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Following a change in market dynamics and a shortage of affordable rental options, workforce housing is beginning to step out of the shadow of luxury apartments and grab the attention of both developers and investors. What has been a white-hot luxury apartment market is starting to cool off amid concerns about oversupply and slowing growth ahead. Instead, capital is shifting to more "recession proof" middle market housing where data supports both overwhelming renter demand and significant barriers to entry to expanding this type of unsubsidized housing.

Generally, workforce housing refers to the middle tier of the market that falls between high-end and high-priced rentals and low-end subsidized affordable housing. The inventory of workforce rentals often encompasses an assortment of "no-frills" Class B and Class C apartments that lack the resort-style amenities and upscale finishes found in many of the newer properties being built today.

Workforce apartments typically serve a broad segment of the rental pool with people who earn 60-120 percent of the area median income. Based on current U.S. averages, that translates to households that earn anywhere between $33,000 and $67,000 per year — a population ranging from teachers and accountants to office managers and nurses. It is these workers that are feeling the squeeze from mounting housing costs and fewer moderately priced options.

Shortage of Affordable Options

Workforce apartments are a solution to what some view as a growing affordable housing crisis in this country. The majority of apartment projects that have been built in the past decade are concentrated on high-end, Class A properties. Construction on lower cost, unsubsidized rentals has been more limited.

Projects that are coming online continue to highlight the disparity that exists at the very high end of the housing market. During the 10-year period from 2005 to 2015, the supply of rental housing stock increased by 6.7 million units, including apartments and single-family rentals. The number of units renting for $2,000 per month or more increased by 97 percent, while the supply of affordable units renting for less than $800 declined by two percent with 260,000 units disappearing from the market, according to the 2017 State of the Nation's Housing Study.

Understandably, development has gravitated to the upper-end of the multifamily market where projects can achieve higher rents and produce higher yields. Signs of softening fundamentals and slower growth in Class A markets around the country are pushing developers and investors to consider other options where the outlook for demand and sustainable growth is more favorable.

Many metros credit empty nesters with helping to absorb the new supply of luxury rentals. However, the prime demographic for renters are those between the ages of 18 and 34, many of whom are millennials who have yet to even get close to the spending power available to baby boomers. As lease-up of new projects starts to slow, it raises the question of just how much those renters are able and willing to stretch to pay rents in newly built, urban projects that charge upwards of $2,000 per month for a two-bedroom unit.

Opportunities to Create Lower Cost Housing

The challenge facing the workforce housing market is how to build the lower-priced units and still make a profit. One solution has been to shrink the size of the units as well as increase the number of studio or micro-units, which helps reduce costs for renters, while still being profitable for builders. Developers are also shifting to suburban markets and garden-style, stick-built projects where land and building costs are lower.

In addition, investors are finding opportunities to buy older Class C or even Class B properties that are a good fit for the workforce housing market. Oftentimes, investment groups can buy older assets and make modest improvements or upgrades to make a project more appealing, while still keeping rents within reach for the workforce target demographic.

Creating more housing options across different price points is expected to remain at the forefront for some time to come. According to a new housing study commissioned by the National Multifamily Housing Council and the National Apartment Association, industry research supports a pressing need for more apartments with a forecast of 4.6 million new units needed by 2030 in order to keep up with demand.

That data sets the stage for a strong demand for multifamily housing, especially affordable rental housing. Additionally, there is equally strong interest from both debt and equity capital sources to partner with developers and investors to expand the inventory of available workforce housing. To learn more, contact Rob Likes, National Director at Robert_L_Likes@KeyBank.com or 801-297-5811.