The multifamily market remained healthy relative to other CRE sectors. With the U.S. economy poised to rebound from the pandemic through 2021, it could attract plenty of attention from investors.
No two crises are alike — and that’s a good thing for the U.S. housing sector in the wake of COVID-19. Compared to the Great Recession of 2008, which saw the housing bubble burst, the pandemic led to strong federal initiatives to keep people in their homes amid significant economic disruption.
Considering the relatively strong position of the multifamily sector, we spoke to Pat Jackson, founder and CEO of Sabal Capital Partners, a financial services firm focused on investing and lending in workforce housing. He details the challenges in workforce housing, including tight margins, changing demographics, and aging properties, while highlighting some opportunities for CRE professionals in a post-COVID-19 world.
CIRE: The shortage in workforce and affordable housing across the U.S. is a problem with more than a single cause. Can you briefly summarize what led us to our current situation?
Pat Jackson: There are two basic aspects behind this historic shortage. One has been the supply over the last decade, having to do with the availability of places where people could rent, and the second, of course, is the demand, which has been increasing as well.
There are a lot of factors involved, but let’s look at demand. One big shift is that people are staying in rental properties longer than they have historically. The American Dream was always that I’m going to rent until I can buy — and then I have a home. But that’s not the driving motivation for a lot of people like it was in prior generations. In part, this is because there’s a lot of flexibility in renting — when a lease ends, you can move.
I think a lot of younger people saw parents lose equity in the global financial crisis, when people were underwater in homes they thought were their nest eggs. There’s fear about that. Renting also provides a convenience factor. You don’t have to worry about property taxes or maintenance issues. You can call the super to come fix it for you, so there are a lot of things driving demand.
Let’s also not ignore the fact that credit standards are much tougher. Since the global financial crisis, down payments are typically a lot higher, credit scores are more rigid, and the ability to prove you’re able to pay a certain amount is tougher. The reality is that it’s become more difficult to save enough for a down payment on a house when people have depleted savings.
On the supply side, when you look at the rent you can get for affordable or workforce housing, you will only be able to build a certain cost per unit to be able to get a return. As building costs have steadily increased, the emphasis on apartment buildings has been more focused on class A and luxury, where they can get a higher rent profile to be able to make it pencil. Therefore, we haven’t seen a ton of new supply coming into this space compared to higher amenity properties.
There’s a natural governor in workforce housing — the ability for someone to pay a certain percentage of their overall income. There is a point where you just don’t have any more money. The tension between supply and demand has kept the ability to price to market in this space under wraps somewhat
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CIRE: What are the primary factors that determine a high-quality investment?
Jackson: Sabal participates in this space in a lot of different areas. As a Freddie and Fannie lender, we’re a provider of financing to operators who already own the buildings and those looking to put durable long-term, fixed-rate loans on properties. So, basically, they collect the rents, they cover the expenses, they pay the mortgage, and they pocket the difference. It’s pretty simple.
As investors, we typically want to find a great partner — someone who has a track record, aligns culturally with us, and has the same views about how we’re going to operate it as an investment. Obviously, the first thing we are looking for is the right property — I mean, it’s got to make sense financially. But secondly, who’s going to be our partner? Who’s going to be the day-to-day person running that property, ensuring that the property’s being properly managed, and doing all the right things for the tenant and our investors?
CIRE: In the affordable housing space, do different developers and investors focus on certain price points? Do they specialize in a specific slice of the market?
Jackson: You do have companies that are focused, for example, in the [U.S. Department of Housing and Urban Development] space, which typically has long 35-year mortgages. That space can be appealing to certain people. And we don’t see a ton of overlap between that and those dealing with market rate properties.
But specifically to a price point, you have to differentiate a bit between workforce and affordable housing. It’s a little nuanced. Workforce housing is simply a designation that says the average median income in this particular MSA is $45,000, for example, so you’re renting properties to somebody for 50 percent of their take-home [after-tax] income. This type of housing puts the renters into a bucket that we see as workforce housing.
When a percentage of someone’s overall take-home income is allocated to a place to live, that’s the governor on how much you can charge for rent. If you’re a landlord wanting to increase rent by $100 a month, you often can’t. Your average tenant is saying, “Hey, I’m already at my limit. I’m not willing to have ketchup sandwiches twice a week to pay higher rent.” As a property owner or landlord, you don’t have the luxury of increasing rent as much as possible. Tenants just don’t have the money. Wages, also, are not growing at such an exponential rate historically that allows them to absorb the rent increases.
Operators in this space have to be very mindful of how they run their business. They need to be efficient because raising rent by $20 could be the difference between keeping your tenants and not. You have to be focused on your costs to be appealing in the marketplace. There are specialists in this area, and a lot of advantages come with scale. You can find yourself squeezing out a bit more profit than a smaller company that only has one or two properties. Larger operators can pool resources, whether it’s maintenance or other costs, and that’s an important advantage when you’re trying to maximize efficiency. As an example, we have a client that has a huge portfolio — hundreds of millions of dollars — and his whole business model is buying properties that need a substantial facelift, rehabbing them, and putting tenants in there. He never wants to sell. But he operates at such a scale that he can buy 500 ceiling fans or 1,000 lighting fixtures. That saves money but it also makes it easier to service apartments going forward. If a tenant has a problem with a microwave, he knows it’s the same model in every unit. If it needs to be replaced, he’s got one waiting and it’ll slide right in the old space. This streamlined approach is only possible when you’re dealing with such scale that you see these benefits.
CIRE: From an outsider's perspective, workforce housing includes an inherent tension because you realize there's a ceiling on income. What can you do to make sure the numbers work to know an investment has potential?
Jackson: I can give you a hypothetical example. Let’s say we have someone come to us with a building where they plan to jack up the rates by $250 after fixing it up. One of the first things we’ll ask is: What’s the median income in the area? Is that a reasonable assumption? A lot of times, you realize that’s not a feasible plan. You’re not going to be able to make the numbers work because other units in the area may come with a certain price point. You just can’t ignore the market. The people renting these units are on a budget where $20 a month can matter a lot. I think that’s an important thing when we are looking at investments — we’re looking at how realistic it is.
I think a lot of younger people saw parents lose equity in the global financial crisis, when people were underwater in homes they thought were their nest eggs. There’s fear about that.
CIRE: Looking forward, how is multifamily positioned as we come out of the worst of the pandemic? Where do you see the sector going in the short term?
Jackson: I’d be foolish not to point out there has been a lot of distress, and certain sectors in the marketplace have been more affected than others. Certainly, hospitality and retail have been impacted greatly. And while not every apartment building has weathered the storm, the nice thing about multifamily is there are a lot of investors looking to buy. That is a positive moving forward — being able to bring in new operators with the financial wherewithal to be able to rescue an underperforming property.
Everybody talks about cap rates, and they haven’t really changed a lot in this sector. They haven’t gone up to create more compelling buying opportunities. I think that is, in part, because it’s looked at more as a steady, reliable return. We don’t see them going a lot lower either, because it’s going to be hard to justify those. For potential investors, look where you can add value — like an older property owner who is ready to move on or a property that needs a facelift, where some sweat equity will make sense. But you can’t approach [the multifamily sector] as a place where you can buy and do nothing, with an attitude of, “Hey, it’s a rising tide that will lift all boats.” That’s not a sound investment plan for the long term.
Editor's note: This article is an adapted excerpt from a full-length Commercial Investment Real Estate
podcast. Visit www.cirepodcast.com to listen to the full episode or stream wherever you listen to your favorite podcasts.