Affordable housing is still a hot button issue in many metros across the U.S. According to a recent Yardi Matrix report, despite a strong half of 2018 for the multifamily market, affordability has highly effected rent growth in New York, San Francisco and other large metros. At the same time, at the National Apartment Association’s Apartmentalize conference in San Diego, in June, industry professionals highlighted the benefits that an affordable housing community can bring to a neighborhood.
Avanath Capital Management President & Chief Investment Officer John Williams and Chief Operating Officer Jun Sakumoto discuss the misconceptions regarding profitability in the sector as well as possible solutions to the growing shortage of units for middle-income renters.
How do you see the affordable housing sector in the U.S. right now?
Williams: The affordable housing sector is unique, as it is one of the only asset classes that is relatively unaffected by changing market conditions. Market fundamentals always tend to remain strong in times of both economic uncertainty and economic prosperity. This is largely due to the significant lack of supply of affordable properties throughout the U.S. and the unlimited, often increasing demand.
In fact, contrary to popular belief, affordable housing targets the masses as opposed to a small percentage of low-income renters. The average household income in the U.S. is approximately $57,000 and according to a 2017 U.S. Census Bureau report, over 58 percent of renters earn less than $50,000 a year. At Avanath, we serve households that make between $30,000 to $70,000 a year, which accounts for approximately 72 percent of U.S. renters.
Further, while the affordable housing sector targets the largest swath of today’s renters, affordable housing supply continues to diminish. Each year, more than 100,000 affordable units are lost due to obsolescence or substandard conditions due to poor management. Others across the nation are rapidly being converted to luxury market-rate apartments.
For example, in New York, more than 45,520 affordable units are at risk of being converted to market-rate apartments over the next five years. The same can be said for states such as California with 45,140 units at risk of conversion and 32,265 units in Texas. This is a major theme across the U.S., which has resulted in an environment where demand consistently outpaces supply.
What fuels the affordable housing shortage?
Williams: There has been a massive influx of capital flowing to new luxury development in major metropolitan areas, which has left workforce housing development in the dust. While rising land and construction costs do play a role, one of the biggest issues with the lack of workforce housing supply is that developers are often over-improving properties. Many developers are acquiring properties and improving them to Class A status, which requires them to significantly raise rents.
For example, rather than replacing cabinets, we may resurface them. We may install durable vinyl plank flooring to replace carpeting. In doing so, we cost effectively improve properties into Class B and B-minus status, which provides a very nice and functional community, but one that is not overly luxurious like many of the properties today. This allows us to capture middle-income earners, which are arguably one of the largest rental segments in the U.S. This results in long-term stability for our properties, average occupancy rates that exceed 98 percent year-over-year and risk-adjusted returns to investors.
What can you tell us about solutions to the affordable housing crisis, especially when it comes to middle-income households?
Sakumoto: There are some governmental subsidies and tax credit programs that are geared towards encouraging more affordable housing development. That said, it is unlikely that we will see federal policy changes that fully address the nationwide affordable housing crisis.
The solution lies within increased investment from private and institutional investors. These investors have the capital, expertise and incentive the federal government lacks. The challenge is overcoming the perception of investment in affordable and workforce housing and the potential for returns. Many investors tend to view affordable housing as a complex asset class that does not present that same opportunity for returns compared to market-rate apartments. This is why historically affordable housing assets have not been commonly included in institutional portfolios.
However, over the last several years, we have seen this change as institutional investors are beginning to recognize the value in affordable and workforce housing and that it is a stable asset class that provides downside protection when economic volatility increases. Many investors are also finding that it is aligned with their goals for positive social impact.
Is the affordable housing sector profitable for both owners and investors?
Sakumoto: There is a very common misconception that investing in affordable housing will not provide returns comparable to market-rate apartments. The fact is affordable housing returns are often consistent with market-rate returns and many times exceed them.
Compared to a market-rate apartment, affordable housing properties exhibit high occupancy and low turnover. This has a direct impact on the bottom line for owners and investors alike. The average turnover rate for market-rate apartments is approximately 50 percent. This is a large number that results in increased costs for investors and owners as they have to clean, repaint, improve any damages and prepare the unit for the next resident. There is also the lost revenue for the time the unit is vacant during this process, as well as the marketing costs associated with attracting new residents. Affordable housing properties require no marketing and often have waiting lists exceeding hundreds of people.
We increase profitability for all our projects by implementing sustainable initiatives that further drive the bottom line for investors. For example, we replaced turf with drought-resistant plants at our Natomas Park Apartments property and saved almost $10,000 annually, reducing the overall water usage at the property by 30 percent.
What are your expectations from the sector for the rest of the year?
Williams: Affordable and workforce housing will remain strong investment types for the remainder of the year and well into the future. Demand will continue to rapidly outpace supply, especially as rents continue to rise and wages fail to keep up throughout the U.S.
As this gap widens, we will continue to see developers over-improve existing multifamily assets and converting them into Class A properties. Thus, further reducing supply and strongly positioning affordable housing assets to perform over time.
Images courtesy of Avanath Capital Management