Why Workforce Housing Is a Smart Play in 2023

Often misunderstood, the asset class is a solid prospect due to its resilience and potential for revenue growth, according to Interra Realty’s David Goss.

David Goss

Multifamily fundamentals have begun to strengthen following uncertainty in 2022. Only time will tell if this trend continues, given the economic storm clouds on the horizon. But there is one sector that performs well in good times and bad: workforce housing. Investors who don’t have these assets in their portfolio should take a look at it now.

The turbulence coming out of the pandemic has led to fluctuating rents within the multifamily sector. According to a recent report from Yardi Matrix, average asking rents in the U.S. ended a four-month skid, increasing moderately by $3 in March. However, the report also showed that year-over-year growth—while still positive—dropped by 90 basis points across the country. Analysis from RealPage shows that apartment absorption ticked up in the first quarter of 2023, the first time the sector experienced positive absorption in four quarters.

Of course, not all multifamily properties perform equally. Workforce housing—which HUD classifies as residential options that are attainable for working families, typically households earning between 80 percent and 120 percent of area median income—is almost always a good investment prospect since demand tends to remain strong in both bull and bear markets.

Defying economic turmoil

As an asset class, workforce housing generally remains shielded from economic volatility. While luxury apartments that cater to those who rent by choice experience shifting demand, residents of workforce housing almost exclusively rent out of necessity. Because of this, there is less turnover when market conditions deteriorate.

The Yardi Matrix report measured year-over-year rent growth for both Lifestyle properties (those that attract Renters-by-Choice) as well as the Renter-by-Necessity asset class. Between February of 2022 and February of 2023, the national average rent growth for lifestyle properties was 2.3 percent, with only three markets—New York, Indianapolis and Kansas City—experiencing growth of over 5 percent. Several Sun Belt markets that had experienced explosive growth in recent years—such as Phoenix, Las Vegas and Austin, Texas—actually underwent rent contraction among their Lifestyle assets. By contrast, all 30 markets that Yardi Matrix tracked over that time period saw positive rent growth among Renter-by-Necessity assets, with the national average standing at 5.9 percent.

The value-add myth

There is a misconception among some investors that these properties usually have deferred maintenance issues. While there are certainly value-add opportunities in this asset class—which can be attractive to an investor with a long-term strategy—this is by no means the defining feature.

My firm, Interra Realty, recently brokered the $13 million sale of reVerb Oak Lawn, a three-building multifamily portfolio in one of Chicago’s more blue-collar suburbs. The property was constructed in the 1970s but underwent a full gut rehab in 2017 that included new roofs, plumbing and electrical, as well as refinished units. This property is indicative of the plentiful turnkey acquisition targets in this category generating stable rental income.

Motivating an unmotivated seller

Over the past year, inflation, elevated interest rates and global conflict have all furthered anxiety of a potential recession—with the recent collapse of several banks only stoking those fears. This may have soured some investors on commercial real estate in the short term, but it has little bearing on the workforce housing sector.

The class of investors who hold workforce housing assets are typically compelled more by individual reasons, such as retirement timeline or other personal factors, than market dynamics when determining the right time to sell. Because economic volatility does little to move the needle with these owners, negotiations can be tricky.

For example, sellers and buyers inevitably look backward during price negotiations to stake their position to other nearby transactions. A lot can happen in a short time, however, so the price on a comp from six months ago may not reflect today’s valuations. In the changing market dynamic, it is incumbent on brokers to educate the parties on up-to-the-minute conditions.

Mixed-use opportunities

Multifamily buildings with a retail component have long enjoyed a symbiotic relationship—the apartments provide an on-site customer base, and the storefronts drive foot traffic and foster a community feel. While a dearth of office workers has hamstrung multi-use properties in the nation’s CBDs, in outer neighborhoods and suburban settings—where workforce housing is typically located—these properties are benefiting from renter demand on the apartment side and low supply of new space on the retail side. And despite the headwinds that the retail sector has faced in years past, a recent report from NAOIP shows that, outside of the CBD, the asset class is healing, with occupancy rates returning to pre-pandemic levels.

Interra recently brokered the $5.8 million sale of a mixed-use apartment building in Chicago’s Ravenswood Neighborhood. Located at 4401-11 N. Hamilton Ave., the property received multiple competitive offers and ultimately sold for a price above the initial listing. The diversity of revenue options afforded by the property’s three commercial spaces, as well as the dynamic atmosphere they help to create helped drive up the high volume of showings and better-than-expected pricing.

The remainder of 2023

Between March 2022 and March 2023, the Federal Reserve’s benchmark interest rate soared from 0.25 percent to 5 percent in an attempt to counteract inflation. Among other things, this has delayed homebuying for many as the debt cost is too high. As a result, some workforce housing residents looking to shift into ownership will remain in place for the near future, further driving demand for this asset type.

The failures of Signature Bank and Silicon Valley Bank likely will slow the Fed’s hand—though it probably has more room to raise rates this year, if not at such a frenetic pace. For well-capitalized investors looking to acquire apartment properties, market pressures should keep demand elevated for workforce housing for the rest of the year at least.

The fact is that interest rates aside, workforce housing has long been a very resilient asset class, well-equipped to weather any economic squalls. The sector is a good bet for long-term value and is just as reliable in the shorter term—even in this economic landscape.

David Goss is co-founder & managing principal of Interra Realty.

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