Affordable housing strategies diverge amid shortage crisis

Everyone agrees that there is a chronic lack of affordable housing, but real estate managers diverge over which residential strategies to place their bets on.

There is a wide range of choices, from standard-issue multifamily buildings to workforce housing to affordable housing, which is typically subsidized by state and local governments with below-market rents meant for individuals earning less than a county's median salary. Workforce housing is aimed at another group, developed for those who earn too much for affordable housing but not enough to pay the going market rate for rents, according to industry executives.

The moves come as housing affordability overall is on the decline, with new supply falling as rising interest rates increase the cost of financing for building and buying homes, according to the 2022 Urban Land Institute's Terwilliger Center Home Attainability index.

"Few available housing units of any kind, even modest rental units, exist that are affordable to many low-wage workers in most regions," reported analysts from the ULI Terwilliger Center for Housing, a housing research and policy center. According to a 2021 housing study by the Harvard Joint Center for Housing Studies, nearly half of all renters earning between $35,000 and $50,000 per year were cost-burdened, meaning that they spent at least 30% of their household income on housing.

The ebbing supply of rental housing of any sort and heightened demand as rising interest rates make home ownership unattainable for some is boosting interest among managers, many of which view affordable housing also as an ESG strategy.

With waning interest in what had been two of the main real estate food groups — retail and office — because of the embrace of online shopping and the pandemic trend of work from home, managers have been piling into rental housing strategies. They expect to benefit from the Federal Reserve's moves to stamp out inflation by increasing interest rates, actions that are pushing up mortgage rates and dampening the for-sale housing market.

As a result of the pressures on for-sale housing, the multifamily, single-family home for rent and other rental housing sectors are attracting interest from investors and managers. The weighted average of multifamily properties for the top 50 managers of U.S. tax-exempt institutional investors was 23.1% as of June 30, a slight increase from 22.9% a year earlier. Single-family rentals accounted for 0.5% as of June 30, compared to 0.6% as of June 30, 2021. Meanwhile, senior housing and student housing — a new category tracked by P&I — each accounted for 1% as of June 30.

"We like the residential sector in this environment — everything from traditional multifamily and single-family rentals to student housing," said W. Todd Henderson, New York-based head of real estate, Americas, DWS Group, which managed $58.7 billion in worldwide real estate assets and $17.9 billion in real estate assets managed for U.S. tax-exempt institutional investors. In the year ended June 30, DWS' worldwide assets grew 6.1% from $55.3 billion as of June 30, 2021, while its assets managed for U.S. institutional investors dipped 6.7% from $19.2 billion a year earlier, P&I data show.

"There is a housing shortage in this country that has driven unprecedented rent growth over the last year," Mr. Henderson said.

At current development pacing, the gap in rental housing will not be closed for five years, he said. At the same time, demand is growing as millennials and Generation Zers begin forming households while baby boomers and Generation X members sell homes to move into rental housing as they downsize, Mr. Henderson said.

"We believe that the supply and demand dynamics will support continued rent growth in residential and the short-lease terms afford owners the opportunity to access higher rents and keep pace with inflation," he said.

On the other side of the spectrum are managers that are focusing on more affordable-housing options.

Barings has invested in affordable housing for 30 years, said Daron Tubian, New York-based head of affordable housing investments and managing director. From the start, Barings has provided financing for subsidized housing for low-income families.

"Many affordable housing projects have traditionally catered to the low- and very low-income population, ranging from 30% to 80% of average median income," Mr. Tubian said. Barings had $40.8 billion in worldwide real estate assets as of June 30, down 5.3% from a year earlier and $5.7 billion in real estate assets managed for U.S. tax-exempt institutional investors, a 1.7% decline from P&I's year-earlier survey.

However, the affordable sector is evolving to include a mix of income levels so as not to segregate low-income residents to buildings that are exclusively affordable, subsidized apartments, experts say.

"A growing number of markets are now also focusing their efforts to create more workforce and mixed-income housing, which caters to the low-, moderate- and middle-income population," Mr. Tubian said. "Housing markets in New York City, Los Angeles, San Francisco and Charlotte to name a few are active in workforce and mixed-income housing."

The percentage of affordable, subsidized units in a mixed-income project can range from as little as 20% to 60%, he said.

"A lot of it depends on the specifics of the project, its cost and what they may be required to do by the local housing agency," Mr. Tubian said.

For example, in April 2021, Barings provided a $9.8 million permanent loan for the construction of Canal Lofts, a four-story, mixed-income 150-unit multifamily housing development in the revitalization district of Houston. The property which is 67% affordable and 33% market rate also has financing through the Community Development Block Grant Disaster Recovery Program, a U.S. Department of Housing and Urban Development program.

Asset owners also are increasingly investing in affordable housing strategies, industry insiders say.

In March, the $304.9 billion California State Teachers' Retirement System, West Sacramento, committed $50 million to SoLa Impact LLC's Black Impact Fund, an affordable and workforce housing fund, through the pension fund's joint venture with Belay Investment Group LLC.

Typically, Black and Latino communities are underinvested, said Martin Muoto, Los Angeles-based CEO of SoLa Impact. The firm closed its fourth fund, the Black Impact Fund, with $250 million in March, he said.

Sixty-five percent of the fund is expected to be invested in new development with the remainder in rehabilitating existing apartment buildings in underserved Black and Latino communities.

"We focus on areas where we have a competitive advantage with the intention of improving the social outcomes of those communities" by adding more affordable and workforce housing, Mr. Muoto said.

The properties have affordable units supported by Section 8 vouchers provided by HUD as well as workforce housing "which are market rate but still affordable because of the areas in which they are located," Mr. Muoto said.

As of March, SoLa Impact had invested in the development of over 3,000 affordable and workforce housing units located primarily in Los Angeles. In addition to providing housing, SoLa Impact through an affiliated non-profit, SoLa I Can Foundation, offers tenants services including vocational training, financial counseling and scholarships, he said.

And there is a pathway to earning a top return in the affordable housing sector, Mr. Muoto said.

The areas with predominantly Black and Latino residents are where "the real estate is undervalued" and so there is "potentially more upside, Mr. Muoto said.

Anand Kannan, Irvine, Calif.-based president of Community Preservation Partners, a developer, owner and operator of affordable housing, said in an email that over the years, he has seen more real estate managers taking an interest in affordable housing investments.

The growing interest in multifamily "has brought a lot more players into the space, leading to increased competition for deals," Mr. Kannan said.

Community Preservation Partners defines affordable housing as buildings in which 100% of the tenants make 80% or less of area median income, with its properties typically serving residents making around 60% or less of AMI.

The companies that are now entering the affordable housing sector are established real estate firms that "may not necessarily have the same mission of preserving affordable housing that we do and may only focus on the financial metrics of a particular opportunity," he said.

The company uses a combination of private funds and government subsidies to maximize that the investment into each property and focuses on affordable housing in high-cost areas in 16 states including Oregon, California, Nevada, North Carolina, Virginia, Hawaii and Texas.

But there are risks in the affordable housing sector, he said.

"Affordable housing deals are complex and can take a significant amount of time to complete due to the associated regulations and oversight," Mr. Kannan said. "In our current unpredictable economic environment, this can create challenges due to fluctuations in interest rates, supply chain issues, and other market factors that can impact the cost and viability of a transaction over time."

What's more, debt financing has become significantly more expensive over the past 12 months due to rising interest rates, said Ann Caruana, Irvine, Calif.-based president and chief investment officer of Preservation Equity Fund Advisors, an affordable housing operator.

Traditionally, most of the private investment in the sector was from banks and insurance companies to take advantage of tax benefits and Community Reinvestment Act requirements, Ms. Caruana said.

It is only recently that affordable housing investment strategies have emerged that meet the needs of pension plans, endowments, foundations and/or sovereign wealth funds.

Not only does investing in affordable housing help investors meet their ESG goals, the sector traditionally was dominated by mom-and-pop owners, so there is room for institutional owners and managers to build scale, Mr. Muoto said.