Institutional Investors are Buying Up Affordable Housing in Droves—Are They on to Something?
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Large investors expanding their affordable housing portfolios has recently become a notable trend in the real estate market. Nuveen, the investment management division of the Teachers Insurance and Annuity Association of America (TIAA), made headlines with its acquisition of a substantial 12,000-unit affordable housing portfolio, predominantly located in the mid-Atlantic region, with a significant concentration in New York City.
Nuveen, which manages $1.1 trillion in assets, is now managing a $6.4 billion portfolio of affordable housing. Prior to this deal, Goldman Sachs, alongside the Michaels Organization and the Community Development Trust, purchased $1.2 billion worth of affordable housing across the United States earlier this year. These investments reflect a growing trend among large investors who recognize the advantages of affordable housing investment.
In this article, we delve into the top four reasons driving this expansion and explain why smaller investors should consider participating in this resilient market. We’ll also talk about how you can start investing in affordable housing to make a significant profit while making a real difference in communities.
1. Increasing Nationwide Demand
Supply and demand are a crucial factor in successful real estate investing. Whether you are fixing and flipping houses, wholesaling, or building a rental portfolio, making a profit will be challenging if there isn’t demand for your product. If there is demand, your vacancy rate will stay low, and your rents will remain strong and consistently increase.
Demand for affordable housing in the United States has reached critical levels and is continuing to rise. The National Low Income Housing Coalition estimates that the nation faces a shortage of 7.3 million rental homes that are both affordable and available to extremely low-income renters. This scarcity means that for every 100 households in this income bracket, there are only 33 affordable rental homes.
Such shortages persist across all states and major metropolitan areas. But it’s not just extremely low-income renters who need affordable housing. To put things into perspective, Nuveen’s research reveals that nearly half of all U.S. renters are considered rent-burdened, allocating more than 30% of their income toward rent payments. Even more concerning is the fact that one in four of these rent-burdened individuals are severely rent-burdened, spending over 50% of their income on rent.
Despite ongoing efforts at the local, state, and federal levels, the need for affordable housing continues to intensify nationwide. This mounting demand creates an attractive investment opportunity for those looking to enter the affordable housing market.
2. Favorable Yield Stability Throughout the Entire Economic Cycle—Including Recession
Large investors are drawn to affordable housing not only due to its social impact but also because it offers favorable yield stability, even in challenging economic climates—including recession.
Nuveen’s research showcases the affordable housing sector’s resilience, illustrating that affordable housing investments, compared to traditional real estate sectors, including market-rate apartments, industrial, office, and retail, have generally delivered higher yields throughout the last 20 years. This long-term track record indicates that affordable housing investments can provide investors with attractive returns and stability throughout an entire economic cycle, even during downturns.
According to Nuveen’s report, an additional favorable aspect of affordable housing is its tendency to avoid downward rent adjustments during a recession, unlike market-rate apartments. This characteristic highlights the durability of cash flow in this sector compared to other forms of housing.
Simultaneously, the scarcity of affordable housing options and the overwhelming demand for them contribute to the sector’s robust performance. Nuveen notes that properties designated for lower-income renters exhibit higher occupancy rates and experience less volatility compared to traditional apartments. This phenomenon can be attributed to the persistent undersupply of affordable housing relative to the substantial demand, creating a stable, consistent pool of potential tenants for these properties.
By diversifying their portfolios with affordable housing assets, investors can potentially mitigate risk while generating consistent income streams.
3. Backed by Government Subsidies
One of the significant advantages of investing in affordable housing that is attracting institutional investors is the access to government subsidies, such as Section 8 vouchers. These subsidies provide property owners with stable, predictable rent collections since the government makes direct payments to owners on behalf of eligible tenants. Consequently, affordable housing investments benefit from reduced risk and enhanced cash flow reliability.
The availability of government support adds a layer of security that makes affordable housing investments even more attractive to investors. My personal experience with single-family affordable housing investments has been that Section 8 voucher rent tends to trend above market-rate rents.
4. Alignment With Public and Private Social Impact Investing Goals
It is crucial to emphasize that the expansion of affordable housing portfolios aligns with paramount societal and policy objectives. Governments at all levels—local, state, and federal—have acknowledged the pressing need to tackle the affordable housing crisis and implemented initiatives to incentivize investments in this sector.
This does not mean all the red tape has been lifted when it comes to developing affordable housing or accepting Section 8 voucher tenants. Affordable housing investors will have to overcome challenges, including public and private resistance. By engaging in this market, investors not only have the potential for financial gains, including reliable, stable income, appreciation, and tax advantages but also play a pivotal role in addressing the vital housing needs of communities.
Institutional investors have been expanding their affordable housing portfolios to make a social impact investment that generates economic returns but also drives positive change and improves the well-being of individuals and families in need.
Why Smaller Investors Should Invest in Affordable Housing
Institutional investors expanding their affordable housing portfolios is a testament to the opportunities present in the sector. The combination of intensifying nationwide demand, favorable yield stability, and government subsidies certainly creates a compelling investment proposition.
However, it’s not just institutional investors who can benefit from affordable housing investments. Smaller investors should take note and consider following suit for several reasons, but they should also fully understand the risk that comes along with affordable housing investments and the factors that are crucial to success in the sector.
As with any investment, with great reward comes great risk. Luckily, however, the risk can be mitigated.
First, demand for affordable housing extends far beyond what major institutional investors are capable of filling. The shortage of affordable rentals and homes affects communities all over the country, of all sizes, from urban cities to suburban and rural areas. Both multifamily and single-family rentals and homes are desperately needed.
Second, the potential for attractive yields and stability applies to investors of all sizes. Nuveen’s research highlights the consistent outperformance of affordable housing investments compared to other asset classes.
Smaller investors can diversify their portfolios and access these benefits by actively engaging in direct investments or passively investing in private real estate investment funds that focus on affordable housing. This allows them to tap into the sector’s potential while leveraging the expertise and resources of established market players.
Third, government support and subsidies are not exclusively available to institutional investors. Smaller investors can also benefit from programs such as Section 8 vouchers and other local and state initiatives aimed at increasing the availability of affordable housing. As discussed, these mechanisms provide stability, reduce risk, and ensure reliable rental income, making affordable housing investments an appealing option for investors of varying scales.
Moreover, the current political landscape and public sentiment favor affordable housing initiatives from everyone, from institutions to private investors and nonprofits. Governments at all levels are actively seeking public-private partnerships to address the affordable housing crisis. By participating in this market, smaller investors can align themselves with government priorities, potentially accessing additional incentives, grants, and deal flow.
An Action Plan
It’s important for smaller investors to conduct thorough due diligence and seek guidance from experienced investors when venturing into the affordable housing market. Understanding local market dynamics, evaluating potential investment opportunities, and complying with regulations are crucial steps to success. Collaborating with experienced investors, contractors, property managers, and housing organizations can provide valuable insights and mitigate risks associated with entering the affordable housing market.
One great thing about investing in affordable housing is there is a low financial barrier to entry—you don’t need a ton of capital to start investing in affordable housing.
However, on the flip side, there is a very high barrier to success when investing in affordable housing. Many times, these homes need to be fully redeveloped or heavily renovated. You will also need to know how to underwrite the renovation cost properly and manage the construction budget, time frame, and quality to ensure you stay in line with your projections and time frame and mitigate the future risk created from shoddy renovations.
It is also crucial you perform strict tenant screening practices. It is a major misconception that all Section 8 tenants will trash your property. This is certainly not the case, and strict tenant screening can certainly help lower the chances of this happening.
Another crucial aspect of affordable housing investment success is aggressive, professional property management. Whether you handle the property management yourself or work with a third party, they need to be proactive and handle everything professionally. I can expand on best practices in the construction and property management of affordable housing in another article.
The expansion of affordable housing portfolios by large investors signals the immense potential of this market. The combination of intensifying demand, favorable recession-resilient yields, and government support makes affordable housing investments an appealing option for both large and smaller investors alike. By capitalizing on this trend, smaller investors can profit with a purpose by making a positive contribution to addressing the housing crisis while generating favorable financial returns. With the right research, partnerships, management practices, and support, smaller investors can navigate this market and unlock the opportunities that affordable housing investments present.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.