By Taylor Williams
A severe shortage of affordable housing that has been building for years and may soon be exacerbated by the expiration of the federal eviction moratorium is forcing developers to be more aggressive and innovative in terms of how they add much-needed supply in dense, high-growth markets.
According to a 2020 report by the National Low Income Housing Coalition, when it comes to housing that American renters whose incomes levels are at or below 30 percent of their area median income (AMI) can afford, the United States comes up about 7 million units short. On average, for every 100 extremely low-income renter households in the country, there are only 36 affordable housing units.
In addition, there is considerable overlap between renters whose incomes dictate that they seek housing that has been designated as affordable or workforce and industries that have been hard hit by COVID-19, most commonly the retail and hospitality sectors.
The federal mandate that prohibits evicting renters who cannot pay rent due to COVID-related job losses has served to keep units occupied and the supply-demand imbalance from worsening — for the time being.
Rental collection rates for affordable housing properties have not fluctuated much during prime months of the pandemic relative to those months in 2019. The sharpest dip in collections came as the U.S. economy entered a partial shutdown in April, a month in which landlords collected 86.4 percent of rents versus 89 percent in March, according to the National Multifamily Housing Council’s rent tracker. Collections soon stabilized, clocking in at 87.9 percent for the month, just 100 basis points lower than the collection rate for July 2019.
“Like others in the industry, we have been pleasantly surprised with the relatively minimal impact on our collections — people are generally continuing to pay their rents in spite of any financial challenges,” says Keith Harris, executive vice president of acquisitions at Avanath Capital Management, a California-based owner-operator.
“Collections are definitely down relative to historical performance, and there is some concern as to the impact this may have if there is no forthcoming federal support, he adds. “Over time, this could potentially impact our residents’ ability to pay rents. That said, residents in our communities typically pay no more than 33 percent of their income towards rent so our affordable properties tend to be better positioned compared to market rate assets. Additionally, we take a holistic approach to investing and are very interested in our residents’ wellbeing, including making sure they get the support they need and that we understand their current circumstances to help them meet their future obligations.”
The eviction moratorium is set to expire at the end of the year. Consequently, some professionals in the affordable housing space are anticipating another surge in demand for a product type that simply does not have the necessary supply.
“The COVID situation has created more demand for affordable housing, and hopefully when we come out of this there will be some recognition that there needs to be much greater production of affordable housing,” says Larry Curtis, president and managing partner of WinnCos., a Boston-based owner-operator whose portfolio spans more than 100,000 units across 23 states.
“It’s all happening at a time when operating costs are going up due to implementation of COVID features and precautions, and at a time in which construction costs are shooting up due to supply chain disruptions,” Curtis continues. “So to get affordable housing built, it requires more and more capital and subsidies.”
More Subsidies Needed
Construction costs have only flattened, not declined, during this cycle, and the pandemic has done little to alter that trend.
According to the Associated General Contractors of America, prices rose from September 2019 to September 2020 for key materials such as concrete (2.4 percent), iron and steel scrap (15.2 percent) and lumber/plywood (49.2 percent). These price hikes were offset by falling costs of other materials, but the basic materials cost index has risen on a year-over-year basis.
In addition, operating costs are rising sharply in 2020 due to owners and managers working to implement more COVID-related health and wellness measures. Between construction and operating costs, developers simply require more subsidies and financial resources in order to deliver product that is affordable to renters who need it and yet still allows the development team to turn a profit.
“While pricing has remained competitive during the pandemic, yields are slightly lower, in part because we’re underwriting more offsets in income related to COVID-19,” says Harris.
“Whether there has been an increase in vacancy or in expenses associated with higher costs of cleaning and buying protective equipment, we have experienced some slight upticks in operating costs,” he continues.
In that regard, Harris says that owners of affordable properties face the same challenges as their market-rate peers. Avanath has adopted virtual tours of units, and specific protocols for handling maintenance requests to minimize in-person interaction. When it comes to actually executing new or renewed leases, the company has pivoted to digital document sharing or leaving papers in Amazon lockers for tenants to review and sign in manners that are socially distant.
Pictured is Independence Way, an affordable housing community in Florham Park, New Jersey, that serves developmentally disabled adults. Rockefeller Group developed the property in partnership with Bergen County’s United Way and Madeline Corp.
Kyle Kolesar, senior vice president at KeyBank Real Estate Capital’s New York City office, concurs with the notion that unique financing solutions and commitments are needed to grow the supply of affordable housing.
“The resource side of the equation for affordable housing is going to be incredibly critical over the next 12 months at the city, state and federal level,” he says. “With construction costs going up and operating budgets constricted at the level where the resources come from, there’s going to have to be continued focus and advocacy from developers, lenders — everyone involved in this business — to be creative in the way we finance affordable housing.”
Kolesar is encouraged by the fact that various types of lenders and buyers in the Northeast are still looking to grow their presence in the affordable housing space.
“There are still investors, whether institutional or non-institutional, banks or non-banks, who are thinking more about affordable housing and what it means for their portfolios,” he says. “If people continue to focus on the social-impact side of investments and make it part of their yield expectations, it will drive the industry forward and ultimately push the effort to meet the demand, which is always the surplus side of the equation.”
While it’s virtually impossible to make the economics of these projects work without tax credits or other significant government financing contributions, there are ample developers out there who are experienced and committed to delivering more affordable housing. Curtis of WinnCos. says that in high-growth markets like Boston, applications for Low-Income Housing Tax Credits (LIHTC) can outnumber the supply of them by four or five to one.
Building Inventory
Development of new affordable housing projects has, like most other forms of construction, continued largely uninterrupted throughout the pandemic.
While ground-up building is the simplest and most common way to grow supply, it’s also the most expensive. According to Curtis, in markets like Boston and New York City, the capital cost to build a single unit typically runs between $400,000 and $500,000. For that reason, developers are looking to redevelopments of historic or older buildings that have become partially or fully obsolete to add to inventory.
The Tyler, WinnCos.’ 70-unit project for seniors in East Haven, exemplifies this trend in action. The project is a redevelopment of the 84-year-old former East Haven High School building that features units that are reserved for renters earning anywhere between 25 to 80 percent of AMI. Several residents of The Tyler actually attended high school in the building when it still served that purpose.
“We call these projects ‘new buildings in old buildings,’” says Curtis. “From the community’s point of view, if developers want to build affordable housing, it can encounter many obstacles. But if they take the blighted high school that’s been vacant for 20 years, they’ll get a lot more encouragement from the community.
Curtis also says that developers can find sites and structures that are conducive to affordable housing redevelopment at discounted prices during economic downtimes, such the present. Apartment communities that delivered during times of high joblessness and that never stabilized and were ultimately foreclosed upon or auctioned off can be recycled into affordable or mixed-income housing, he says.
In this period of rising costs, it’s important for developers to stick to their specialties, whether that be historic redevelopment or ground-up construction, says Kolesar.
“We haven’t seen developers shift strategies from preservation projects to new construction or vice versa,” he says. “Those projects are financed differently, but both are necessary to maintain existing product and add new buildings.”
“There are a lot of markets in the Northeast, particularly larger metro areas, with numerous buildings that could be coming off of land-use agreements or different compliance agreements, and there are some developers that would prefer to take those deals to market,” he adds. “But to combat that, cities have come up with new tax incentives to keep at least portions of those buildings affordable. It’s a lot of moving pieces to constantly navigate, but the industry tends to become pretty cohesive when resources become limited.”
Workforce Housing Update
As a subcategory of affordable housing, there is even greater alignment between residents of workforce housing and employees of industries that have been ravaged by COVID-19.
The Urban Land Institute defines workforce housing as residential properties that are affordable to households earning between 60 and 120 percent of AMI. Affordable housing, by contrast is typically reserved for renters earning 60 percent or less of AMI. These units tend to be leased to civic workers — police officers, firefighters, healthcare workers, teachers — in addition to retail and hospitality staffers.
“If you follow the narratives on collections, that segment of the market is being hardest hit because it’s in that space where you have a lot of service industry employees or entertainment or other industries that have seen significant layoffs,” says Kolesar. “Workforce housing hasn’t necessarily had as much on the resource side in terms of tax credit equity or different financing products out there that affordable has had. Nonetheless, demand for workforce housing is clearly there.”
Due to the extensive levels of bureaucratic involvement required to jump-start these developments workforce housing projects have been among the slowest to recover following the severe decline in construction activity during the Great Recession.
Because of the relative lack of new supply to come on line in the last decade, demand for workforce housing is inevitably directed toward (somewhat) older properties. Many of these assets are in need of extensive repairs and maintenance work — a cost incurrence that typically leaves owners with little choice but to raise rents.
“There are older properties that would be naturally affordable that all of a sudden have become less affordable, maybe because an owner is trying to take care of deferred maintenance and capital needs, and the only way to pay for that is with increased rents,” says Harris. “And it’s really difficult without some support to take care of those capital expenditures. That said, our team works extremely hard to make updates to a community that improve resident life, as well as keeping rents affordable.”
Harris points out that because workforce housing is a highly regulated space, those increases in operating costs that owners bear from renovating their properties are only marginally passed on in the form of higher rents. But these costs do put pressure on returns for investors. As such, owners really have to do their homework when it comes to finding unit fixtures and finishes that represent upgrades but that don’t break the bank.
While undoubtedly challenging, developing, owning and operating in the workforce housing space is important work, sources agree. Amid COVID-19, society has become more acutely aware of what it means to be “an essential worker.” It’s these individuals who keep the wheels of basic economic and civic services turning that stand to be hurt the most by the supply-demand imbalance.
Curtis explains the pitfalls that these workers face, using the backdrop of Boston, where AMI is about $80,000 and the threshold to qualify for affordable housing therefore about $48,000 (60 percent). With scant options near their places of essential employment, renters who earn too much to qualify for affordable housing end up dealing with longer commutes and diminished capacities to serve their communities.
“If you’re in Boston and you earn slightly more than $48,000, which many people do, there are no programs for you — you’re a victim of the marketplace,” he says. “Building more workforce housing for people that are doing everything right and are developing careers and can’t afford to live in markets like New York or Boston is an incredibly important problem for the industry to address.
“In the Northeast, the cost of delivering housing doesn’t work for those members of the renter population,” he adds. “So you have politicians hearing from their constituents that their sons and daughters are doing everything right but still can’t afford to live in the communities they grew up in.”
— This article originally appeared in the October 2020 issue of Northeast Real Estate Business magazine.