Affordable housing’s double-edged investment appeal

Real estate investors are increasingly turning to the affordable housing sector in an attempt to marry social and economic returns.

That poor-quality overcrowded housing harms public health will come as a revelation to practically nobody. Nevertheless, the correlation between the two has rarely been held up to the light with such blinding clarity, especially within the developed world, as it has been during the coronavirus pandemic. In many countries it has further rooted the issue of how to increase provision of decent, affordable living space near the top of the
political agenda.

The problem is one that most national and local authorities have struggled to address, to the extent that the OECD calculates that across its members one in three low-income tenants in the private rental market are overburdened – defined as spending more than 40 percent of their disposable income – with housing costs. Meanwhile, government spending on housing in those countries as a percentage of GDP has continually declined over the past two decades.

Some private investors are now beginning to perceive an opportunity. It is clear that there is demand for decent, low-cost housing. And if they can find a way to deliver it, the sector offers attractive return characteristics.

“We invest on behalf of Dutch pension funds and insurance companies which take a very long-term view, and affordable housing is very suitable for that,” says Robert Koot, director of European investments at Amsterdam-based Bouwinvest Real Estate Investors. “It is a basic need, and with occupational rates at very high levels.

“Moderate rental increases give you a very stable and growing net operating income. Add a little bit of financing and development exposure in some markets to bring the return to 7 percent, and it is a very safe investment in the long run. Perfect product for a pension fund.”

Finding affordable options

“Affordable” is a term that covers a multitude of product types, from subsidized social housing to mid-market rented accommodation, and recent years have seen a variety of private real estate managers trialing strategies across the spectrum.

The UK, with 48 percent of low-income tenants overburdened with rental costs, has one of the worst affordability problems in the world.

Both Blackstone, through its Sage Housing vehicle, and CBRE Global Investors, via its £250 million ($353 million; €291 million) UK Affordable Housing Fund, have dipped their toes in the low-cost homes market.

They have recently been joined by BMO Real Estate Partners, a subsidiary of Canadian investment manager BMO Global Asset Management, which launched its own UK affordable housing strategy last year, aiming to raise £500 million. “We are targeting a 4.5 percent income return and a 6 percent total return, so it is a very core return,” says director and real estate product specialist Jamie Kellett.

“There is real need for mid-market and affordable housing, so you have deep occupier demand, and a resilient income stream with high occupancy rates and low defaults. When you put that together it builds you a very smooth income stream. It is relative certainty in an uncertain world.

“Delivering low-cost housing in the UK is very difficult. It is directed towards home ownership, and the highest bidder typically wins. We have to be very smart with our acquisition strategy in terms of looking to get off-market deals, or schemes in areas with higher local authority affordability requirements.” BMO will employ a “flexible rent” leasing model under which individual units within a scheme can be let at either a market or discounted rate with the ratio between the two flexed over time to meet a pre-defined income for each asset.

Bouwinvest invests in the social housing segment in Ireland, where it perceives an undersupply and therefore attractive returns, but takes a different tack in continental European markets, where it targets mid-market unsubsidized rental accommodation. CBRE GI is adopting a similar approach for its new European Residential Impact strategy, which will buy and develop assets where the rent payable is no more than 30 percent of median local household disposable incomes.

“In the higher-priced segment, prices are much more volatile, and in the lower-priced segments there are often alternative providers such as housing corporations. But there is the greatest imbalance between supply and demand in the mid-priced segment, particularly in the capital cities of Europe,” says fund manager Paul Oremus.

“Before the coronavirus crisis we were telling investors that this was a resilient sector and that has been proven. Rent collection rates at 98 to 99 percent were much higher than commercial sectors. And in many markets, we saw some modest rental growth.”

Navigating North America

In the US, managers are looking to affordable housing to provide higher returns with a value-add risk profile. Since its inception in 2007, California-headquartered Avanath Capital Management has raised four value-add vehicles to invest in rent-regulated, “naturally-occurring” affordable housing. The latest, Avanath Affordable Housing IV, had a $760 million first close in January this year, including a commitment from Bouwinvest.

Founder, chairman and CEO Daryl Carter says Avanath targets returns in the “low to mid teens.” However, he argues that while returns across the value-add apartment sector in general have a large capital appreciation component, returns for affordable housing are more evenly balanced between income and value growth, making them more predictable and less volatile.

Affordable housing the grove
The Grove: the 85-unit senior housing community in Orange County California, is one of Avanath Capital’s most recent acquisitions

Investor interest in the affordable housing sector is growing, he says, but there is still plenty of opportunity: “We can still find good investments to make, albeit they are a little pricier than five years ago. Most institutional capital flows into the A and B properties, and there is still significant capital need in the space that we are in.

“The US affordable housing market is very fragmented. The top 50 owners own about 8 percent of the assets. It is dominated by small developers and non-profits. Scale is very important in the apartment industry, and at the upper end of the market the REITs take advantage of economies of scale. But very few have done it in the affordable market.”

It is not only financial returns that are attracting investors to the sector, however. There is a growing appetite among capital providers for assets that contribute toward their ESG goals.

Stoneybatter affordable housing
Sociability: Bouwinvest is backing social housing projects in Ireland, including Ardstone’s Colmcille House development in Dublin

“Impact investing in real estate is increasing. It is the biggest growth area when you look at the total impact investment universe,” says Philip Hirst, a director in JLL’s upstream sustainability services team, which helps investors create and implement ESG strategies. “And when you think about the most impactful forms of real estate, housing tends to come top of the list. Not only because everyone needs a roof over their head, but also because most developed economies have some form of housing crisis in affordability, quality or supply.”

Covid has served to emphasize the social impact of affordable housing, observes Tanja Volksheimer, a senior portfolio manager at Nuveen Real Estate, currently charged with developing a European strategy in the segment for the London-headquartered global manager. “Times have changed since the pandemic,” she says.

“People have really felt how interconnected we are, and how much we rely on the working class. All our investors now want to be part of the solution, and they see that they can do more than just make a return. Especially with the EU Sustainable Finance Disclosure Regulations being introduced that will make everything more transparent and comparable, they are asking themselves which of their funds are really making a positive contribution, so the pandemic is driving this from one side and regulation from the other.”

During the crisis, Communidad Partners, a private equity investor in workforce housing in culturally diverse communities across the US Sunbelt, offered its residents free virtual health services and a “covid calculator” to provide information about claiming government support. “Many folks have the misconception that social impact and ESG is concessionary, that there is a trade off, but they are not mutually exclusive,” argues principal and managing partner Antonio Marquez.

“The value proposition for our investors is having their values aligned with their business objectives. They drive not only an economic return, but also a social return.”

Moreover, providing assistance to tenants makes for resilient income. “Covid has been very profound for our business. In a downturn folks being able to pay their rent and stay in their home can be attributed directly to our ability to support and help them through social impact services. It gave us an opportunity to showcase social impact in action and how it could translate into resiliency in our communities and for our residents,” says Marquez.

Managers in the affordable housing sector admit that investors will face obstacles: building scale when individual assets are often relatively low in value; dealing with a wide variety of state or national bodies in a sector rife with regulation; and acquiring development sites in land-constrained markets where luxury developers can easily outbid low-cost providers.
A pivotal challenge, particularly in the US, is overcoming negative perceptions, says Carter. “Sometimes we need to dispel the myths about certain neighborhoods that our industry invests in.

“People have perceptions about who our residents are that are simply not correct. These are people that work hard every day, and have aspirations for their kids, and they are pursuing the American dream. We have to convey that story.”