Publications

- June 1, 2018: Vol. 5, Number 6

The affordable majority: Three misconceptions about investment in affordable housing

by John Williams

The affordable-housing sector presents tremendous opportunity to investors, yet it remains one of the most commonly misunderstood product types. While an increasing amount of institutional and private capital has flowed to the sector over the past several years, a variety of common misconceptions persist. Here is what investors really need to know about affordable housing.

MISCONCEPTION 1: AFFORDABLE HOUSING IS A NICHE

Contrary to popular belief, affordable housing targets the masses and serves the primary rental cohort in the United States, with about 72 percent of renters falling in the affordable-housing category.

The average U.S. household income is $57,000 and, according to a 2017 U.S. Census Bureau report, 58 percent of renters earn less than $50,000 a year. Many affordable-housing investors serve households that make between $30,000 and $70,000 a year. This means affordable-housing investors are targeting the largest swath of today’s rental market, while much of investment in the sector is geared toward luxury multifamily space.

During the past several years, there has been a rapid influx in luxury apartment development throughout the country. Investors and developers alike are pouring massive amounts of capital into the sector, and new luxury apartments are popping up on every corner. This has many wondering if a possible oversaturation of the apartment sector is on the horizon because these investors are targeting renters who make in excess of $100,000 per year and only account for about 15 percent of today’s U.S. renters. Naturally, a rampant increase in development and investment in a sector that only 15 percent of renters can afford would certainly be cause for concern. There is simply not enough demand to sustain this influx in supply.

Affordable housing, on the other hand, targets the largest segment of renters and gets the rap for being niche investing. So how did 15 percent become mainstream and 72 percent become niche? The common misconception is affordable housing only targets ultra-low-income residents, when in fact it provides housing to arguably one of the largest and most significant rental cohorts in the United States today: the average American.

MISCONCEPTION 2: AFFORDABLE HOUSING BRINGS REDUCED RETURNS

Many investors believe with an affordable-housing investment the opportunity for returns is much lower compared with market-rate apartment investments. This is a widespread misconception and could not be further from the truth. Affordable- and workforce-housing investments increasingly provide risk-adjusted returns that are consistent and oftentimes exceed market-rate performance. The reason: Affordable housing is the only sector that has unlimited demand and very limited, and often diminishing, supply.

Compared with market-rate apartments, affordable and workforce housing are, in a sense, recession-proof and provide downside protection to investors. Exceptionally strong demand exists for affordable properties both in times of economic prosperity and economic uncertainty. In fact, demand in this sector is almost always growing. In times of economic prosperity, rents and home prices tend to rise much faster than wages, resulting in increased demand for affordable housing. In times of economic uncertainty, when economic growth, job growth or other factors may slow, demand in the sector goes up.

So, demand constantly increases, regardless of the stage of the market cycle. Yet supply cannot keep up with this growing demand and, in many cases, continues to fall behind market demand. Each year, more than 100,000 affordable units are lost due to obsolescence or substandard conditions resulting from poor management. Others are lost to conversion to market-rate apartments.

Many affordable-housing developments are developed using low-income housing tax credits, which require they remain affordable for a certain number of years. As these tax credits expire, the apartment units risk conversion. This can be seen in a variety of U.S. states. New York, for example, has 45,520 affordable units at risk of expiring and converting to market-rate in the next five years. California and Texas are right behind, with 45,140 and 32,265 units, respectively, at risk of expiration.

Because of this rising demand and diminishing supply, affordable-housing units experience little to no turnover and are almost always fully-occupied, consistently maintaining occupancy rates of about 98 percent.

This differs significantly from market-rate apartments, which average about a 50 percent turnover rate. These high turnover rates come at a cost, including lost revenue while the unit is vacant, and the administrative and marketing costs of securing a new resident, completing the lease process, and preparing and cleaning the unit. This ultimately cuts into investor profits, while affordable-housing properties encounter almost no costs associated with apartment turnover.

Overall, “affordable” does not necessarily mean smaller returns. Investor portfolios in the affordable-housing sector tend to have stronger returns on investment, increased and stabilized cash flows, and provide investors with downside protection.

MISCONCEPTION 3: AFFORDABLE HOUSING IS DILAPIDATED AND UNSAFE

Oftentimes, when people think of affordable housing they think of run-down, unsafe apartment communities likely in need of capital. Many affordable-housing projects today are developed to such high standards, they are extremely comparable to market-rate units. Most people would not be able to identify an affordable-housing project by sight. The affordable apartment communities of today feature the latest in innovative design, high-quality interior units and amenities, large-scale community rooms, and children’s “tot lots,” among other features. They are not the run-down properties that people imagine. They are well-designed apartments that provide safe and quality places for residents to live and prosper.

Ultimately, affordable housing is an industry that is commonly misrepresented by misconceptions, yet presents tremendous opportunities to investors. It is a sector that targets the largest rental cohort and delivers returns on par with market-rate housing.

 

John Williams is president and CIO of Avanath Capital Management.

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