Over the next five years, several federal rent protection programs and subsidies for tenants will be ending, leaving landlords free to set their rent rates without any restrictions. This sets the U.S. on track to lose approximately 188,000 affordable housing units by 2027, Moody’s Analytics reported in June.
According to the National Rent Report for the second quarter of 2023 from data firm Apartment List, a 25% surge in rental rates for market-rate units occurred between January 2021 and the summer of 2022, leading to one of the highest periods of rent growth in recent U.S. history. Not surprisingly, that trend is forecast to continue, with many landlords expected to favor raising rents to market rate over renewing federal tenant subsidy program agreements.
The expected rise in rents, coupled with the fact that more than 400,000 low-income housing units were lost during the pandemic (between 2019 and 2021) due to expiring Low-Income Housing Tax Credits (LIHTCs), according to the National Low Income Housing Coalition, may be creating new challenges for the nation’s affordable housing sector.
But in spite of some falloffs in fundraising for affordable housing this year, equity sponsors ranging from insurance companies and banks to family offices continue to see the sector as an attractive and safe investment option. In fact, some investment firms report increased interest from RIAs and non-institutional money sources that haven’t been as active in affordable housing previously.
“The demand is huge, the supply is way short,” said Mark S. McDaniel, president and CEO of Cinnaire Corp., a community development financial non-profit organization specializing in affordable housing. Cinnaire, founded in 1986 to revitalize Michigan, currently services eight additional states: Wisconsin, Minnesota, Indiana, Illinois, Pennsylvania, New Jersey, Delaware, and Maryland. In addition to the supply/demand imbalance, three post-pandemic economic challenges—inflated construction costs, rising interest rates and investors demanding higher rates of return—“are compounding the problem,” all of which has turned the affordable housing sector into a “strange market,” McDaniel noted.
The U.S. multifamily market relies on the 37-year-old federal LIHTC program as impetus for developers to build affordable housing. According to McDaniel, “I’ve been in this market for a long time, since 1986—I was part of the original LIHTC program getting started, and I’ve never seen these three things [happening] together. It’s all kind of going in the wrong direction.”
In Michigan alone, approximately 190,000 affordable housing units are needed in the next three years, but more than 100,000 affordable apartments are currently being lost there annually, he noted. The affordable units are being taken out of the affordable market and turned into market-rate apartments because they are often in locations that are appealing to potential renters and can bring attractive returns, McDaniel said. “That’s compounding the problem, along with the economic challenges [we’ve been facing] from the last three or four years from the pandemic, which makes it tough to develop units without a lot of GSE [government-sponsored enterprise] financing.”
And yet despite the difficulties developers are facing when it comes to making affordable housing deals work, investment is still flowing into the sector, albeit at a slower pace and with greater economic caveats. “The investor market is not as deep as it was, maybe even a couple of years ago, but the investors are still out there,” McDaniel said, and they fall into two camps: “economic investors” and ones that are driven by the Community Reinvestment Act (CRA), instituted in 1977. For the economic investors, he said, “It’s all about the return, and that they’re going to get a tax credit. For the banks, they’re really serious about the CRA, so it’s as much about getting that benefit as it is about the return they’re going to get.”
With returns in the affordable housing space currently ranging from 4.00% to 7.25%, Cinnaire’s “economic” investor pool includes insurance companies, corporations and regional and community banks, as well as major global banks like Chase and others. However, McDaniel noted, many other investors, including companies needing workforce housing for their employees, as well as a few larger banks are being driven by the CRA. “They’re able to invest in LIHTCs and they’re not in it for the economic return,” he said. “They want to invest in a fund to do development in a community that would serve their workers.”
Because of the variety of investors and their different objectives, Cinnaire’s multi-investor funds feature tiered returns, McDaniel said, “so we can address everybody’s needs and balance it all out at the end of the day—it’s very complicated fund management to make all that work.” In 2022, Cinnaire had its biggest fundraising year on record with $450 million in four different multi-investor funds and a couple of proprietary single-investor funds.
According to McDaniel, “There was significant investor demand, but the deals were tighter because of higher returns demanded and higher construction costs.” This year, Cinnaire is targeting a fundraising total of $300 million to $350 million. “Just yesterday, I got a report on this and it looks like we won’t get our record number, but we will do well,” McDaniel noted. The firm is also keeping a conservative outlook for 2024. McDaniel does expect to start to see a turnaround in sentiment in 2025, based on the data has seen, as well as the fact that new types of investors, like family offices, are catching on to the consistency of profits affordable housing offers.
What many investors miss about affordable housing, financed with a combination of LIHTCs, equity and credit, is that it is very low risk investment option, he said, an especially important consideration in today’s volatile investment market. “Everybody’s afraid of default and foreclosures, but out of all the different categories of real estate where you can put your money, this is the safest. We have never had a foreclosure or a default—I mean zero—and that’s with about $6 billion in equity investment that we’ve raised and managed over the years.”
When Cinnaire was founded, its average investment size ranged from $1 million to $5 million, McDaniel said. Its current investment funds range from $5 million to $20 million. When the company was created, its goal was to get investors to bet on distressed communities with neighborhood-scale deals involving 100-unit, 50-unit or sometimes even 20-unit buildings. Cinnaire’s most recently closed fund was used for an 800-unit, six-property package of deals with the Lansing Housing Commission in Lansing, Mich. Each property was repositioned under the Department of Housing and Urban Development’s Rental Assistance Demonstration (RAD) program, requiring an investment of $11 million to $15 million per property and offering a return of approximately 6.625%.
New types of sponsors
Enterprise Community Partners, another non-profit focused on increasing housing supply, shares Cinnaire’s dim view of the current state of the affordable housing market. Enterprise works with national, state, and local organizations to fund and develop affordable housing throughout the U.S., Puerto Rico, and the U.S. Virgin Islands.
“The fundamental sort of headline here is that there’s a supply-demand issue that’s not being solved,” said Rob Bachmann, senior director of capital originations of Enterprise’s private equity real estate investment arm. Ten to 20 years ago, affordable housing shortages tended to be regional, and often confined to big cities, but “now it’s ubiquitous. It’s an everywhere issue,” he added.
Founded in 1982, Enterprise has a $17 billion capital platform that encompasses LIHTC/new affordable housing construction, a Community Development Financial Institution fund (CDFI), New Markets Tax Credits Program (NMTCP) and other types of investments. Its Real Estate Equity and Preservation platform acquires existing buildings and rehabilitates them to preserve or create affordable housing.
The firm structures its funds with “a double bottom line, sort of a win-win,” Bachmann said. “We’re acting as fiduciaries for our investors, so we have to make sure we’re delivering the returns we say we will. But we’re also a mission-oriented organization, so we’re also ensuring renters have an affordable place to call home.”
Historically, Enterprise’s investors have mostly been insurance companies and “the biggest medium-sized and small banks, who take advantage of the tax credits that come with investing in affordable housing and are able to meet their CRA obligations through such investments,” he noted. But since the pandemic began, Bachmann has noticed a broadening of the firm’s investor base.
“We’re seeing increasing interest from family offices, registered investment advisors, and other types of investors—non-institutional and institutional alike,” he said. “There’s a broad awakening to affordable housing as a very viable asset class to invest in, through funds or directly. We’re seeing that as a major trend and we’re actively trying to meet that market where it is, very consciously looking to work with new investors like those.”
Enterprise requires a minimum investment of $500,000 from its equity sources.
In some markets, zoning issues and NIMBYism make it challenging to build new housing, so Enterprise's Real Estate Equity and Preservation platform acquires assets that are “affordable but may be losing their affordability because they’re ending their compliance period, or they could even be in particular markets where rents are increasing, meaning they’re at risk of going market rate and no longer being affordable.”
These assets are acquired through joint ventures with developers that can then help Enterprise enhance and manage the buildings. They are then put into a fund structure with a 10-year hold, with “some liquidity features,” according to Bachmann. The firm's preservation arm currently manages a total of 11 funds and is working on its fifth preservation fund.
When it comes for the returns for investors, “Without getting into specific numbers, I can say that we definitely position our funds [at] risk-adjusted market rates, and all of our past funds have either met or exceeded our return targets,” Bachmann noted.
At press time, Enterprise was closing on “the largest affordable housing property outside of Portland,” a 224-unit property in Salem, Ore., an area that is in dire need of more affordable housing. Bachmann described the property as a “once a standard, low-income housing tax credit property.” Without some intervention, the property would simply be sold to the highest bidder, potentially “some private equity player” that would likely hike the rents up to market rate. To prevent that from happening, Enterprise reached out to the State of Oregon, offering its help with keeping the complex affordable.
The State of Oregon agreed and offered a low-interest loan of $20 million and tax exemptions to make Enterprise’s purchase and rehab of the property possible. “We talk so much about how as a country we need more affordable housing, but what gets buried in that conversation is the need to preserve the affordable housing that’s already there, that’s at risk of being lost,” Bachmann said. “We’re already swimming upstream, so our strategy is to get those properties and preserve them.”
Reliable asset
BH Properties, a Los Angeles-based family office that specializes in commercial real estate investment, is also bullish on affordable housing. In June, the firm launched a new investment initiative with a plan to build a $1 billion portfolio of affordable housing assets. Bill Stoll, formerly a long-time affordable housing executive with the commercial real estate investment firm Steadfast Companies, serves as the managing director for the new national platform, which has been designed to be an adjunct to BH Properties’ 10 million-sq.-ft. portfolio (which also includes a value-add multifamily platform), focusing on LIHTCs, Section 8, and age-restricted housing.
Speaking to WMRE during his third week on the job, having already begun scouting potential investments in Texas, California, Arizona, and Colorado, Stoll sounded both cautious and bullish. “You don’t get big homeruns with affordable housing—it really is about rent increases that match the area’s median income,” he said. “What we find is that [affordable housing] provides consistent cash flow that you can count on, and BH’s platform is really about buying deals that create cash flow from day one, and that are safe and that we can count on each and every year.”
While the firm’s main investment focus will continue to be on office, retail, and industrial properties, BH plans to invest $100 million in affordable housing by the end of 2023 and $250 million to $300 million per year over the next five years, with the goal of investing a total $1 billion by 2028. Part of the strategy has to do with mitigating the risk of retail and office investments, Stoll noted.
“We’re buying empty buildings, putting money into them, and leasing them—creating cash flow, which usually doesn’t occur for two, three, or four years. That’s our initiative—it’s not to overtake what we’re doing in retail, industrial, and office, but to mitigate some of the risk out there right now and also create cash flow while we take advantage of other opportunities.”
BH currently has $22.4 billion in assets under management, and ultimately, Stoll said, affordable housing will account for about 25% of the firm’s portfolio.
BH is aiming to buy affordable housing assets in markets where the maximum tax credit limit is well below market rent and occupancy tends to be strong, so even if there is a recession, “we’re not going to see a big fall-off in rents.” Even if the firm will raise its rents by just 3% a year, over a 10-year hold, at the end of the day, it will still be making money, he noted. “It’s good to have a tried-and-true investment [like affordable housing] while you look for homeruns in other categories.”
Stoll is currently scouting for 15 deals, with the criteria of 100 units or more each, located within the Sunbelt. Funding for the deals will come directly from BH Properties’ founder, chairman, and CEO Steve Gozini. “The structuring will be easy because it’ll be his family’s money, and we’ll put simple agency debt on it and buy it, not look for a lot of joint ventures or co-investors in the properties,” he said.
Among the assets Stoll is looking at are two age-restricted communities in Texas and Tennessee. “I’m looking at the rate, the agency, what it’s going to look like, what is our debt service coverage, how does that all come together?” The deals feature cap rates in the low- to mid-5% range. But the assets are located in attractive markets, “with a good delta between the market rent and the maximum tax credit rent limits, so there are some opportunities there as long as the purchase price doesn’t get up too much.” Offers are not due yet for either property, but Stoll said both are under close consideration.
While BH Properties is investing in affordable housing as a purely for-profit play, Still said its consistent performance and low risk is what attracts investors like BH to it. “Affordable housing has its ups and downs, but it’s pretty consistent—that’s why some of the biggest owners in the market are non-profits,” he said. “They’re not doing it for cash flow necessarily, they’re trying to create affordable housing for communities that desperately need it. But whether you’re a non-profit or a for-profit, this is a great structure.”