affordable housing review 2q2019 v3 · demand: demand for workforce rental housing far exceeds...

AFFORDABLE HOUSING REVIEWQ3 2019

CBRE AFFORDABLE HOUSING

WORKFORCE HOUSING EDITION

FOCUSWORKFORCE HOUSING

on

We are dedicating this edition of the Affordable Housing Review, and our next, to the topic of workforce multifamily housing. In this edition, we focus on the performance and drivers of unregulated workforce housing, as well as financing options for unregulated workforce properties. In our next edition, we will switch our focus to regulated affordable housing.

This conversation always starts with the question: What is workforce housing? While the answer often varies, it is generally defined as properties targeting middle-income households earning between 60 and 120 percent of area median income (AMI), with the upper range sometimes stretching to 150 percent in certain markets. For the research presented in this publication, we use a definition of 60 to 100 percent of AMI. Within the discussion of workforce housing there are two types: unregulated and regulated.

Unregulated workforce housing properties offer units affordable to middle-income families who earn a working wage between 60 and 120 percent of AMI, but are not subject to agreements that limit rents that can be charged to tenants—these properties are often described as naturally-occurring affordable housing or “NOAH”. Regulated workforce housing, the topic of our next Affordable Housing Review, represents properties where rents are contractually restricted to certain levels of AMI (a range greater than 60 percent of AMI). Local inclusionary housing programs for affordable housing, for example, may create tenant income-based rent restrictions in exchange for incentives to the developer/owner to create or preserve stock.

How big is this market? It’s tough to pin it down. Determining the stock of workforce housing is challenging due to the fluid nature of the NOAH inventory. Properties often “age into” NOAH inventory as they become older and less competitive, while at the same time, properties exit NOAH inventory due to obsolescence, rising rents, or gentrification (sometimes a result of the same value-add investment strategies that previously made the workforce housing investment attractive). Fannie Mae has estimated that since 2014, two NOAH units have been lost for every new unit added to inventory and approximately 120,000 NOAH units per year are lost to higher rents and renovation into more expensive properties. Regulated workforce housing inventory, on the other hand, is stable and subject to reporting requirements, making their inventory levels easier to track in the market.

Sources: Zahalak, Tanya, Sr. Multifamily Economist. 2019 Multifamily Affordable Outlook – An Overwhelming Need for Workforce Housing. Fannie Mae. February 2019.

Anderson, Bendix. “Fannie and Freddie Double Down on Financing Workforce Housing.” National Real Estate Investor, https://www.nreionline.com/multifamily/fannie-and-freddie-double-down-financing-workforce-housing.

John FioramontiSenior Research Analyst

© 2019 CBRE Affordable HousingPAGE 2

Current estimates put total rental housing inventory at approximately 43.3 million units. Of that total, regulated workforce housing accounts for 1.4 million units and NOAH accounts for 5.3 million units. There are also approximately 23 million rental units in properties with less than five units, and it is reasonable to assume that many of those have rents low enough to be counted as NOAH units.

Whatever the active workforce housing inventory is, it is vital that investors and developers in this space be supported to build and preserve stock as demand far outstrips supply and has done so for the better part of the past decade.

Workforce housing has increasingly garnered interest from buyers and capital providers who recognize the long-term supply imbalance, widening rent spreads between B/C and A product (and related value add strategies), as well as higher rent growth rates compared to A product in many markets. Furthermore, due to these dynamics, investors see workforce and other affordable housing as a safe(r) haven in an economic downturn.

Size and Segmentation of Rental Housing

20%

10%

0%

40%

30%

50%

80%

70%

100%

90%

60%

20.2M5+ units

23.1M1-4 units

8.8MMarket Rate

5.3MNOAH

5.3MNOAH

1.4MLocally Regulated

Workforce1.4MLocally Regulated

Workforce

1MSection 80.4M

FHA/Other

6.7MWorkforce

Housing Units

1MLIHTC + Other

1MPublic Housing

1.3MLIHTC Only

4.7MFederally

Subsidized

Rental Housing43.3M Units

Multifamily Housing20.2M Units

Affordable Housing11.4M Units

Sources: ULI, Fannie Mae, CBRE Database

CBRE Affordable Housing Review

CBRE Affordable Housing Third Quarter 2019

PAGE 3

THE CASE FOR WORKFORCE HOUSINGRevisited

Recently, CBRE Multifamily Research released a report analyzing the state of the multifamily workforce housing market in the United States1. Continued strong investor interest driven by solid market fundamentals supports another look at the market-rate workforce housing niche. A significant majority of workforce housing consists of a combination of older (pre-2000s built) Class B/C market-rate rental housing. These communities are often located in the suburbs and are mostly garden-style construction.

Historical sales activity in the older Class B/C multifamily market demonstrates the growing investor awareness of the strength and potential of this asset class. In 2008, sales volume on units built between 1980 through 1999 totaled around $15.9 billion, while sales volume on units built in 1979 or earlier totaled around $18.9 billion2. Ten years later, the 2018 sales volume of apartment units built between 1980 through 1999 totaled around $45.5 billion, while sales of apartment units built in 1979 or earlier totaled around $57.5 billion3. What market dynamics are driving this increase in workforce housing sales activity?

National Apartment Sales Trends (Sales $1 Million and Greater)

1 https://www.cbre.us/research-and-reports/The-Case-for-Workforce-Housing

2 National Real Estate Investor, “Demand for Workforce Housing to Remain Strong in 2019,” https://www.nreionline.com/multifamily/demand-workforce-housing-remain-strong-2019

3 Id.

0

3,000

6,000

9,000

12,000

$0

$20,000

$40,000

$60,000

$80,000

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Transaction VelocityDol

lar V

olum

e (M

il)

Class A $ Volume Class B $ Volume Class C $ Volume

Class A Transactions Class B Transactions Class C Transactions

Sources: CBRE Research Services, CoStar Group, Real Capital Analytics


Demand: Demand for workforce rental housing far exceeds available supply. According to the Census Bureau, there were approximately 13.5 million workforce housing renter households in 2017, comprising roughly 32% of all renter households that year. Household formation is greatly outpacing new apartment construction. For example, in 2018, 807,260 new households formed, while only 287,007 new apartment units were brought to market3. While most of the newly formed households have workforce-range incomes, the vast majority of new apartment construction over the past decade has been Class A luxury housing, priced well above what workforce renter households can afford. Most workforce housing renters lack the financial ability to buy a home or to move up the quality spectrum to Class A or B+ units, as wages have grown much more slowly than home prices or rental rates over the past decade. Workforce renters also compete for affordable rental units with renters from both higher and lower income brackets. Higher income households choose more affordable housing for a variety of personal and financial reasons, while lower income families who qualify for subsidized affordable housing such as LIHTC or HAP, are forced into higher-cost workforce housing due to the lack of availability of regulated units.

Supply: New supply additions to the workforce housing segment (typically Class B/C assets) are limited by the high cost of new apartment construction. Without some form of subsidy or other financial assistance from local jurisdictions, new apartment construction for the workforce renter simply does not pencil out. In the 275 metro areas tracked by REIS, there were a total of 1,463,039 new apartment units built between 2010 and Q1 2019. Of those, only 40,124, or 2.7% were Class B/C units.

Historic National Market Rate Completions

National B/C Class Asking Rent Growth

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

2010 2011 2012 2013 2014 2015 2016 2017 2018 Q1 2019

$880/month

$1,159/month

Asking Rent Growth = 31.7%

2010 2011 2012 2013 2014 2015 2016 2017 2018 Q12019

Class A 87,637 36,937 75,171 135,46 180,69 202,46 208,53 227,01 235,64 33,357

Class B/C 6,068 2,928 2,526 1,583 2,102 2,210 5,512 6,483 8,613 2,099

0

50,000

100,000

150,000

200,000

250,000

Class A Class B/C

Sources: REIS

Sources: REIS



PAGE 5

Historical Multifamily Vacancy by Class

With new production not a viable source, workforce housing supply has developed organically in the form of product aging, also known as naturally occurring affordable housing or "NOAH". Aging apartment communities normally offer fewer amenities, outdated appliances and fixtures, and more basic housing features, all of which keep rental rates more affordable to the workforce renter. Current market dynamics are reducing the addition of workforce housing inventory. In this cycle, we are seeing a higher rate of unit obsolescence and removal from inventory due to the unusually large amount of inventory added in the 1960s and 1970s. These outdated units are predominantly workforce and affordable housing. Other factors reducing the workforce supply are the demolition of older apartment communities in favor of new Class A properties and value-add acquisitions. Thru value-add strategies, some properties are so upgraded that they are elevated to B+/A- grade, resulting in rent increases above what workforce renters can afford. The net result of these market dynamics is fewer NOAH rental units being added to the workforce housing inventory than in previous cycles.

Market Performance: The supply-demand imbalance in the lower-tier (Class B/C) market-rate apartment segment where almost all workforce housing exists has kept market fundamentals strong. Both vacancy and rent growth metrics for workforce housing since the end of the recession have consistently performed better than the high-end product. Since the second quarter of 2010, vacancy in the workforce housing sector has dropped just over 33%, while top-tier vacancy has grown 16% in that same time. As demonstrated in the National B/C Class Asking Rent Growth on the previous page, national asking rent growth in the Class B/C asset class has expanded 31.7% since 2010. The ongoing shortage of rental units affordable to the workforce renter will continue to drive superior performance in this sector for the foreseeable future.

0%

2%

4%

6%

8%

10%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

Class A Class B Class C

Class A Class B Class C

Sources: CoStar Group

Year-Over-Year Effective Rent Growth

CBRE Affordable Housing


Third Quarter 2019

Conclusion: The solid performance of the workforce housing sector over the past decade explains the strong investor interest in this niche. While the job market continues to grow, driving robust household formation, workforce housing inventory has stagnated. Minimal new supply over the past decade has only intensified demand as alternative housing options for the workforce renter are lacking. While this market has some limitations, such as greater sensitivity to rent increases and more moderate returns, overall, in the current market environment, whether for value add or stabilized asset acquisition, workforce housing remains an attractive investment strategy.

WORKFORCE HOUSING PROJECT SPOTLIGHT

Built in 1903 and last operated in 2009, the historic Lowney Chocolate Factory is being redeveloped as a mixed-income, mixed-use property using Historic Tax Credits, EB5 funds, subordinate financing through MassHousing’s Workforce Opportunity Fund, and one of the very first Freddie Mac Non-LIHTC Forward perm loans. The workforce housing restrictions require 20% of units to be rented to households with incomes at or below 80% of AMI.

Jim Flinn, Executive Vice President of CBRE Affordable Housing’s Debt and Structured Finance team and Todd Trehubenko, Senior Vice President of CBRE’s FHA team, secured a $26.7 million forward commitment from Freddie Mac to provide permanent financing for the developer upon construction completion and stabilization of the project. The 10-year fixed rate loan includes two years of interest only payments and eliminates interest rate risk and volatility for the developer during the project’s multi-year construction period.

THE CHOCOLATE FACTORY

Mansfield, MA

Photo Sources: (top) Lowney.net, (middle) TheSunChronicle.net, (bottom left & right) freddiemac.com

1903

2018

2018 rendering



PAGE 7

FINANCE OPTIONS FOR WORKFORCE HOUSING

The critical shortage of rental units affordable to the workforce renter has prompted the development of loan products by both Freddie Mac and Fannie Mae targeted for workforce housing. These loans are available for both new construction and substantial rehabilitation and are generally open to both for-profit developers and owners and non-profit groups. Following are brief descriptions of some of these important financing tools.

Financing options for workforce housing are limited. There is no federal housing program, such as the LIHTC program, that supports the creation or preservation of workforce housing. The reduced rents necessary for the workforce renter do not cover the high cost of apartment construction. It is not uncommon for developers of new workforce housing to assemble a complicated capital stack of many capital sources as they attempt to fill the gap between what it costs to build the project and the equity they have available.

FREDDIE MAC NON-LIHTC FORWARD LOAN

This product has created quite a buzz within the workforce housing sector because it provides an unfunded forward commitment for permanent financing to projects that do not use low income housing tax credits, thus eliminating the risk of higher interest rates as projects transition from construction or rehabilitation to completion, stabilization, and permanent financing. Rent and income restrictions are required but they are far less restrictive than LIHTC requirements, allowing developers and owners greater flexibility in setting rent levels that will make the project financially viable. For example, guidelines for the for-profit borrower on rent or income restrictions recognize market differences and allow maximum rents to range from 100% of area median income (AMI) to 150% of AMI for 80% of the units and allows market rents for 10% of the units. Fixed rate and adjustable rate loan terms are available and the maximum loan-to-value ratio is 80%.

Our own Affordable Housing Debt and Structured Finance team completed one of the first Freddie Mac non-LIHTC Forward permanent loans for the conversion of the historic Chocolate Factory in Mansfield, Massachusetts into a mixed-use asset consisting of 130 rental units and approximately 34,000 square feet of commercial space. The $26.7 million loan is a 36-month forward commitment that will convert to a fixed-rate, ten-year loan once the project is completed. All 130 units will lease to workforce renters with 10% of the units restricted to 80% of AMI or less and the remaining 90% restricted to 130% of AMI or less. The certainty of a 36-month forward commitment on permanent financing terms and interest rate provided security to the construction lender and confidence to the developer that the project will be feasible upon completion.


FANNIE MAE MULTIFAMILY AFFORDABLE HOUSING (MAH) PROPERTY SPECIAL PUBLIC PURPOSE

This product is limited to multifamily properties that do not meet the definition of a MAH property in the Fannie Mae Multifamily Selling and Servicing guide but do have recorded rent and/or income restrictions with a minimum of 20% of the units affordable at 80% of AMI or less and are monitored by some third-party public entity. A lender must request and receive a Guide Waiver for a property to qualify as a Special Public Purpose Property before financing under this program is available. Upon approval of the Guide Waiver, the loan is automatically eligible for a discount of 10 basis points off conventional financing. It is important to understand that this product is about achieving a property designation. Once the property is designated special purpose by virtue of the Guide Waiver, many of the Fannie Mae multifamily financing options are available.

This product could be uniquely useful to regulated workforce housing. Typically, rent and/or income restrictions on regulated workforce housing are imposed by local or state entities in return for some favorable tax or regulatory treatment. Those restrictions are normally recorded, and the property is monitored. These properties satisfy the requirements of the Special Public Purpose designation, and once a Guide Waiver is granted, the myriad of favorable Fannie Mae affordable multifamily loan programs would be available to them.

Without a federal subsidy program like the LIHTC program, workforce housing production and/or preservation is limited to market-rate multifamily financing options. However, rents affordable to the workforce renter generally will not support the debt load necessary to cover today’s construction costs. The products developed by Freddie Mac and Fannie Mae described above are important and valuable opportunities for the workforce housing market niche but much more must be done to give workforce housing developers and operators the financial tools needed to substantially expand and preserve the workforce housing inventory.



PAGE 9

DEAL SPOTLIGHTRECENT TRANSACTIONS

GOVERNOR'S POINTEChesapeake, VA• UNITS: 88

• AFFORDABLE RESTRICTIONS: Section 42 LIHTC

• LENDER: Fannie Mae

Seattle, WAWINDHAM

• UNITS: 60


LEGACY FAIRVIEWFairview, TN• UNITS: 112


• LENDER: Fannie Mae

ABOUSSIE PAVILLIONSt. Louis, MO• UNITS: 273

• AFFORDABLE RESTRICTIONS: Section 42 LIHTC & Section 8 HAP

SALES & FINANCING SALES & FINANCING

SALES & FINANCINGSALES

CBRE Affordable Housing


Third Quarter 2019

KEYCONTACTSLEADERSHIP

ROBERT SHEPPARDManaging DirectorE [email protected]

JEFF ARROWSMITHSenior DirectorE [email protected]

ARMAND TIBERIOVice ChairmanE [email protected]

SPENCER HURSTVice ChairmanE [email protected]

INVESTMENT BANKING

RESEARCH SERVICES

JUSTIN LANGEVice PresidentE [email protected]

JOHN FIORAMONTISenior Research AnalystE [email protected]

INVESTMENT SALES

JEFF KUNITZExecutive Vice PresidentE [email protected]

TIM FLINTExecutive Vice PresidentE [email protected]

JOHNATHAN SMITHFirst Vice PresidentE [email protected]

BEN BARKERSenior AssociateE [email protected]

MATTHEW KOTFirst Vice PresidentE [email protected]

MIKE CANORIAssociateE [email protected]

JARED CARPENTERAssociateE [email protected]

TAYLOR FROLANDAssociateE [email protected]

DEBT & STRUCTURED FINANCE

SARAH GARLANDDirector, Affordable Housing ProductionE [email protected]

JIM FLINNExecutive Vice PresidentE [email protected]

JUSTIN FITCHETTVice PresidentE [email protected]

BLAKE ILGENFRITZVice PresidentE [email protected]

STEPHEN LANGProduction ManagerE [email protected]

KARU ARULANANDAMChief UnderwriterE [email protected]

COURTNEY SORCEManager of Loan ClosingsE [email protected]



PAGE 11

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+1 206.826.5800

[email protected]

www.cbre.us/affordablehousing

© Copyright 2019 All rights reserved. Information contained herein, including projections, has been obtained from sources believed to be reliable, but has not been verified for accuracy or completeness. CBRE, Inc. makes no guarantee, warranty or representation about it. Any reliance on such information is solely at your own risk. This information is exclusively for use by CBRE clients and professionals and may not be reproduced without the prior written permission of CBRE’s Global Chief Economist.

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