What do Forest City, Iowa and San Francisco have in common?
Both communities share a common need for more workforce housing.
The young professional workforce is part of the housing market that we’ve been lacking,” says Forest City’s economic director, Beth Bilyeu, in describing the first apartment community built in this north central Iowa town (pop. 4,013) in more than 25 years.
Today, the call for more workforce housing is heard nearly everywhere. How should multifamily housing professionals respond? What financing strategies make sense? What can multifamily owners, developers, and lenders learn from successful workforce housing projects?
Recently, Trent Brooks and Daniel Hogan shared their insights. Brooks is president and national head of production at RED Mortgage Capital, a Fannie Mae DUS and MAP- and Lean-approved FHA lender and Freddie Mac SBL lender with a mortgage-servicing portfolio of nearly $17 billion. Hogan is director of research at RED Capital Group, the parent company of RED Mortgage Capital. Their thoughts:
The need for workforce housing has gained new urgency in recent years. What’s changed?
The supply of naturally occurring affordable housing continues to decline while demand is increasing. In particular, the widespread deployment of value-add renovation and repositioning strategies has depleted the inventory of Class B space in many markets. At the same time, developers have focused largely on the luxury and affordable segments, creating a growing shortage of product affordable to working families, especially in growth markets such as Dallas and Atlanta and high-cost coastal areas.
Do Class B properties represent an opportunity area?
Attracting development capital for workforce housing is more difficult today because the returns are lower than other investment options. NRI and NOI growth are relatively modest compared with Class A development and, in some cases, relative to subsidized affordable housing. In addition, cap rates for value-add properties have fallen dramatically during the past two years as competition for properties with revenue-enhancement potential has intensified. This makes it even more difficult to reach hurdle rates of return in workforce renter projects.
The good news is the increasing appeal of workforce development as a late-cycle investment strategy. As the real estate cycle reaches its later stages, investors tend to seek lower-risk situations, even if it means accepting lower expected returns. In our view, workforce-targeted space fits the bill perfectly. Although near-term revenue growth may be slow, demand among tenants for lower-cost space is tremendous and is likely to remain so even if economic growth decelerates.
What’s an example of lender innovation in workforce housing development?
There’s a greater acceptance of mezzanine financing to help boost leverage and reduce the amount of required development equity. Moreover, we’ve seen considerable growth in the GSE small-balance loan programs. With these tools, investors in smaller properties have access to advantageous financing tools that weren’t there before. The small-property segment makes up a considerable portion of the workforce housing stock.
What other workforce housing financing strategies show promise?
There are creative solutions being developed in the area of affordable housing preservation. Bridge-to-resyndication programs, for example, are being offered by the GSEs as well as some balance-sheet lenders, including RED Capital. Additionally, there are a number of funds providing preservation equity to help fill gaps in the capital stack.
How should developers view workforce housing opportunities?
They should view opportunity in two ways. First, a transaction that seems impossible at first can be accomplished with the right combination of financing tools and structural creativity. Second, it’s critical to have the right team on the field to achieve a successful outcome.
