This blog post is one of a series excerpted from Aaron Quach’s white paper on rental housing, available at the link above. For other posts in the series, click here.

The vast majority of institutional real estate portfolios are invested in the rental housing sector in some form. The rental housing sector is unique in that it fulfills the basic human need for shelter and therefore benefits from a certain inelasticity of demand not found in most other property sectors.

The rental housing sector is comprised of several different housing types serving various segments of the market, including market-rate multi-family apartments, rent-regulated multi-family apartments (“affordable housing”), manufactured housing communities, single-family rental homes, student housing accommodations, and senior housing facilities.

This blog post will detail issues for institutional investors regarding affordable housing. Other blog posts will examine the additional sectors as well as implementation issues faced by all of the housing types categorized under the rental housing sector.

Key Features of Affordable Housing

Unlike market-rate multi-family apartments, affordable housing generally refers to multi-family apartments with some level of rent- or income-restriction that aims to provide units for residents earning below 80% of the area median income (AMI). Investment in these properties often involves collaboration with local governments, housing authorities, federal entities such as the U.S. Department of Housing and Urban Development (HUD), nonprofit organizations, or affordable housing developers to leverage subsidies, tax incentives, or public-private partnerships such as property tax abatements. Investors in affordable housing properties therefore need to navigate complex regulatory frameworks, compliance requirements, and income restrictions.

Affordable housing presents an opportunity for institutional investors seeking both social impact and financial returns. Market participants argue that investing in the preservation or development of affordable housing units helps address the nation’s worsening affordability crisis and creates more inclusive communities. A common misconception is that investors must accept concessionary returns in exchange for this positive social impact; however, proponents of affordable housing in institutional real estate portfolios argue that investors can generate compelling risk-adjusted returns for several reasons, including higher occupancy, lower tenant turnover and therefore reduced turnover costs, government subsidies and incentives, insulation from new supply (which tends to be Class A market-rate housing), and more favorable financing terms from GSEs and other lenders.

Under the affordable housing umbrella, there are several different sub-types to consider, three of which are detailed below:

Low-Income Housing Tax Credit (LIHTC) Properties: LIHTC properties are developed or rehabilitated with the help of tax credits provided by the federal government. Institutional investors generally do not invest directly in the LIHTC development because the equity portion of the capital stack is primarily provided by tax credit investors, often banks or other financial institutions. Tax credits are generally paid out to investors in the first 10 years, after which the original tax credit investors often look to sell the asset to redeploy their capital into other projects. At this point, institutional investors may acquire LIHTC properties that are still under regulatory agreements, which span from 30 years to 55 years, depending on the state in which they are located.

Project-based Section 8 Housing: Section 8 housing refers to properties that participate in the federal housing assistance program administered by HUD. Institutional investors may acquire and operate these properties, at rents as determined by HUD each year. Under the Section 8 program, tenants pay 30% of their household income toward housing, with the balance paid for by HUD.

Voluntary Regulation: This general category is meant as a catch-all for various solutions that owners of affordable housing properties may implement in concert with state and local governments. Owners can elect to adhere to specific guidelines—typically a restriction on a certain percentage of units at a certain level of AMI—in exchange for some public subsidy such as a property tax abatement. These programs exist in various states and municipalities across the U.S., and nuances exist between each of them, emphasizing the importance of manager selection in this specific sub-sector. In some cases, there may be opportunities for experienced affordable housing investors to establish new programs with government agencies and housing authorities. 

Institutional investors targeting affordable housing properties will find that the universe of investment managers focused on these strategies is approximately half that of the market-rate multi-family space. Even shorter is the list of investment managers with the requisite track record, personnel, and relationships to navigate the complexity of affordable housing.

While historically most investment vehicles focused on affordable housing were closed-end funds, Callan has noted a significant shift beginning in 2020 toward open-end structures focused on preserving the existing stock of affordable housing units. These open-end funds offer quarterly liquidity and have more of a core plus profile, compared to closed-end funds, which tend to be more value-add in nature.

The term “affordable” can refer to many different strategies that vary based on the affordability offered to prospective tenants. Therefore, it is imperative that investors understand how affordability is defined by each unique investment manager.