Our investment strategy focuses primarily on multifamily workforce housing. What is that, and why is it our strategy?
What? Multifamily workforce housing generally includes Class B and C properties, which are mostly older communities with limited amenities and basic interior finishes. They tend to be located in suburban areas and are often low-rise or garden style construction. The rents are affordable to lower-middle and middle-income families with jobs in fields like construction, healthcare, retail, transportation, government, office administration, hospitality, education, nursing, and the police force. Note these communities are not government-subsidized housing. Renters in these communities are often renters by necessity instead of by choice.
Why? Let’s take a closer look at the fundamentals.
There is demand across nearly the entire renter spectrum, and the demand does not appear to be letting up any time soon. While demand for workforce housing tends to come from households who make 60% to 100% of the Area Median Income (AMI), some households with higher incomes may decide to live in workforce housing due to proximity to a job, debt, saving for a home, etc. Some low-income households (<60% AMI) on vouchers or government subsidies also live in market rate workforce housing due to the shortage of low-income housing.
Most of these renter households tend to be “renters by necessity.” They may have aspirations of owning a home, but may not have the financial means. For the past decade, housing prices have risen faster than median household incomes, putting home ownership out of reach for most. It is becoming increasingly difficult, especially in large metros, for workforce housing renters to purchase a home near the area in which they work which also suits their family’s needs. Moreover, fewer starter homes are being built due rising to land costs and construction costs. Multifamily rents have risen too, albeit not as fast as single-family home prices, making it even more difficult to save for a down payment. This cycle is keeping households in the renter pool for longer.
Land, labor, materials, and regulation are driving up the cost of new construction. Rising costs are not new, but the topic is carrying more weight because of the rapid increase. It took almost 60 years, from 1940 to 1998, for the national RSMeans Construction Cost Index to climb from 0 to 100, but only 20 more years to climb from 100 to 200, doubling the index’s measure in one-fifth of the time. At no other point in America’s history have construction costs accelerated so aggressively (CBRE Research, Southeast Construction Costs, 2019).
Rising construction costs means higher rents are required to justify new construction. In other words, for real estate developers to turn a profit on a multifamily development, they must focus their attention on the upper-end of the rental market. For the past decade, essentially all new development has been Class A luxury. For context, the Class A market makes up only 20% of the total rental market. Building affordable market-rate units is just not financial feasible, and likely won’t be for some time. For this reason, there’s been virtually no new meaningful workforce supply added this past decade. In fact, not only has the total workforce housing supply not increased — it’s actually decreased, with older units being torn down to make room for Class A construction.
As shown above, in metro Atlanta, the total number of Class A units increased by 84% from 2000 to 2019 while the total number of Class B/C units decreased by 3%. Every year some of the oldest product is leveled to make way for new Class A development or other higher and better uses of the land. Importantly, though, occupancy rates for Class B/C surpassed Class A, as shown below.
Our strategy makes sense because strong workforce housing fundamentals — strong and growing demand, coupled with steady to declining supply — are driving rent growth and, in turn, cash flow to investors.
Few market rate solutions exist to add new supply. Legislators are focused on housing solutions for the low-income households (<60% of AMI), while developers and institutional investors are focused on the only segment whose rents can justify their construction costs: the high-end renters. Opportunities abound in the middle, and we can capitalize there.
Investing in workforce housing isn’t without risk, of course. Investors must consider housing affordability (i.e., are renters able to absorb rent increases), resident credit risk, rent control policies and other widespread public programs that may improve the supply/demand imbalance. Despite the risks, given the fundamentals described above, we feel confident that workforce housing is and will continue to be an attractive strategy for Acorn Property Group and our investors.
Source: CBRE, The Case for Workforce Housing – A Market Perspective, November 2018
Source: CBRE, Southeast Construction Costs, 2019/2020 Edition