Is Affordable Housing Still a Safe-Haven Investment?
Kairos Investment Management Co.’s Jonathan Needell makes the case for affordable housing investments in the face of heightened economic risk.
The U.S.’s decadelong economic growth officially ceased when 701,000 residents lost their jobs in March, in stark contrast with the 275,000 positions gained in February, according to figures released by the U.S. Bureau of Labor Statistics. With millions of laid-off or furloughed workers, multifamily operators are preparing for months of uncertainties, despite nearly 70 percent of rental households across the U.S. having paid their April rent, according to a recent report from the National Multifamily Housing Council.
Will the percentage maintain in May? Are property owners of low- to moderate-income multifamily housing more vulnerable since their tenants are more likely to have a hard time during this period of disruption? Jonathan Needell, president & CIO of Kairos Investment Management Co., answered these questions and others in an interview with Multi-Housing News.
To what extent has the coronavirus crisis impacted your affordable housing portfolio?
Needell: The most immediate impact from COVID-19 has been on our daily operations. We are taking active steps to reduce the risk and threat to our residents, management teams, employees and our multifamily housing communities. For that reason, our property managers have enacted contingency plans for day-to-day operations and strategies to mitigate operating challenges.
These plans are evaluated regularly and adjusted for new information based on the Centers for Disease Control and Prevention and the World Health Organization’s recommendations, and federal and state mandated orders. Some measures include closures of all fitness centers and nonessential amenity spaces, and suspension of nonemergency work orders. New leases are handled online, utilizing digital communication, where possible, and limiting exposure to walk-in traffic in our leasing offices.
On the financial side, no impacts have really been felt in late March. The first week of March we received rent for March and the virus really hit the U.S. in a bigger way after that time frame. I think most people understood the impact when the NBA cancelled the season on March 11. The first real test will be this month, as the first few weeks of jobless claims have been logged.
It will likely be most of April until we know something (on rent collections), since we believe the coronavirus relief bill will not cause the direct payments to consumers to be received until roughly three weeks from now. We may be collecting April rent through most of April rather than just in the first few days. The bill’s direct payments include an increase of unemployment insurance by $600 per week, and by $1,700 to $3,400 in a one-time payment for a two- (one child and one parent) to four-person (two parents and two children) family, respectively. The payments should be an effective financial backstop that gives affordable tenants the money needed for basic necessities like rent.
What measures are you taking to ensure your tenants will spend their payments from the coronavirus relief bill on their rent?
There is a potential for a moral hazard where someone could take the money from the relief payment and not pay rent. We are working with our property managers to mitigate that effect by communicating to tenants how to access their relief benefits and educating them on the need to pay rent with the money. Tenants still need to protect their credit, as landlords and lenders will look to see if they have ever defaulted on rent before, when they go to lease a new apartment or buy a house. Credit counseling has an important role to play in affordable housing.
Is affordable housing still a safe-haven investment in a high-risk environment?
Needell: We believe affordable housing performs with better resiliency, higher occupancy and lower credit default when compared to market-rate properties in down markets and recessionary environments. This makes it an attractive submarket of multifamily in the later stages of market cycles and during recession. Occupancy rates are typically higher in low-income housing tax credit properties during recession compared to market-rate multifamily, due to a continual shortage of affordable units, particularly when businesses are faced with layoffs and unemployment increases.
Market-rate rents are driven by supply/demand characteristics and typically experience declines during recessionary periods. LIHTC properties are uniquely positioned during recessionary times, as rents are published by HUD annually and are based on three-year trailing income growth metrics. As such, in the early years of a recession, while market-rate rents are being driven down, LIHTC typically continues to experience rental growth in years one and two—based on the three-year trailing income growth figures—or at least the rents don’t drop. This creates a compression between market-rate rents and affordable rents, decreasing the discount to market rents that LIHTC properties typically provide.
Furthermore, LIHTC properties benefit from a hold harmless clause, which states that any LIHTC properties built before 2009 are not required to lower their rent if income growth is negative. This effectively provides a rent floor for the owner or landlord in the later stages of a recession and into a recovery.
Because there continues to be a spread between market-rate and LIHTC rents and a lack of supply of affordable units, we often see resilient and strong demand for affordable housing units during times of recession. Low-income tenants still need to keep a roof over their heads and some tenants living in market-rate properties may look to move into more affordable options during difficult times.
Rising layoffs will certainly impact tenants within the residential sector if the mass closure of nonessential businesses caused by the COVID-19 pandemic lasts beyond the short term, particularly those that may experience, or have already experienced, layoffs as a result. Many tenants in affordable properties are supported by unemployment insurance and sometimes Section 8 vouchers. This somewhat mitigates the layoff risk in the rent roll for affordable properties, along with tenants that move down from more expensive properties in tough times.
Are multifamily owners reaping the benefits of low Treasury rates?
Needell: Absolutely. This has already happened with us and, to a certain extent, the market has adjusted a little. A week ago, we determined certain properties in our portfolio might benefit from refinancing and we initiated the process on half a dozen refinancing transactions on multifamily deals, four of which are in our affordable strategy. We locked in one transaction below 3 percent interest-only for 10 years. The rest got caught in the Fannie Mae and Freddie Mac repricing—spreads gapped out over 100 basis points—and may pay higher interest rates. Even after that, several transactions are very attractive, especially in the affordable space where the agencies are particularly supportive.
Could this health crisis cause rent increases?
Needell: We are already in a shortage of affordable housing and rents are controlled by the restrictions in place. It is the same with rent control in certain states, which will limit increases even if there is a local supply shortage.
With market-rate apartment demand being down, we don’t think you will see a limiting of supply lead to rent increases in the short term. During this crisis, we believe most owners will renew tenants in place at current rents or even offer incentives or concessions to entice tenants to not move. New tenant traffic will be down with shelter-in-place guidance.
What are your most important pieces of advice to help affordable housing property owners protect their investments?
Needell: Stay informed and communicate. Keeping engaged with property managers is mission critical. Come up with a game plan for policies and procedures surrounding renewal, new leasing, late fees, eviction policies—in jurisdictions where eviction holidays are not in play. You can’t let the property manager, who is the owner’s representative on the ground, be caught flat-footed. They need to know the answers to the questions that tenants are asking about eviction, late payments etc.
Of course, it’s also important to provide the necessary resources to our residents. With the largest fiscal stimulus bill passed by Congress, we can support and educate our tenants by providing the facts and resources available to them locally—if available—and nationally like the coronavirus aid bill. Place a handout in mailboxes and slip it under doors since you can’t gather the tenants together for a meeting, given social distancing guidelines.
How should affordable housing property owners and managers prepare for the aftermath of this crisis?
Needell: My advice is to prepare for uncertainty. Anything is fair game in this massive economic experiment and we don’t know how long or how deep this crisis will be and if it will recur. Generally, we think to prepare for the worst and if things are better, great. We expect in the aftermath of this crisis we will be better prepared for how to handle the next pandemic as a country, and as property owners. We also expect the number of buyers of affordable properties will have been culled to those that truly have access to discretionary capital.
Many experts predict the coronavirus impact on multifamily properties, at least in the immediate future, will be less severe compared to other real estate sectors. Do you agree?
Needell: We agree. We believe multifamily is a net winner in this pandemic compared to other real estate sectors, as it generally benefits from the social distancing and stay-at-home measures being imposed by the government. Shelter-in-place orders demand that people who are part of nonessential businesses stay home, and that those that are able to work remotely to do so from home for an undetermined period of time.
We also believe industrial is doing well and seeing temporary demand from logistics users. We think that this sector wins in the long run as well. Pandemic preparedness got a $16 billion investment in the coronavirus rescue package from the federal government to source medical and personal protective equipment to be prepared for pandemics in the future. That material must be stored somewhere.