The Laramar Group is bullish on workforce housing.

The Chicago-based apartment investment and management company recently closed a $350 million fund that, leveraged, gives it $1.4 billion in buying power to target value-added acquisitions.

More specifically, the fund is focused on buying Class C properties that have been neglected, capital starved, or poorly managed, and renovating them to the level of Class B communities. Those are the kind of apartments that tend to fit the definition of “workforce housing,” serving tenants earning anywhere from 80 percent to 120 percent of an area’s median income.

“The easiest way to serve that market is not with new units but with older but solid-quality units,” said Leanne Lachman, president of Lachman Associates, a real estate consulting firm. For many developers, that means taking the same approach as Laramar: Buying Class C properties and turning them into Class B products.

“We very specifically don’t over-improve these properties because we understand where the market is,” said Dave Woodward, the Laramar Group’s CEO.

At the 436-unit Park Baldwin Palms development in Orlando, Fla., that meant upgrading kitchens and bathrooms, installing new cabinets, countertops, appliances, carpet, and vinyl flooring in the units. The company also renovated the leasing and sales area, installed new landscaping, and renovated the clubhouse, creating a fitness center, theater, and Internet café.

On an average 300-unit property, the firm typically spends about $10,000 to $15,000 per unit in renovation costs. “One of the key areas we focus on is making sure when the completed renovation is done, we’re at no more than 70 percent of replacement cost,” said Woodward. “Anyone coming in new is going to have to spend a bit more and charge quite a bit more in rent as well.”

Average rents in the company’s portfolio are in the $700- to $900-per-month range, he said. Although these properties may not earn top rents, targeting residents who earn around the median income helps keep turnover costs low. “These are people who don’t tend to move as often,” said Woodward. “These are renters by necessity, not by choice.”

His company is hardly the only one targeting this population, and like Laramar, many apartment investors have found that acquisition/rehabilitation is the best strategy for serving the workforce and still making a profit—despite the fact that what’s sorely needed, according to those passionate about serving the housing needs of moderate-income residents, is a construction boom.

The coming boom in demand

The number of renter households is projected to increase at least 1.8 million by 2015. Meantime, net rental production over the decade ending in 2004 was just 1 million units. Much of the new stock added was high-end units renting for luxury prices and much of what was lost was low-cost apartments. “We have had a production shortfall for the last several years in multifamily [housing],” said Doug Bibby, president of the National Multi Housing Council. “Rental apartments have been produced at far below the rate they were needed.”

Yet developers say it’s tough to make new construction projects that can rent at prices low enough to serve median-income renters pencil out.

“Buying land and constructing a community are cost prohibitive to workforce housing now,” said Bibby. “The rents you can get that are affordable to the teacher, that are affordable to the firefighter, are far below what you would have to get to make it affordable [to build].”

Even with for-sale housing aimed at buyers earning the median income or just below, “it’s difficult to make the economics of these deals work,” said Doug Guthrie, CEO of Kimball Hill Urban Centers (KHUC), a subsidiary of market-rate homebuilder Kimball Hill Homes.

Letting luxury subsidize the middle-income market

KHUC is working with the city of Chicago on several mixed-income redevelopment projects on former public housing sites. At Stateway Gardens, developers are mixing public housing apartments with affordable and market-rate for-sale homes. The affordable homes, priced to be within the financial reach of buyers earning up to 120 percent of Chicago’s median income, are being sold with second mortgages designed to allow the owners to make a limited amount of profit when they resell the units, with much of the profit funneled back to the city’s affordable housing trust fund.

“We make our money on the market-rate, make a small amount of money on the [low-income housing] tax credit housing, and lose a small amount of money on the affordable for-sale,” said Guthrie. “That’s blended into a pro forma that gives us a reasonable amount of return.”

When it comes to rentals, even Trammell Crow Residential, whose chief executive has been extremely vocal about the need for more workforce housing, hasn’t been able to lower rents by more than about $40 a month at several Texas apartment projects designed specifically to squeeze out costs and come closer to serving this market, according to CEO Ron Terwilliger.

The cost constraints

“It’s been difficult to get enough of the costs out, because the land value is the land value, and unless somebody is subsidizing the land value, you’re going to pay whatever the market is,” Terwilliger said. “You can reduce the crown molding, you can do a little bit smaller project, you can buy less expensive appliances, your amenity center can be relatively small and limited, but it’s still hard to get enough money out of it to make a great big difference.”

When the company experimented with building two projects in Houston with standard floorplans and no amenities—no pool, no fitness center, no business center—investors didn’t like the product. “It seemed like a very logical thing to do: Give people a nicer apartment for a lower price,” said Terwilliger. “But that also met with some resistance from the institutional investment market who didn’t want to buy a project that didn’t have a swimming pool, particularly in Houston, or a leasing office.”

In the Los Angeles area, Urban Eco Housing, based in Santa Monica, has been able to keep its stock of about 1,000 apartments profitable through a relentless focus on cost reduction and a strategy of centralization.

“We’ve done it because we’ve internalized most of our functions and integrated vertically,” said CEO Scott Chaplan. “We now manage our own properties, we maintain our own properties, we manage our own construction crews, and we do everything we can to reduce expenses and continue to provide a quality product.”

Some of those cost reductions tend toward environmentally friendly efficiencies, which, as the name suggests, is another key component of Urban Eco Housing’s mission. The company provides better natural lighting, using less electricity, and has installed flash water heaters, which heat water at the time of use rather than maintaining a boiler at a constant temperature.

“By ingesting the providing of those services ourselves, we’re managing the labor component better, turning units faster, [creating] less downtime in units,” Chaplan said. “It lowers our effective overall vacancy on an annualized basis and increases our revenue.”

Because land costs in Southern California today are so high, though, the company is looking into diversifying geographically as it pursues new acquisition opportunities. In mid-February, the company was in the process of acquiring a 105-unit property in Austin, Texas, and was negotiating on a property in Atlanta, as well as doing a conversion in Portland, Ore.

“At today’s economics, buying a [Class] C property in Southern California is almost mathematically impossible if you’re going to service a traditional amount of debt,” said Chaplan.

Keeping renovations modest

In other parts of the country, buying and renovating Class C developments can still be a good business strategy, as the experience of the Laramar Group shows. The Bozzuto Group, an apartment company that has developed, built, or acquired more than 25,000 housing units since its founding in 1988, takes a similar approach, but does renovations on a smaller scale.

“We’ve acquired something in excess of 5,000 units that we have tried to modernize,” said CEO Tom Bozzuto. “We’re replacing windows, adding security in some circumstances, adding heating systems in some circumstances, replacing deteriorated roofs or siding, but we’re not for the most part doing full-scale replacement of cabinets and appliances because we’re trying to keep these reasonably affordable.”

The renovations average about $7,000 or $8,000 per unit, and improve the apartments enough to push rents up by about 10 percent to 15 percent, he said. When completed, though, “they’re still serving the same economic grouping of people who were being served previously, if not exactly the same people,” Bozzuto added.

Still, if local governments want to make sure working-class, lower middle-class and even middle-class residents can afford to live in their areas, it’s time for them to step in and help multifamily developers and owners serve this population at prices they can afford, many developers said.

“There are lots of ways that policy-makers can help create incentives that could make a project that isn’t otherwise economically viable, viable,” said Chaplan. “If you have operators that are willing to and capable of operating a property responsibly, give them incentives, assist their tenants with subsidies. How about the developer that reduces the consumption of energy? Do they get a credit? They could.”

For new construction deals, municipalities could create more rental housing by using the power of eminent domain, using publicly owned land for housing, and freezing property taxes, among other things, he said. In fact, municipalities have to step in if they want to add new housing to their rental stock, others said.

Said Bozzuto: “There is no way that I’ve seen that a private developer, absent some form of public assistance, can build this type of housing at all, let alone do it and make a profit on it.”