Multifamily Developers Set For 'Pandemic Pivot' Into Workforce Housing
As the coronavirus storm clouds began to gather in March, CRG Managing Partner J.J. Smith was hired to help run the firm’s residential sector. In the first few weeks, he concentrated on developing a plan that leaned heavily on urban infill projects in high-density markets, the profitable strategy pursued by so many builders in the last decade. But after watching downtowns turn into ghost towns, Smith decided on another approach.
“I called it the pandemic pivot,” he said.
Dense urban cores now cause unease among many affluent renters, Smith noted, and even if vaccines tamp down the coronavirus pandemic, developers need a new product type that investors find appealing. When he ran the numbers, the answer seemed logical.
Middle-class and workforce housing fared better during the 2020 downturn, especially in the suburbs, with rents and occupancy staying near pre-pandemic levels, Smith said. CRG, the real estate development arm of Chicago-based Clayco, took that data and in November committed $1B toward the development of Class-B workforce housing across the nation, mostly in first-tier and second-tier suburbs.
“You will still see urban living, of course, but in a more balanced state,” he said.
The shift could provide a silver lining. Before the pandemic, the apartment industry got a bit too set in its ways, far too reliant on the same luxury-centric formulas, Smith said.
“Nobody had to innovate or think of a way to build a better mousetrap,” he said.
It is time to realize that workforce housing can also be a business that generates solid returns, he added. But it has to be done right, with an eye kept on controlling costs and making careful choices when it comes to location.
Other players in the multifamily market agree.
His Santa Monica, California-based firm just closed its second workforce housing fund with $350M of committed capital, and it plans to leverage that into $1.25B of investments, acquiring up to 10,000 units in existing communities affordable to the working class.
Smith and CRG decided to focus on regions that enjoy the strongest job and population growth. That means favoring the Sun Belt over gateway cities like Chicago or coastal markets, Smith said. Metros such as Austin, Charlotte, Dallas, Nashville and Phoenix were among the most attractive, although a few high-growth standouts like Minneapolis, Denver and Salt Lake City will also be considered.
A focus on each area’s respective suburbs was also an easy call. Smith said even in the Chicago region, which has recently experienced little or no population growth, new apartment developments in its affluent western suburbs like Naperville and Wheaton are opening with high levels of occupancy. That greatly increased CRG’s confidence in suburban Atlanta towns such as Alpharetta and Decatur.
“It directly lines up with where the institutional investor community is looking for product,” Smith said.
He anticipates the $1B the company plans to raise will fund about 10 new apartment communities over the next three years. Tax incentives or subsidies won’t be used, and residents will most likely earn between 80% and 120% of the area median income.
CRG will debut its first project in June, when it opens Broadway Chapter, a five-story multifamily housing complex in Fort Worth, Texas. The 320K SF development isn’t suburban, but it is about 1 mile from downtown in the city’s Medical District, and Smith said the company has already seen great interest from local health care workers who can’t afford top-flight luxury housing.
Such strong demand convinced Smith other markets were aching for developments like Broadway Chapter — ones for renters with solid incomes, such as health care workers, teachers or police officers, but renters who can’t afford all the amenities of Class-A housing.
“It’s right down the middle of the fairway,” he said. “That’s always been a void in the market.”
That doesn’t mean every region is likely to see new workforce housing in the post-COVID-19 era. Developers in small Midwest markets still confront a dilemma. Rents in many of these markets just aren’t high enough to justify new construction of apartments targeted toward those with modest incomes, according to Hannah Ott, executive managing director of Cushman & Wakefield’s Indianapolis office.
“I’ve checked our pipeline in Indianapolis, and it is just about all luxury,” she said.
It’s been years since a large number of Class-B units were built in the city, even though the occupancy rate for this asset class is more than 94%, she added.
“I feel certain that if a new Class-B property was built, people would be very excited about it,” Ott said.
Similar conditions prevail in tertiary metros such as Cincinnati and Columbus. But with construction costs going up, bringing about change will be difficult.
“Without some sort of subsidy, it’s just hard to make it work,” Ott said.
Even in its vibrant Sun Belt markets, CRG plans a number of strategies to boost returns as it constructs apartments that charge modest rents, Smith said. Broadway Chapter’s wood-frame construction is just one way to utilize less expensive materials. In the future, builders in the space may also need to adjust unit sizes, perhaps use modular components created off-site, and leave out amenities such as stainless appliances or quartz countertops.
“All of these items are sure to come into play as we attempt to serve the middle-market segment,” Smith said.
Even before the pandemic, workforce housing was a solid performer, with relatively low vacancy rates and above-average rent growth, according to a 2018 CBRE study. Slow wage growth across much of the nation, which locked so many out of more expensive units, was part of the reason. But developers didn’t necessarily see it as an attractive business, and the sector lost about 100,000 units each year, many demolished to make way for high-end properties, CBRE said.
Turner said the industry needs to reverse that trend.
The pandemic is worsening the housing situation in the U.S. for so many, and even before COVID-19, millions of families were severely rent-burdened, paying more than 60% of their income toward housing costs, he added.
“We have so many people living in survival mode, and it’s not sustainable,” Turner said.
His company has been making money in the workforce housing sector for years. Its first affordable multifamily housing fund invested nearly $700M, acquiring 7,840 existing workforce units that housed more than 14,000 residents, Turner said. The second fund has already acquired seven multifamily communities and has an eighth under contract for a total of more than 3,000 units. The company also owns developments in the Atlanta, Austin, Dallas, Houston and Las Vegas metro regions, including Portola Del Sol, a 350-unit workforce housing community in Las Vegas it purchased one year ago.
Although Turner said he believes business can be a force for good, he also said this work isn’t philanthropy. There’s money to be made in preserving workforce housing, even where his company works, primarily in communities heavily populated by immigrants and people of color. But raising rents would defeat the goal of holding down costs for working families.
“The only other option is to reduce expenses, and the biggest expense is turnover,” he said.
Turner keeps apartments filled by also providing free employment assistance, community health facilities, homework help for local children and other services, sometimes through local community groups such as food banks or by building its own facilities.
The average rent throughout the Turner portfolio is $924 per unit, he added. But building managers rarely have to spend time and effort seeking out new renters for vacant units. That leaves enough money on the table to improve the properties without government subsidies and keep investors happy.
“It’s not rocket science,” he said. “I do think of myself as being in the real estate business, but I also consider myself to be in the service industry. That’s why our tenants become sticky tenants.”