A lot of apartment owners can’t wait until 2012. It’s not hard to see why. If and when the economy recovers, rental owners will be looking at a perfect confluence of events—a shortage of available entry-level housing units; a boom in demand driven largely by Millennials; and the ability to push rents to astronomical highs.

“It’s hard to sit here today—when people see the value of their homes falling and apartment owners advertising free rent—and get anyone to believe that we’re going to have a housing shortage ,” says Tom Bozzuto , CEO of Th e Bozzuto Group, a Greenbelt, Md.-based multifamily manager overseeing 28,500 units throughout the Mid-Atlantic. “It’s not a
lot of fun right now to be in the apartment business. But, you take pleasure in knowing that this is the trough of the wave.”

That trough is deep and cavernous. Today, housing starts have sunk to historical lows, making it nearly impossible to add any kind of meaningful supply over the next couple of years. And the current stock of housing supply—and the impending shortage—belies an uptick in demand that has yet to manifest itself. Consider that there’s a simmering flood of Millennials waiting to strike out on their own. Currently doubling up, living at home, or still residing in dorms, this demographic group only needs for the economy to get a much-needed jolt before it can begin fueling housing demand.

And that has apartment owners salivating. “I think a spike will occur in demand,” says David Nischwitz, senior vice president and director of property redevelopment for Mid-America Apartment Communities, a Memphis, Tenn.-based REIT with more than 40,000 units. “We’ll have an absorption opportunity because a lot of new supply is not put out there. I think 2011 and 2012 could be phenomenal years for us from a pricing power perspective.”

Indeed, the future seems phenomenal—from a business perspective. But what about the impact this socially depraved amalgam of events will have on society? In the first quarter of 2009, average U.S. rents hovered at $1,015 a month, an increase of more than 10 percent over the past five years, according to Carrollton, Texas-based M/PF Research.The result is a reality in which the average U.S. worker and his or her family are forced to spend a disproportionately large share of their income for shelter. Consider that a recent study found that three-quarters of severely cost-burdened households had low incomes, with a striking 51 percent of low-income renters and 43 percent of low-income homeowners paying more than half of their incomes for housing.

Now the question plaguing most industry observers is: How bad will it get? And what is the role of the multifamily industry in addressing this looming affordability crisis? No one seems to have the answers. And ultimately, that hurts us all.

Spiraling Out of Control

Housing affordability is a dynamic entity. It’s not just a measure of how high rents or home prices go but also a glimpse into salaries, lifestyles, and choices. For instance, in a market where $100,000 salaries are commonplace, rents of $1,500 to $2,000 a month might be considered affordable. The flip side, of course, is that in recessionary times, it doesn’t matter how much home prices and rents fall—people are losing their jobs and taking pay cuts.

What’s more, research suggests that the housing “oversupply” media pundits often discuss doesn’t tell the whole story. Oversupply exists, but not at the price it needs to be. “Even if there is oversupply, it doesn’t necessarily equate that those homes are within people’s budgets,” says Andrew Mooney, executive director of the Local Initiatives Support Corp. (LISC) Chicago, a New York-based group that helps community residents transform distressed neighborhoods into healthy, sustainable communities.

Harvard University’s Joint Center for Housing Studies, considered one of the foremost authorities on affordability, looks annually at households with both moderate cost burdens (those that pay more than 30 percent of their income for housing), as well as severe cost burdens (those that pay more than half of their incomes for housing).

Historically, affordability hasn’t been as significant an issue. From 1980, when Harvard first began looking at the problem, to 1990, the share of households with moderate cost burdens increased 1 percent, while the share of severely burdened households actually fell by about 0.5 percentage points. In the ’90s, both moderately and severely cost burdened households rose less than 1 percentage point.

Then came the housing boom. In 2001, the number of severely cost-burdened families rose to more than 16 percent, while those with moderate cost burdens jumped to 13 percent—both all-time highs. By 2007, families with cost burdens jumped by almost 6 percentage points, topping out above 19 percent. All told, about one-fourth of Americans faced cost burdens when the housing bubble burst (and just before interest rates rose on many of their adjustable loans). Put another way, 17.9 million households had severe cost burdens, while another 21.6 million had moderate cost burdens, meaning a whopping 35 percent of the 112.4 million total households in the United States faced financial hardship of some sort.

The Components of Inventory Change (CINCH) report, based on the biennial American Housing Survey conducted by the U.S. Department of Housing and Urban Development (HUD), finds that from 2005 to 2007, the net number of units that renters with incomes at or below 50 percent of AMI could afford declined by a range of 1.5 million to 2 million units. The report attributed three-quarters of the loss to units becoming less affordable over the two-year span, while the remainder of the loss, representing approximately 500,000 units, was attributed to units being transitioned into owner-occupied, seasonal, or non-residential units—or being demolished outright.

Since the Bust

Unfortunately, Harvard hasn’t published any new statistics on affordability in the tumultuous time since 2007. In the two years before the study was released, the country’s rental housing stock grew by approximately 200,000 units per year. Entering 2005, we had about 1.5 million excess units. Simultaneously, new household formation between 2000 and 2005 averaged 1.37 million; from 2005 to 2008, that number fell to an average of 1.06 million. As a result, by 2009, the country will be in parity with long-term demand, Harvard reports.

Those numbers fail to tell the whole story. Since 2007, starts have also plummeted, falling from roughly 200,000 units per year during the height of the boom to a projected 106,000 units in 2009 and a mere 95,000 in 2010, according to the National Association of Home Builders. And most industry observers believe the resulting supply/demand imbalance will be problematic. “We’ve gone from building too much housing to a period when [virtually] nothing is getting started,” Bozzuto says.

Ultimately, such undersupply is a recipe for affordability problems—particularly if you consider that the country is building too few homes at the worst possible time. Between 2008 and 2010, more than 10 million students will graduate from high school, according to the National Center for Education Statistics, and begin looking for jobs—and housing. The Futures Co., a research firm based in Chapel Hill, N.C, recently surveyed 2,500 Millennials and found that 15 percent of those aged 16 to 30 have taken a pay cut this year; 11 percent of that group has been laid off. Once the economy bounces back and job creation revs up again, many of those individuals plan to move out on their own, searching high and low for apartment units that are within their financial means. They won’t find any: There will be little housing stock left for them.

“[The reason is because] the downturn in construction has taken a big chunk out of the 1.5 million units [in excess],” says Daniel T. McCue, a research analyst at Harvard’s Joint Center for Housing Studies. “By the end of 2008, we were either right at the equilibrium level or 500,000 units oversupplied. Right now, we’re probably unbalanced looking at long-term demand.”

Ron Terwilliger, chairman of the country’s largest multifamily builder, Trammell Crow Residential, agrees. His Dallas-based firm built 8,194 multifamily units in 2008, and Terwilliger expects rents to rise 5 percent in 2011 and 10 percent by 2012 after falling 6 percent in 2009 and another 1 percent in 2010. “It looks to me like there will be a rental housing shortage in late 2012 and 2013 in this country,” Terwilliger adds.

Of course, market-rate developers such as Terwilliger, as well as affordable housing advocates, see opportunity in this demand. And they’d like to tap into it, but the financial markets make that difficult. In the market-rate sector, for instance, financing is impossible to find. On the affordable side, there’s little demand for the tax credits necessary to build housing. Meanwhile, state programs funding housing have little or no remaining money to dole out to developers. [Editor’s note: For a comprehensive look at the state of affordable tax credits and alternate financing vehicles, see “Finding Shelter” on page 40.]

“It’s very difficult to get our arms around the idea of buying land or putting out redevelopment dollars not knowing what programs are going to be out there or whether or not we will be able to finance a project,” says Lydia Tan, interim president and CEO for BRIDGE Housing, an affordable housing developer based in San Francisco.

Plus, once land is bought, things don’t get easier. “The lead time on a project is three to four years in restrictive markets,” Bozzuto says. “Suddenly, if in two years, we see that demand has picked up and capital is available, and we tie up a site, it won’t be delivered to the market for two years after that. And when we are back in a position of starting projects, we won’t go back to 300,000 a year. There just isn’t the capacity to do that.”

Unintended Consequences

In this economy, with what many observe to be a state of excess inventory, affordability seems to have improved—at least for the “workforce” sector—those households that earn between 80 percent and 120 percent of the area’s median income (AMI). The CINCH report supports this, saying that the number of units affordable to renters with incomes greater than 50 percent and up to 80 percent of the local AMI increased by a net range of 1.2 million to 1.6 million units.

Part of that may be because fewer people are looking for those units—7.2 million people have lost their jobs since December 2007, according to the Bureau of Labor Statistics. “We’ve seen a decline in household formation,” says Tim White, president of Pittsburgh-based commercial lender PNC ARCS. “That causes vacancy rates to go up.”

But the job losses and salary cuts in the past year present a double-edged sword in calculating affordability. Unless their nest eggs were immune from the assault on 401ks, stocks, and other retirement vehicles, the 7.2 million people laid off and the millions of others who have taken pay cuts are likely not looking for more expensive homes. “This is not an economy that’s pushing up incomes,” says Oramenta F. Newsome, director of the Washington, D.C., division of LISC. “We still definitely have a serious affordability problem, exacerbated by the fact that more people are losing their jobs.”

That’s why things are so uncertain. “All the evidence and data on affordability gives a mixed picture. “On the one hand, one would have to believe affordability is more within reach because of the foreclosure effect of bringing prices down,” says Henry Cisneros, former secretary of HUD and now executive chairman of CityView, a Los Angeles-based investment company that finances homebuilders. “In some places, affordability is not within the reach of many families.”

Cisneros is right. Regionally, the struggle to deliver affordable housing is even more pronounced. And that’s true even if buildings have high vacancy rates, which some say indicates oversupply. In 2008, nearly 53 percent of renters in New York were rent-burdened, paying more than 30 percent of their income towards rent, according to The Furman Center for Real Estate and Urban Policy, a New York-based research center. Yet New York also has a rental vacancy rate of 4.9 percent in the first quarter, according to the Census Bureau.

In Chicago, affordability is a huge issue in the lower tier of the market, where there has always been a housing shortage. But the Windy City simultaneously has a rental vacancy rate of 9.7 percent. “There was never an oversupply of affordable housing in Chicago,” says LISCs Mooney. “Any study on the city showed that it was in terrible need of affordable units prior to the economic slowdown.”

Meanwhile, the Washington, D.C., area has a rental vacancy rate of 9.6 percent, yet affordability remains a critical issue there as well. “At less than 30 percent [AMI] is where you see the vast majority of housing affordability challenges,” says Linda Couch, deputy director of the National Low Income Housing Coalition (NLIHC), a Washington, D.C.-based organization that advocates for affordable, decent homes targeted to people with the lowest incomes.

For the multifamily sector, this can be particularly problematic because if affordable housing continues to be hard to come by, local and state governments will begin to legislate affordability through inclusionary zoning programs, rather than encouraging its construction through other incentives. Currently, many municipalities require developers to “include” affordable housing in up to 20 percent of what they build.

That’s the case in D.C., where inclusionary zoning requirements were introduced this year. Local developers are worried that the government’s hand won’t stop there, however. “The scary thing is that you could see rent control coming back out of the woodwork,” Bozzuto says. “We’re in an environment of increased government intervention—not just at the federal level, but at the state level.”

Montgomery County, Md., which also falls within Bozzuto’s footprint, is taking a different tack to maintain affordability. It’s seizing a last right of refusal on every transaction in the county. “I could see other people trying to do it,” Bozzuto says. “The very fact that they reserve that right puts a damper on the whole transaction process.”

Crisis on the Horizon

This grim picture of too few homes, ever-increasing rents, and severe affordability shortages will likely get worse before it gets better. And the consequences will be far-reaching, starting first with families. “It’s enormous pressure on the family,” says Denise Scott, managing director of LISC New York. “A lot of times, you see families doubling up.”

Often, affordability problems push those with the lowest incomes together—much like the failed urban high-rises of the ’50s and ’60s did. “We also see concentrations of poverty when you have affordability issues,” says Leila Edmonds, director of the Department of Housing and Community Development (DHCD) in Washington, D.C.

Eventually, the trickle-down will impact entire communities. “It depends on where people cluster up,” Scott says. “You may be over-burdening certain [neighborhoods]. You may see a spillover in school systems. You may end up with more pressures on municipal systems.”

In some circles, the mixed-income movement—which seeks to replace public housing high-rises with urban, garden-style homes that mix households of all income levels—is expected to counteract the problems of poverty concentration and resource strains. Unfortunately, there is still debate as to how successful such projects can be. [Editor’s note: For more on the debate over the mixed-income movement, see “Behind the Façade” on page 32.]

As a result, if families don’t find suitable urban housing—mixed-income or otherwise—they generally drive. A good example of this is in Washington, D.C., where the Urban Land Institute, along with the Center for Housing Policy, and the Center for Neighborhood Technology, found earlier this year that households spend an average of $23,000 on housing and $13,000 on transportation costs annually. Their study said an estimated 60 percent of households have either high housing cost burdens, high transportation cost burdens, or both.

“The basic affordable housing strategy in this country is to drive until you qualify [for a home],” says Christopher B. Leinberger, president of Arcadia Land Co. in Haverford, Pa., and a visiting fellow at The Brookings Institute, a nonprofit public policy organization based in D.C. “We see a situation in this country where our poorest have disproportionately high transportation costs—they have to maintain a fleet of cars to survive.”

Ultimately, the lack of affordable housing will strain society as a whole. “It frays both the household, family, and neighborhood fabric,” Leinberger says. “You go up and down any suburban street in an entry-level neighborhood, and there’s nobody. Whether they have young children or school-age children, life is not overly pleasant because both working parents are stuck in traffic. They aren’t spending time together as a family.”

Number Crunch

All signs—and stats—point to a looming shortfall in affordable housing supply.

Average U.S. rent in the first quarter of 2009
Source: M/PF Research

1.6 million
No. of homeless people between 2007 and 2008
Source: Harvard Joint Center for Housing Studies

No. of Section 8 housing units lost per year due to property owners exiting the program
Source: International Alliance of Inhabitants

Median U.S. income
Source: U.S. Census Bureau

Portion of low-income residents who spent more than half of their income on housing in 2007
Source: Harvard Joint Center for Housing Studies

No. of families on the New York City Housing Authority’s Section 8 voucher waiting list
Source: New York City Housing Authority

3.2 million
No. of multifamily starts in 2008
Source: U. S. Census Bureau

No. of multifamily completions in 2008
Source: Survey of Market Absorption

No. of multifamily rental completions projected for 2010
Source: Survey of Market Absorption

Problem Programs

These four initiatives were supposed to alleviate the low-income housing shortage. Here’s a look at why they fell short and current plans to revive them.

Hope VI

Since HOPE VI’s inception in 1992, the government-backed program, which sought to reinvigorate public housing, has demolished more than 90,000 public housing units and renovated 75,000-plus homes. Hope VI has grossed $6.1 billion in funding for the demolition and construction of new units. Still, the program has its critics. Some claim it does not do enough for severely poor communities. And the Bush administration attempted to eliminate it altogether. The National Low Income Housing Coalition discovered that 30 percent of residents in public housing still live in “high-poverty and high-crime neighborhoods.” HOPE VI reportedly received $120 million for the 2009 fiscal year but will receive no money come 2010. It is expected to be upgraded to the “New Choice Neighborhood Initiative” program, which will receive $250 million in funding. The new initiative will focus on the transformation and preservation of public and assisted housing, as well as affordable housing and community development in surrounding areas. The leftover budget of more than $900 million from HOPE VI will be depleted over several years as developments are completed.

Low-Income Housing Tax Credits (LIHTCs)

With the crash of the housing market, the LIHTC program was grossly affected. Many of the largest investors withdrew from the program, which began in 1986 as a way to finance affordable projects through the buying and selling of tax credits. Today, the price of tax credits has plummeted, and more than 1,000 projects, containing almost 150,000 units, are on hold. More than $2 billion was allotted by the federal government to help state housing credit agencies spur stalled LIHTC projects forward. Through the funding, the government expects to help produce thousands of affordable housing units. Recently, more than $1.2 billion was allocated through the program to help build housing in states such as Alabama, Indiana, Montana, Missouri, Ohio, Tennessee, and Washington, D.C.

Section 8

The program, which was launched in the early 1970s and offers voucher-based housing assistance to 2 million low-income families, received $2 billion in funding from the 2008 American Recovery and Reinvestment Act. The funds will supplement monies in existing contracts and allow for a continuation of payments through 2010. It will also provide a full year of rental assistance payments to multifamily property owners. Unfortunately, the Recovery Act states that no new assistance will be awarded under the initiative. The Obama administration plans to provide almost $25.9 billion in funding for both tenant-based assistance and project-based assistance. Meanwhile, in July, the House Committee on Financial Services approved the Section 8 Voucher Reform Act of 2009, which would allow public housing authorities to be more flexible on setting their own rent limits and income eligibility requirements. It would also protect voucher holders from being evicted if housing authorities withhold payments to landlords; authorize funding for 150,000 more vouchers; and help reduce the increasing voucher waiting lists.

Community Development Block Grants (CDBG)

The program, launched in 1974, provides communities with resources to address community development needs. The Neighborhood Stabilization Program (NSP), a subcategory of the CDBG, received more than $1 billion in funding from the 2008 American Recovery and Reinvestment Act. The funding was allocated to 55 U.S. states and territories. Now, the NSP will have the ability to purchase and/or develop thousands of foreclosed and abandoned U.S. properties. The funding allocated through CDBG will also help to provide financing for infrastructure, housing, economic development, public service, and property acquisition. President Obama has requested $4.45 billion in CDBG funding for the 2010 fiscal year. —Amber V. Smith

Benign Neglect

If owners of rent-controlled units continue to disregard basic repairs, an entire generation of affordable units could fall by the wayside.

When it comes to affordable housing, Douglas Shoemaker, director of the San Francisco Mayor’s Office of Housing, has a lot on his plate. Of course, there are the production issues. But that isn’t Shoemaker’s No. 1 concern. Instead, he's worried about those older, rent-controlled units that San Franciscans are living in today. Many owners of those units are facing financial difficulties, and he is concerned that the city could ultimately lose those homes.

“If we get to a place where it’s clear that the borrower won’t make good on the note, then we will see a disinvestment in the property and a lack of willingness [by the owner] to put basic repairs into the place. They don’t feel they’ll get that money back out,” Shoemaker says.

He’s not alone. In New York, another city with a significant share of rent-controlled units, Denise Scott, managing director for the New York division of the Local Initiatives Support Corp. (LISC), saw a lot of multifamily housing fall offline when owners struggled in the ’70s and ’80s. A recent New York Times story said that of the 200 properties on the New York housing agency’s 2008 list of the most poorly maintained apartment properties, at least 77 were in foreclosure from January 2005 to October 2008, according to PropertyShark.com. “We’re very concerned about the issue of ‘deferred maintenance,’” Scott adds. “Owners start juggling their expenses. In an effort to keep the mortgage current and the taxes current, what’s likely to suffer is the maintenance. We expect to see an uptick in problems with deferred maintenance because of the over-leveraged situations or because the owner is strapped for cash.”

Michelle Norris, chief development officer for National Church Residences, a nonprofit affordable housing owner and developer based in Columbus, Ohio, has already seen what can happen to units in seniors housing when the owner faces financial difficulties. “You can walk down the hall and see rips and stains in the carpet,” she says. “There’s deferred maintenance on the boiler systems and the heating and cooling systems.”

The hope, for now, is that these units don’t altogether disappear. Some may fall offline briefly, but down the road, an opportunistic investor may eventually swoop in and bring them back online, says Richard Moody, chief economist at Austin, Texas-based Forward Capital. “Somebody else might buy them at sharply reduced prices,” he adds. “There are too many factors that come into play to make an assumption about a likely outcome.” —Les Shaver