Affordable housing might be the most critical property niche in the country. The need for product is profound, with the national housing shortage stacking up to over 5 million homes, and the opportunity for investors is tremendous. Yet the vertical is nonetheless highly specialized, with its own verbiage, underwriting metrics, government incentives and regulations keeping the field esoteric to other commercial real estate professionals.
We recently chatted with Edd Hamzanlui, an affordable housing expert and Bullpen freelancer. Edd is a Vice President on Bank of America Merrill Lynch’s Housing Development team, working on tax credit investments around the country. Before Bank of America he completed an MBA at Chicago Booth and held various roles in development, construction, and as a licensed architect.
Edd gave us some fantastic insights into how investors look at affordable housing investments, So let’s dive right in. We’ll start with a primer on the affordable housing space and then move into strategy and other important distinctions from conventional multifamily.
Low Income Housing Tax credits
Affordable housing investors leverage a number of federal and local housing incentive programs. Low Income Housing Tax Credits (LIHTC) are the most popular and are discussed in our in-depth guide here.
In short, these tax credits are awarded to developers for constructing or purchasing and rehabbing, and subsequently operating, affordable housing properties. The tax credits can be used to offset the developer’s own tax liability or otherwise sold to large financiers with much larger tax liabilities of their own.
There are several distinct groups of affordable housing players that are important to be aware of.
According to data from Affordable Housing Finance, the biggest affordable owners are The Michaels Organization, Dominium, and Starwood Capital. Owners make investment decisions across different regions and niches, such as older adult living or property rehab deals, and either develop their own properties or buy completed ones from other firms.
According to Affordable Housing Finance, LDG Development, The NRP Group, and Dominium were the largest affordable developers in 2020. Developers are technically a subset of owners and are responsible for bringing new affordable inventory online through ground-up construction. To help finance this activity, developers often sell their tax credits to large investors with significant tax liabilities.
According to the National Affordable Housing Management Association, the biggest affordable property managers are WinnCompanies, The Michaels Organization, and Related Companies. Affordable housing carries additional regulatory considerations and nuances beyond conventional multifamily, so expert property managers with niche experience are essential.
Tax Credit Investors
Tax credit investors are typically larger corporations with a substantial and predictable tax liability. These investors, often major banks, insurers or investment firms, contribute equity to each LIHTC deal in return for a portion of the earned tax credits. According to Novogradac, major names in tax credit equity investing include Boston Financial Investment Management (now owned by the Japanese Orix Corporation), The Richman Group Affordable Housing Corporation, and National Equity Fund. Fannie Mae and Freddie Mac are also notable investors but after the Great Recession left the LIHTC investment space until 2017.
Tax credit syndicators
Tax credit syndicators are firms that bring tax credit investors together with developers ready to sell their earned tax credits. According to data from the National Multifamily Housing Council and Multifamily Executive, 2021’s leading syndicators by volume included Boston Financial Investment Management, Raymond James Tax Credit Funds, and PNC Real Estate.
Edd pointed to a number of trends shaking up the affordable housing world today.
Demand is growing
First, he suggests we’ll only see an increase in the number of prospective and actual residents for affordable housing properties in the future. And given that we’re already experiencing a dire housing shortage, this means massive demand in the future.
Big cities are the hottest markets
All this demand has geographic connotations as well. “From the developer’s point of view this is good news, as you don’t need to worry about having tenants or vacancy but at the same time there is a general macroeconomic trend to witness too,” he says. “Big cities that are the hottest markets for affordable housing are often the most expensive for market-rate housing as well. We may not see all those incentive programs in cheaper cities.”
More developers are entering the market
The other trend Edd says he’s seeing in the affordable world is an increase in interest from market-rate developers in affordable, often spurred by increasing requirements for affordable across market-rate developments. “Affordable is becoming a hot sector as developers start looking at it. The rules are a very different animal from market rate development, you need a different network and nuanced understanding to succeed,” he says.
Underwriters looking at affordable housing deals need to be aware of how the asset class is different from other property types and especially conventional multifamily.
What are typical affordable housing rent levels and occupancy rates?
One of the prime examples of this difference is the degree to which rents and vacancy levels are predictable in the affordable space. Edd says that many affordable properties have multi-year-long waiting lists, meaning that a big chunk of uncertainty is removed from the investment equation. “When you’re building market-rate your concern is stabilization and finishing on budget, and you want to project your exit cap as accurately as possible. But you don’t have those concerns in affordable,” he says. “You know what rents and occupancy will be early on and you aren’t looking to dispose of the asset when you stabilize,” so there are other questions to ask instead.
Are there housing assistance contracts in play?
For instance, Edd pointed to the need to completely understand what types of housing assistance contracts may be in place at the property, such as Section 8 or HAP (Housing Assistance Payments), each of which will imply a specific allowable rent level.
What is the time horizon for an affordable deal?
Affordable properties follow different time horizons than market rate multifamily. Tax credits are redeemable for 10 years and properties then carry an additional five years of affordability restrictions. While properties can be disposed of before the entire 15 years elapse, or otherwise see their tax credits re-syndicated for an additional 10 years, investors considering affordable need to have a very clear exit or continuation plan beyond the typical “stabilize and sell” of market-rate multifamily.
For investment firms considering moving into the affordable world, Edd has a few pieces of advice.
#1: Lead with the right hires
“Slowly start bringing people on board to start with,” he says. Hire expert executives in the sector to build an affordable housing department organically.” Bringing in affordable housing leaders instead of low or mid-level professionals will help kickstart your investment team and avoid pitfalls along the way.
#2: Leverage outside experts
Edd says that without deep (and local) experience in-house, hiring a tax credit consultant is practically a necessity. “Affordable is all about legal and accounting principles. You need to be working with established tax credit advisory firms even outside of the bank you choose to work with,” he says.
#3: Build a relationship with a nonprofit
Finally, Edd suggests partnering with an established local nonprofit on affordable housing projects. “They understand the neighborhood, culture, and community from the non-real estate side, which is indispensable for a successful project,” he says. In this way, you can focus on core investment competencies for your firm and outsource the potential weak spots.
Affordable housing is a specialized niche within multifamily housing but the impact of tax credits and other incentive programs can be massive for affordable investors and the industry that has spawned around them.
Essential commercial real estate principles and information.