According to the U.S. Department of Housing and Urban Development (HUD), rental prices have been outpacing income growth since 2000, while the number of renters has risen steadily since the Great Recession.1 Today, there are approximately 44 million renter households in the U.S.; of those households, roughly 10.8 million qualify for federal subsidies, programs, and benefits.2 The COVID-19 outbreak and subsequent government response have only intensified this demand by putting more financial pressure on renters, and especially low-income workers, who have struggled to keep up with rent payments.
Despite skyrocketing demand for affordable units, supply remains constrained. For every 100 low-income renter households, the National Low Income Housing Coalition (NLIHC) estimates there are only about 37 affordable rental homes available.3 Put another way, the U.S. is facing an affordable housing shortage of roughly 6.8 million units.4
Contributing to this shortage is the general inefficiency of the affordable housing market itself. Participation requires specialized knowledge of the various regulations and subsidy programs specific to affordable housing properties. Consequently, the need for such specialization has made it difficult to source adequate capital for new construction projects and sorely needed renovations.
Source: NLIHC tabulations of 2019 ACS PUMS data
In our view, such overwhelming long-term demand, coupled with constrained supply, have generated a rich investment universe in the affordable housing space. Skilled investors can benefit from this environment by partnering with capital providers who have the requisite combination of knowledge, connections, and expertise. We examine why and how below.
Finding Equity- and Debt-Based Deals
Within the affordable housing space, knowledgeable capital providers can identify and invest in the best-positioned markets, property types, and capital structures. Opportunities span both equity and debt-based deals, including loans secured by affordable housing properties or direct acquisition and improvement of properties themselves.
Source: CohnReznick LLP, “Housing Tax Credit Investments: Investment and Operational Performance 2019 Report
On the debt side, lenders typically generate interest by originating short-to-medium-term loans, often in the form of first mortgage or bridge loans, to finance acquisition and renovation of existing multi-family properties.
On the equity side, investors use capital improvements, rent arbitrage, cost control, operational improvements and occupancy growth processes to add value to acquired properties. Rent increases can be pre-negotiated with local and federal housing authorities eliminating rental rate risk and lease up risk. In both cases, compelling investment opportunities can be identified and implemented through highly specialized networks and underwriting expertise, as well as knowledge of complex subsidy programs and key players in the space.
From a portfolio perspective, returns on affordable housing investments are attractive because affordable units tend to have reliable occupancy rates, even in recessionary environments, which generate compelling returns that are non-correlated with other asset classes. In addition, the short-term (or floating-rate) nature of affordable housing loans provides protection from exposure to rising interest rates, and government programs supporting rent payments and/or providing liquidity for refinancing capital further reduces downside exposure.
Moreover, returns on many affordable housing-related strategies offer potential tax benefits in the form of deferrals due to depreciation/improvements and/or favorable tax treatment of REIT structures. Furthermore, takeout financing provided by government-sponsored entities represents a reliable source of liquidity at exit. Lastly, affordable housing investments often generate a measurable social/environmental benefit by enabling renovations that improve water conservation and energy efficiency, and reduce waste, among other social benefits.
While we see a broad opportunity set in the affordable housing space, identifying the right investments requires thorough research, due diligence, and a solid understanding of government regulations and subsidy programs. Through our decades of experience, Westmount has built a diverse network of high-quality private lenders that specialize in these markets. By investing with these lenders, often through private funds structured as limited partnerships, Westmount clients can access these opportunities with the benefit of professional, institutional-class investment managers.
1U.S. Dept. of Housing and Urban Development: https://www.huduser.gov/portal/pdredge/pdr-edge-trending-110716.html
2,4National Low Income Housing Coalition: https://reports.nlihc.org/gap/about
3National Low Income Housing Coalition: https://reports.nlihc.org/gap
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