Affordable Housing has a problem-solving ethos and as costs rise, that mentality is showing up in new ways.
By Ryan Cunningham, Manager, Investments at IMPACT Community Capital
Article originally published in Pensions & Investments.
Given the news headlines so far this year, it’s understandable that some investors might be approaching affordable housing with caution.
Even under ordinary circumstances, marshalling the resources to create or preserve such housing can be challenging. In economically difficult times, it becomes even more of a struggle – and we are experiencing one of those difficult periods right now.
A growing spectrum of rising expenses has eroded property performance in recent years, despite rent increases. Operating and insurance cost increases threaten to impact investment performance and worsen housing shortages. They have already created an uncertain financial landscape for affordable housing developers and operators.
However, this is not a story of an industry in crisis.
The affordable housing sector has proven remarkably resilient in times of economic stress, and the current environment is no exception. Historically, multifamily properties financed via the Low-Income Housing Tax Credit (“LIHTC”) have significantly outperformed their market-rate counterparts, as described in CohnReznick’s biannual LIHTC property performance report.
While much of this resilience comes from the unique LIHTC structure, a significant portion can be attributed to the industry’s ability to respond and adapt to economic headwinds. Right now, we are seeing that problem-solving mentality unfold in new ways.
For institutional asset owners and money managers, this resilience offers significant value – providing a buffer against broader macroeconomic uncertainty and supporting the sector’s competitive, risk-adjusted return profile. Indeed, such investors may see affordable housing’s current headwinds not as a red flag of caution, but as a unique moment of opportunity.
Payroll Costs and Staffing Shortages
One major rising cost for affordable housing originates in the labor market. Property management companies face significant challenges in hiring and retaining experienced staff for both leasing and operations. These staffing shortages often contribute to operational inefficiencies and financial strain that manifest in property occupancy and performance issues.
On this front, novel responses abound.
Sophisticated property management companies have found creative ways to reduce payroll costs – such as by utilizing contract maintenance providers instead of full-time staff, or by leveraging economies of scale and sharing staff across several properties in the same market. It is a solution that’s working on the ground: One property that IMPACT financed in a rural market was able to limit maintenance cost increases simply by sharing staff with another property they own nearby.
Elsewhere, we have seen local governments and housing authorities step up as problem-solvers, providing valuable tenant referral services and housing subsidy vouchers. These additional resources have helped developers find breathing room to adapt to cost increases.
The Growing Hurdle of Property Insurance Expenses
As a result of increases in the frequency and severity of extreme weather, wildfires, and other catastrophes, property insurers have faced a significantly higher volume of claims in recent years. Affordable multifamily housing is not immune to these trends, which ultimately affect the cost and availability of property insurance.
Increases in property insurance premiums have made it difficult for properties to meet performance targets needed to convert from construction financing to permanent financing. Higher insurance costs also add cashflow stress to operating properties.
For large institutions considering affordable housing but concerned by recent insurance increases, the industry’s proactive approach should offer reassurance.
On the front end, lenders and investors are now refining underwriting standards to account for future movements in insurance markets. Some lenders are now stress-testing projected insurance cost increases and requiring extra cushion in their initial underwriting models. Stakeholders throughout the industry, including major lenders like Freddie Mac, have begun reexamining their insurance standards to find areas where requirements can be safely relaxed. Additionally, the industry continues to incentivize long-term solutions, such as more resilient and sustainable building design through the allocation process for Low-Income Housing Tax Credits.
On the back end, developers and operators have responded by honing their risk management strategy, utilizing novel combinations of corporate blanket insurance policies and incremental policies to bring down overall costs while ensuring their portfolio remains protected.
Construction Delays in a High-Interest-Rate Environment
Permitting delays and administrative hold-ups are longstanding issues in the construction industry, but their impact is particularly painful in the ongoing environment of elevated interest rates.
In this rate environment, delays can quickly kill a project. In response, stakeholders across the industry have focused on making their closing processes more efficient. Here at IMPACT, we’ve streamlined our underwriting and legal review process to keep closings on track. We have also continued to offer early rate lock options to expedite the underwriting process and reduce administrative delays. Other investors are following suit.
Furthermore, project completion delays lead to strained lease-up schedules as developers rush to meet placed-in-service cutoffs or other funding milestones. This urgency can compromise tenant screening processes, which may result in delinquent tenants and add further financial stress. Here, again, the industry is solving problems in real-time through more effective oversight.
On one transaction that IMPACT financed in the Southeast earlier this year, the sponsor discovered during the lease-up process that their property manager had failed to process tenant applications in a timely manner, causing the property to fall behind key leasing milestones. The sponsor quickly removed the nonperforming manager and selected a new management company. Thanks to their close attention and decisive pivot, they were still able to complete their lease-up on time.
A Comprehensive Approach to Meet the Urgent Need
Despite the economic headwinds, affordable housing continues to be a shelter in the storm. While the sector’s creative problem-solving is minimizing the pain of the current environment, the long-term supply and demand fundamentals provide a stabilizing force for institutional investors seeking a steady stronghold in a diversified portfolio.
Renter demand for affordable housing remains greater than ever. Half of all U.S. renters – a record 22.4 million households – spent more than 30% of their income on rent and utilities, according to a report published earlier this year by the Joint Center for Housing Studies at Harvard University. Meanwhile, the National Low-Income Housing Coalition’s ‘The Gap’ report finds the U.S. has a shortage of 7.3 million affordable and available rental homes for low-income and extremely-low income renter households.
With demand for such housing at an all-time high and supply persistently low, the outlook for investment in affordable multifamily housing remains positive. The present economic landscape is undeniably tough, but affordable housing is clearly up to the challenge.
For a deeper look into these trends and solutions, read Ryan Cunningham’s article in Pensions & Investments: https://www.pionline.com/indus...