in this price range ensures that the space is not overly leveraged and is a minor refresh, but still provides enough of a value-add to bolster revenues and change tenant perception. Renovations that don’t adequately improve the space and tenant profiles – or ones that happen too soon after a previous revamp – can prove disastrous to a project and derail the entire plan. Forecasting is also incredibly important in securing a loan with the best possible terms. Viable projects should aim for a return on investment of 15 – 20 percent, as lower projections may not be viewed as being worth the risk.
As the multifamily sector continues to tighten and working people keep flexing their market muscles, industry leaders will continue to take notice and pursue innovative lending and investment solutions that support this long-ignored sector of the economy.
At KeyBank, we believe the foundations of any successful partnership are rooted in common goals, knowledge and understanding. We understand the dynamics of multifamily and workforce housing, and work with clients to deliver solutions that meet business plans, including interim bridge loan financing, construction debt and a wide variety of permanent debt options. To learn more, or discuss your workforce housing project plan, we can be reached at Amber_A_Rao@keybank.com and Justin_Wilbur@keybank.com.