12 min read 6 May 22
The multifamily housing sector holds wide appeal for institutional investors looking for stable cashflows from income-producing assets that typically have lower correlation to other asset classes. Workforce housing, which is a category of multifamily housing that aims to deliver high-quality, affordable rental homes for low-income households, is inherently more difficult to access because the assets require a more specialised, active management approach than other assets. However, workforce housing has demonstrated its resilience during the Covid-19 pandemic. This is largely because of supportive supply/demand dynamics and favourable demographic tailwinds, with the shortage of affordable housing continuing to fuel demand for multifamily rentals.
In 2021, the vacancy rate in multifamily housing fell to 5%, below the long-term average rate of 6%1. At the same time, vacancy in ‘Class C’ workforce housing also declined, to 3.7% from 5% at the end of 2020. Vacancy rates are expected to remain relatively low, on average, as the economy continues to recover from the pandemic.
We believe workforce housing offers investors an attractive way to access the US multifamily housing sector. In particular, platforms that are able to target underperforming workforce housing assets and implement a turnaround and repositioning strategy can potentially drive compelling risk-adjusted returns.
Multifamily housing is a category of residential real estate comprising multiple separate housing units or dwellings contained within one building or several buildings, which are under single ownership and professional management.
Multifamily housing is a common form of housing in the US, particularly in more urban areas where demand for rental property is high. Growth prospects for the sector remain favourable, with DBRS Morningstar expecting multifamily and single-family rentals to remain the fastest-growing segment of the US housing market2. US multifamily housing is categorised according to the target market, quality, location and age of the property.
Workforce housing is classified as a combination of Class C and some Class B multifamily rental housing that caters to households where the income is between 60% and 100% of the local median household income3. The term ‘workforce housing’ can literally mean housing in a community or neighbourhood that is affordable to those who work there. Reportedly, the number of single-family and multifamily workforce renter households was 13.5 million nationally in 2017, according to the U.S. Census Bureau4, with demand driven by the high cost of home ownership and prime rentals in city-centre locations.
We believe increased demand for workforce housing units and limited supply of well-managed schemes has created attractive market conditions for platforms that have the skills necessary to efficiently acquire and manage assets.
Demand for more affordable housing units from low-income families varies by region, largely driven by local house prices and mortgage availability. As tenants of workforce housing typically earn less than the average salary, they are only able to enter the property market if house prices fall or wages increase. The long-term trends in housing affordability are likely to increase the demand for workforce housing, in our view.
The US Federal Reserve’s (Fed) ultra-loose monetary policy stance over the past decade pushed mortgage rates to historical lows by mid-2021. Now with the Fed having turned more hawkish in recent months as inflation bites, the average interest rate on a 30-year fixed-rate mortgage has climbed to over 5% (Freddie Mac) with the Fed raising short-term interest rates for the first time since 2018 in March. Many first-time buyers are still struggling to get on the property ladder as house prices remain beyond their reach – US home prices rose by a record 19% year-on-year in 2021, according to the S&P CoreLogic Case-Shiller US National Home Price Index, representing the biggest annual increase in 34 years.
While the younger working-age population – including the ‘Millennial’ and ‘Generation Z’ cohorts – are widely thought to prefer renting over buying, the decision to rent is not solely based on demographic groups. Households may also choose to live in more affordable workforce housing units for a variety of individual reasons, including to pay down debts, saving up to buy their first home or proximity to family and jobs.
Many also simply prefer the flexibility that renting offers for geographic mobility, amid changing preferences and needs that may dictate where someone wants to live, work and socialise. A proportion of demand for workforce housing comes from households migrating out of populous urban cores to lower-density areas – a theme that increased in focus during the Covid-19 pandemic, given the need for more space and preference for outdoor options.
With only limited federal support, states and local agencies are doing what they can to expand the affordable housing supply in the US. In September 2021, the Biden-Harris Administration announced a number of steps aimed at boosting the supply of quality, affordable rental units, including to provide low-cost capital for affordable housing developments.
When it comes to workforce housing, it is not economical to build new, purpose-built properties. Instead the national supply of Class B and Class C assets primarily comes from the downgrade of properties from A to B and B to C, due to the increasing age of properties or changes in neighbourhood appeal. The high cost of redevelopment often leads to increased rents, which make improved properties less affordable for low-income families. The supply of affordable housing is also constrained by the fact that in many states and counties there is no requirement for developers to include affordable housing units within new developments.
Developers therefore tend to either focus on new developments at the upper end of the market, ie Class A housing assets that generate higher market-rate rents or look to pursue value-add strategies of lifting Class B assets to Class B+/Class A status. Consequently, this has led to a decline in Class B and Class C workforce housing stock as a share of total multifamily housing stock, and reportedly “on average, about 120,000 Class B and C units are being lost each year due to obsolescence, gentrification, and conversion into Class A units.”5
This confluence of factors has led to tighter supply conditions against a backdrop of still-elevated demand, and more limited competition from new supply additions than Class A assets6. As a result, there is a greater need for investment, and in particular, attractive opportunities in projects that seek to acquire and reposition underperforming workforce housing assets in the US.
Multifamily housing is gaining appeal with investors looking for stable cashflows and diversification potential, leading to increasing amounts of capital flowing into the asset class. There has been growing interest to allocate capital from large institutional investors, including investment managers, pension funds, equity funds, insurance companies and sovereign wealth funds. According to CBRE, the total volume of US multifamily housing investment is expected to grow by at least 10% in 2022 from 20217.
We believe that workforce housing can offer attractive risk-adjusted returns for investors, particularly when investing via a platform that has the necessary skills to acquire and turnaround underperforming assets. Workforce housing is inherently more difficult to access because the assets require a more specialised, active management approach than Class A housing.
Workforce housing could offer investors a number of potential benefits, provided they can access the opportunity by investing in a platform with the right capabilities:
Potential for attractive risk-adjusted returns: Investment could provide attractive risk-adjusted returns for yield-seeking institutional investors. As well as earning income on a portfolio of assets from rental income streams, we believe investing in this area could offer the opportunity for appreciation through 1) value-add strategies aimed at reinvesting rental cashflows to improve the asset; and 2) selling the stabilised asset at a higher value than the purchase price, depending on the timing and nature of exit.
Sustainable cashflows from rental income: Stabilised assets are typically cashflow-generative, derived primarily from the net rental income earned on the units (gross rental income less vacancy and credit loss, repair costs and other operating expenses, and any debt servicing costs). Given the relative supply/demand imbalance, vacancy rates have tended to be lower historically and rents have been increasing on average – this is because Class B and C renters have had fewer housing options than those of Class A renters, so they tend to move less.
Demonstrable resilience and solid fundamentals: Market observers suggest that workforce housing proved to be relatively resilient during the pandemic, as longer-term demand trends held up, and even accelerated – this category of multifamily housing also performed well through the global financial crisis. In 2021, overall occupancy and net effective rents finished the year above pre-pandemic levels. For affordable ‘Class C’ multifamily housing, specifically, vacancy fell by 1.3pp year-over-year to end 2021 at 3.7%8 and is expected to remain relatively stable as the economy continues to recover from the pandemic.
Diversification potential in a portfolio: Allocating capital to investment strategies that seek to acquire workforce housing assets could offer potential to diversify investment portfolios. In addition, portfolios of workforce housing assets tend to have a large volume of leases, so the credit risk is well diversified across many leases and lease holders.
Despite growing investor interest, there are challenges in accessing workforce housing opportunities, particularly platforms that have the skills to drive higher returns from acquiring and turning-around underperforming assets. Acquiring older properties requires specialist skills and more hands-on active management, so there are higher barriers to entry than other categories of multifamily housing.
The provision of affordable housing solutions in areas where there is a high need can offer positive social benefits especially to low-income families facing proportionately higher house prices and rents in urban areas. Workforce housing platforms that have the skills and capital to improve the quality and condition of housing units (including physical improvements to make homes pleasant, safe and secure places to live) could help to deliver positive social outcomes for tenants.
The development or project may also support local community development. Operators of assets that, for instance, implement community-based initiatives could potentially enhance the surrounding communities over the longer term.
In addition to potentially delivering positive social outcomes for tenants and communities, investment strategies aimed at delivering capex programmes focused on repairing and improving older housing units and repositioning underperforming assets in high growth markets, could also help to boost average rental income, assuming vacancy rates and delinquencies remain low.
The value of workforce housing assets tend to be impacted by regional supply and demand dynamics. To target the best returns from the asset class, therefore, we believe it is important to invest through a platform that has a long-term track record in the sector and understands the demographic and migration trends, which drive occupancy and rents.
It is also important to invest through a platform that has the required skills to acquire and turnaround underperforming assets, which could potentially provide attractive risk-adjusted returns for investors in our view. There are few platforms with this level of experience and skills, however.
M&G has therefore chosen to build its own workforce housing platform, using the experience gained by investing and operating in real estate, private assets and Special Situations financings over the years. In September 2020, M&G created Elandis, a specialist workforce housing platform, in partnership with a management team with a long-standing track record in the asset class9.
The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.