This is one of the most common questions asked by CBRE clients this past summer. The answer is a qualified “yes.”
Before elaborating on that qualified yes, some sort of definition is warranted since the term “workforce housing” means different things to different people.
The best way to think about workforce housing is to consider it as the housing where families in the 60% to 100% of AMI (area median income) live, families which do not qualify for government-sponsored affordable housing. These households are often “renters by necessity,” and the predominant housing stock which offers affordable rents is a combination of Class B and Class C multifamily, mostly older and mostly garden-style communities.
Demand clearly outweighs supply
From a market fundamentals perspective, the story is favorable and leads to an unqualified “yes, investment in workforce housing still makes sense.”
One way to measure performance is to compare Class B and Class C multifamily with Class A. Class B and C multifamily are outperforming Class A in all basic performance measures.
The lower classes had fewer vacant units relative to the totals of each class. CBRE Econometric Advisors’ (CBRE EA) most recent statistics of vacancy by class (Q1), showed the tightest vacancy rates in Class C (4.5%). Class B vacancy was 5.0% while Class A was 5.6%.
Similarly, rental growth was higher in the lower-class categories. Class C’s year-over-year rent growth was averaging 3.0% and Class B 1.6% vs. Class A’s 0.7%.
In the same vein, older product has been outperforming newer product, and garden product has been outperforming high-rise. CBRE EA’s Q2 statistics revealed 4.8% vacancy rates for multifamily units built in the 1960s, 1970s, and 1980s vs. vacancy rates in the low 5’s for the more recent decades. As of Q2 year-over-year rent growth for garden properties averaged 3.3% vs. 1.2% for high-rise communities.
This cycle has produced minimal new workforce housing supply
From a supply standpoint, the story is well known that there has been very limited new supply in Class B and C space this cycle., Of course, throughout history, most development has been at the top of the quality spectrum. But the trend has been amplified this cycle by high land, steadily rising construction costs and preferences for building mid-rise and high-rise product in urban and urban-suburban areas. Development in this decade has created a new genre of multifamily housing, not simply newer suburban garden product. The organic creation of more moderately-priced multifamily units will be slower this cycle than in previous
Moreover, families of more moderate means continue to struggle to enter homeownership and move up in multifamily housing, thereby staying in Class B and C multifamily housing longer. The steady increases in multifamily rents (all classes) has put more distance between Class A rents (some Class B rents as well) and households needing moderate rent level.
From the recession through Q2 2018, multifamily rents have risen at 3.6% per year on average, yet wage levels have risen by only 2.2% on average over the same period. Single-family median home sales prices have risen by 6.5% per year since the recession, making it even harder for middle-income households to buy homes. (Other factors such as limited lower-priced inventory, strict mortgage credit standards and rising mortgage rates further hinder renters from entering homeownership.)
The result is that demand levels for Class B and C multifamily housing remains very high and workforce housing is very likely to hold up better during the next downturn compared to prior cycles. During past downturns, Class A product has outperformed Class B and C due to the greater financial vulnerability of renters in lower-priced communities. This situation is not going away, but the current market dynamics offers fewer choices for the residents of Class B and C multifamily housing, thereby mitigating some of the downside risk.
Nearly half of all renters pay more 30% or more of their income on rent
The “qualified” part of the market fundamentals picture comes from the perspective of multifamily residents’ ability to pay higher rents. Affordability is a real problem. In 2016 (latest data available), for 46% of all renter households in the U.S. (both multifamily and single-family renters), rent payment represented a high 30% or more of their incomes according to the U.S. Census Bureau’s American Community Survey. For renter households who made less than $50,000 per year, 73% paid 30% or more of their incomes on rent.
Rising rents for many of renter households creates financial stress. While there is no clear answer as to how far Class B and Class C rents can rise, the challenge which some households have in keeping up with these increases is apparent in some parts of the marketplace (such as slower releasing of renovated communities). Yet, from a multifamily supply/demand standpoint, the scale remains tipped in the owners’ favor.
Current investment returns favor garden product
NCREIF returns provide the best overall view of investment performance, albeit somewhat limited to the higher-end Class B assets (and Class A) due to the institutional nature of the NCREIF database. Despite, this limitation, the garden product return data provides some insight to older product performance.
The Q2 one-year return for garden assets averaged a healthy 9.57% vs. the below-average high-rise return of 4.92%. For garden assets, both the appreciation and the income returns were favorable at 4.38% and 5.02%, respectively.
Both value-add and stabilized asset investment are attractive
Workforce housing investment strategy generally falls into two categories—stabilized and value-add—with the latter, by far, the most popular in recent years.
Pricing for assets with value-add potential reflects the popularity of the strategy. CBRE’s recently released North American Cap Rate Survey H1 2018 revealed that expected returns on cost for value-add acquisitions fell in H1 2018. The declines were small, but still clearly reflected the competitive buying landscape, strong appetite for value-add opportunities and acceptance of moderate returns. Expected returns on cost for infill value-add acquisitions edged down 3 basis points (bps) to 5.95% and 6 bps to 6.27% for suburban assets.
Value-add buyers must carefully assess whether they will be able to obtain the rent increases ($100-200/month) needed to reach their desired investment returns. However, despite the stress on some renter households today, the odds of success still appear in favor of the investors. And the sustained enthusiasm of value-add buyers provides convincing evidence of continued success at pushing rents.
Investment of stabilized workforce housing assets is also supported by market fundamentals. It’s a different strategy; the focus is on current income and income durability. Owners do not obtain large NOI bumps from rent increases on renovated units, but obtain steady income (with moderate rent growth). Buying stabilized workforce housing is an attractive longer-term strategy. The investment marketplace today is generally less competitive for stabilized product than value-add, and therefore offers better pricing for stabilized asset buyers.
Yes, workforce housing investment still makes sense
Market fundamentals definitely support workforce housing–-housing which caters to America’s large middle market. The last decade has produced only minimal new supply, and demand remains very strong. Returns are moderate in today’s highly competitive marketplace, but workforce housing investment—both for value-add and stabilized assets—remains a very attractive strategy.
By Jeanette Rice, Americas Head of Multifamily Research, CBRE.
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