On May 1, tens of thousands of people across the US participated in a national rent strike. It was the largest of its kind in decades. Using the slogan “Can’t pay, Won’t pay,” the campaign aimed to put pressure on lawmakers and landlords to cancel rents for the duration of the covid-19 public health crisis. Given shelter-in-place norms, the movement was virtually orchestrated by activists through Zoom calls and messaging apps. One year ago, a similar number of protesters took to the streets of Berlin in rebellion against rising rents.

These mass protests are an outcome of a longstanding and deepening global housing problem. Even before the outbreak of the pandemic, about 2 percent of the world’s population was homeless, another 20 percent lacking adequate housing, according to demographer Joseph Chamie, former director of the United Nations Population Division. Governments the world over have long been struggling to find solutions to this crisis. A collapse of the US housing market triggered the 2008 global financial crisis and a resulting recession. Today, a pandemic-fueled recession will trigger further housing challenges as an almost-global lockdown kills jobs and shrinks economies.

Is the institutionalization of affordable housing a part of the solution? Over the past decade, affordable accommodation has attracted increasingly more private capital aimed at building real estate that serves society and, at the same time, generates institutional returns. But supply of affordable housing is still nowhere close to matching the demand due to a prohibitive mix of regulatory, political and financial roadblocks. Opportunistic investors, often using a “buy-fix-sell” strategy for their investments, have been criticized for profiting from the housing crisis. At the other end, mission-oriented low-income housing investors have struggled to make the math work.

“The federal government has printed money left and right, in an unprecedented stimulus. There is a very slim chance it will be in a financial or legislative position to also enhance government-subsidized housing to meet the affordable housing needs resulting from the pandemic,” says Inna Khidekel, partner at US manager Bridge Investment Group. “Local and state governments are extremely stretched providing medical supplies and have not been getting any tax revenue. A private sector solution will be critical.”

What’s in a name?

The first hurdle in providing that solution is overcoming the ambiguity around the term affordable housing itself, which can stretch the typical definitions of affordability.

Under one model introduced in the UK in 2010, affordable housing rents can reach as high as 80 percent of market rents in any specific area. In the US, where affordability is linked to income on a relative basis across different state, affordable housing is typically aimed at individuals from the lowest income demographic – earning 30 percent of an area’s average median income – but can also extend to those making up to 80 percent of an area’s average median income.

True affordable housing, some say, implies social or government-subsidized housing where investors get financial incentives, like tax-exempt bond financing or below-market cost land acquisitions. In September, Dutch pension manager Bouwinvest Real Estate partnered with Irvine-based Avanath Capital Management to invest $85 million on behalf of its parent investor, bpfBOUW, the Dutch construction workers fund, through the Low-Income Housing Tax Credit program, a US federal affordable housing initiative.

London-based manager Nuveen Real Estate also invested $50 million for a similar venture with a US-based non-profit affordable housing developer Enterprise Homes in 2016. Then there is non-market rental affordable workforce housing, catering to teachers, healthcare workers and other moderate wage earners. Madison, New Jersey-based manager PGIM Real Estate has invested more than $1.5 billion in this space over the last two years.

Brian Chinappi, partner and head of Asia real estate at London-based manager Actis, thinks “affordable housing” is an overused term. The firm is part of a $200 million affordable housing joint venture partnership in India, together with lenders Asian Development Bank, the International Finance Corporation, and the Mumbai-based developer Shapoorji Pallonji.

“We originally referred to the strategy as being affordable housing. This led to some misconceptions, so we then considered the term ‘workforce’. But this also led to misconceptions of being worker dormitories,” he says. “So, we have moved away from using a single word over time. Our focus is simply on delivering urban, higher-density housing, targeting the population making 55 to 75 percentiles in the income bracket.”

“People are pitching concessionary, almost charitable investments. But that promises deep affordability for a long period of time. Then, there are people pitching opportunistic returns, but no binding affordability. Understanding where you fall on that spectrum is important” – AJ Jackson, JBG Smith

For some institutional investors, confusion around how to characterize affordable housing has been difficult to overcome. When London-based manager Cheyne Capital was raising its first Social Property Impact Fund in 2014, some investors explicitly said they would have invested if the fund did not contain the words “social” or “impact.”

“Five years ago, funds with the word ‘impact’ or ‘social’ in the name made it difficult for some investors because of their resistance to being forced to take into account non-financial factors in their investment decisions,” says co-founder and president Stuart Fiertz. “There still is resistance today in some investment committees, and by some CIOs, partly because they are, in my view, compensated on financial returns, not on a total double bottom line.”

Cheyne Capital and the Salt Lake City-based manager Bridge Investment Group have seen a gradually increasing desire among foundations and endowments to not only invest the 5 percent of their portfolio typically mandated towards program-related investments or charitable donations, but also think about how to sustainably invest the remaining 95 percent. Bridge Investment Group’s 2017-vintage $619 million Workforce & Affordable Housing Fund, which closed this October, has banks and impact investors invested. And Cheyne Capital’s second impact real estate fund, an evergreen UK-focused vehicle, is also seeing more interest from long-dated income investors. The manager has so far deployed £150 million ($184 million; €169 million) through the vehicle, against a longer-term target of investing up to £1 billion in the sector.

Impact versus profit

Investor concerns do not end at nomenclature. One of the toughest pieces in the affordable housing puzzle to place is the right balance between impact and returns.

“People are pitching concessionary, almost charitable investments. But that promises deep affordability for a long period of time. Then, there are people pitching opportunistic returns, but no binding affordability. Understanding where you fall on that spectrum is important,” says AJ Jackson, executive vice-president of social impact investing at developer JBG Smith, a Washington DC-area owner and developer.

When the pendulum swings too much either way, criticism follows. A high profile example of criticism of profiteering followed private real estate giant Blackstone’s Invitation Homes portfolio. The New York- based manager founded the single-family rental homes business after the financial crisis, taking it public in 2017. It was merged with Starwood Waypoint Homes to create a residential behemoth soon after. Blackstone later gradually started cashing out and the exit from Invitation Homes was fully completed in November 2019 when the firm sold its remaining 11 percent stake for $30.10 per share, bringing in roughly $1.7 billion.

The transaction was intensely scrutinized. Even today, a Facebook group of disaffected tenants called Tenants of Invitation Homes, with over 1,600 members, regularly posts personal accounts of tenant evictions and says it is working towards filing class action lawsuits. In March 2019, two UN human rights experts wrote to Blackstone condemning the egregious business practice of “scooping up low income and affordable homes around the world, upgrading them, and substantially raising rents, forcing tenants out of their own homes,” adding that its actions were “inconsistent with international human rights law.”

Blackstone has publicly disputed the assertions, claiming them to be “false, misleading claims about Invitation Homes’ business and practices,” in a statement on its website in November. The manager asserted that the project – and the $10 billion the firm has invested to acquire and renovate homes – has stabilized local housing markets, spurred economic growth and created jobs.

With other private real estate managers caught in similar crosshairs, the industry has been confronted with questions over whether higher yielding capital should be allowed to invest in affordable housing. Also, if affordable housing rents are increased during the holding period, does the property stop being affordable? Conversely, if rental increases are capped, where does the upside for private capital come from? And are asset improvements sufficient to generate opportunistic returns?

These conundrums are playing out in cities like New York and Los Angeles today. Last summer, New York City passed sweeping rent laws allowing more protections for tenants in its one million-plus rent-stabilized apartments, deepening the rift between regulators and private landlords. Alicia Glen, the city’s former deputy mayor for housing and economic development, says it is unclear if such changes will deter private equity investing. But she also believes opportunistic investors making 25-30 percent returns do not have a place in the sector.  Meanwhile, JBG Smith’s Jackson says it is hard to make adequate returns since development costs for affordable housing are the same as those for market-rate housing. Indeed, a report published by University of California, Berkeley’s Terner Center this March found that between 2016 and 2019, the costs to develop a new affordable unit in California under the LIHTC program increased from $425,000 to more than $480,000.

Click here to read PERE’s full interview with New York’s former housing czar Alicia Glen

But Jackson disagrees with the moral criticism around whether firms should profit from housing issues. “This framing is incongruous with the way we address problems in a market system,” he says. “What private capital does is make investments to meet needs and solve issues in a way that hopefully generates a return. But you need to collectively come to that right balance between return and affordability that is socially acceptable.”

Making the math work

Firms running other risk-return strategies have also needed to experiment with rent and tenancy structures to convince investors the sector can make money.

“This is an asset class with not enough supply. There is high going-in occupancy, less of a J-curve, and strong cash flows.” Inna Khidekel, Bridge Investment Group

According to Remco Daal, president for Canadian real estate at the pension investment corporation QuadReal: “Being good in the multifamily space means you understand ‘affordable’ and you work it into your projects because it makes them better projects.”

In Canada, QuadReal operates a land lease affordable home ownership platform called Parkbridge. The project has a total value of C$1.5 billion ($1 billion; €980 million) and represents more than 10 percent of QuadReal’s global residential holdings. In 2017, the firm also purchased the Oakridge Centre in Vancouver for a retail, office and residential redevelopment project.

“It is an integrated site, where there are elements of market housing, elements of rental and elements of affordable. And they all live in the same community. It is a different model than the US, where you’re targeting a certain income level,” he says regarding the Oakridge residential project.

For Bouwinvest, having a partner specializing in the LIHTC program compliance was key. “You have the risk of a potential recapture of credits used originally, and that keeps investors away,” says Gijs Plantinga, the firm’s director for North America investments. “That, however, also leads to higher entry yields and that forms part of our return.”

Naturally, tax relief and government-backed financing is financially advantageous. Nuveen uses tax-exempt bond financing in assets where a portion is dedicated to affordable housing. James Martha, its head of housing for Americas, says the cheaper cost of debt, in addition to the strong sector demand, creates a stable revenue stream. The firm typically targets a seven to 10-year hold period for investments and has also held properties for 15-20 years. Its typical realized returns have been in the low double digits.

Meanwhile, PGIM Real Estate has investments in Austin that have benefited from subsidized operating costs because the state has no income tax, and managers get a 100 percent property tax abatement if 50 percent of the apartments are made affordable.

Lending to the sector is also favorable. Lisa Davis, PGIM Real Estate’s executive director of impact investing, who previously helped establish the investor Ford Foundation’s impact investment program, says: “Much of the permanent debt in the workforce housing space comes through government sponsored entities like Fannie, Freddie, and the Federal Housing Administration. Those lending vehicles will remain liquid, even when other credit markets start to seize up. We are seeing that prove out now, with the lending volumes in the government-sponsored entities space accelerating in the last eight weeks.”

Beyond social housing, recent efforts have also focused on housing for people commonly referred to as the missing middle – those in the workforce, overqualified for government subsidies, but not earning enough to afford market-rate housing.

Bridge Investment Group caters to this demographic, which Khidekel says represents approximately two-thirds of the US renter base. In 2018, the firm received $750 million of balance sheet capital from Freddie Mac for a special social impact facility financing. “This is an asset class with not enough supply. There is high going-in occupancy, less of a J-curve, and strong and durable cashflows,” she says. “It will also outperform in a recessionary environment because of ongoing and growing demand and migration from more expensive housing, which we expect to see in the aftermath of this crisis.”

The upside in such a value-add strategy comes from the mixed-tenancy model. “We will take about 40 percent of the units to a market upgrade, with around $8,500 of capex and rent increase of $100-$175. That helps to subsidize the remaining 60 percent of units that get a light and environmentally sustainable upgrade, so we are able to maintain the overall asset level affordability,” she says.

JBG Smith is also raising capital for its debut affordable workforce housing fund, based in Washington, DC and part of the Washington Housing Initiative launched by the developer in partnership with the Federal City Council in 2018.

The fund has attracted $104 million so far from investors, including banks JPMorgan Chase and Bank of America Merrill Lynch, and is aiming to acquire around 2,000 units in four to five years through a core to core-plus strategy. The fund’s gross hurdle rate is 9 percent, much like other workforce housing strategies.

But the fund has some unique structures to drive more impact: the maximum return to its investors is capped and extra returns generated beyond the hurdle rate will be donated to affordable housing non-profit organizations. In addition, all fund investments have a 15-year affordability covenant.

“We have focused on investors interested in the binding affordability commitment and covenant and who understand there is a trade-off between that and total return,” Jackson explains.

Cheyne Capital’s Fiertz believes asset allocators are gradually understanding that impact investing can be achieved without comprising risk or return. Having long-dated leases is one way. In the UK, productivity growth has been low and real wages have struggled to rise, so the firm ensures rents on its properties do not increase faster than wages. Assets acquired from its funds have a 20-40-year head lease with the social sector organization, with leases linked to the inflation rate.

“Our objective is to pay a real dividend of between 4-6 percent that is inflation linked. And with long-dated interest rates around 1 percent or less, we think that represents an attractive return profile for investors,” he says.

Public-private partnerships

The other crucial balancing act is between the public and private sectors. Providing affordable housing is a priority for most governments. Former US democratic presidential candidate Bernie Sanders’ Housing For All plan included a national rent control standard. In India, Prime Minister Narendra Modi’s long-cherished dream is to provide housing for all by 2022.

But the degree to which private capital should be involved in providing this solution has always been contentious. Jackson says the past two years have seen more recognition by US public officials of the need to address affordable housing issues in the US than at any other point in his career.

“There is also a recognition that one has to get the private sector into it, at a scale,” says Jackson. “The problem is so great that the government cannot do it alone. You are not going to have an Austrian model of government-owned housing across the US.”

Nuveen’s Martha agrees there is a desire to have a public-private partnership stateside, but adds: “There is just too big a gap between the understanding and motivation on both sides.”

Actis’s Chinappi says his firm has never considered investing in India’s social housing sector because it is too policy driven. “We are comfortable relying on governments to give us our permits and approvals and other perfunctory things. But as soon as you rely on the government to deliver subsidies, such as releasing land, subject to building rental housing, it makes us nervous.”

The spotlight that comes with being in this space is another factor. “State and public pension plans tend to shy away from housing strategies that are rent-regulated to avoid making headline news. They do not want to be criticized for trying to maximize rent,” says Doug Weill, founder and co-managing partner of New York-based advisory firm Hodes Weill.

Investor groups believe a closer partnership with the developer and local governments can help bridge the gap, says Michiel de Bruine, director for Dutch residential investments at Bouwinvest, which runs a Dutch Residential Fund with mid-market rental assets. “For example, when land prices are lowered, or the building costs are further optimized,” he says. “And when we are restricted to keep the homes in the mid-rental segment, for example, for 15 years instead of 20 years, or when rent increase inflation plus 1 or 2 percent is allowed, then we can settle with a lower return and it can all come together.”

Jay Kwan, managing director for international real estate, Europe, at QuadReal agrees: “I think where it is easier for private participants to price land and develop social housing is when the regulations are clear, reasonable and predictable. Some of the noise around the difficulties in executing on that strategy is where local government may not have all three of those elements: where it is not clear, it may not be reasonable or it is constantly changing, and you’re subject to the winds of political change.”

Future blueprint

The debate around affordable housing has mostly centered around the stakeholders and the role they should play. But assumptions about the physical aspects of ideal housing have remained unchallenged over time, even as cities become less dense and people move further outwards for cheaper housing.

“This 20th-century ideal of living 20-40 miles away from work is not really that ideal. Expansion of geographic space horizontally increases congestion, fuel use and is just not an efficient way to live,” says Gunnar Branson, chief executive of Association of Foreign Investors in Real Estate, a Washington, DC-headquartered industry association. He recalls how his New York apartment in his 20s had a galley kitchen and no fancy appliances, yet it was “enough and close enough to where I needed to be”.

For him, figuring out more intelligent and efficient uses of space – micro apartments in the city using fewer square feet per unit, for example – needs to be part of the conversation, too.

That’s especially the case in a post-covid world. If the public health crisis makes people wary of using public transportation to shuttle between home and work, or if more companies decentralize operations away from cities, suburban housing costs could quickly escalate, too.

“Society moves a lot faster than buildings do. Real estate is slow; it takes us many years to invest, build and change the built environment,” Branson says. “We are the big ship that is trying to turn. We are trying to do it as smartly as we can. But it is going to take time.”