More Investors Are Checking Down To Workforce Housing

Across the Midwest, market-rate apartments are packing pipelines and fueling speculation of a downturn in multifamily development. Meanwhile, developers and municipalities struggle with the obstacles to building affordable housing.

This has resulted in growing interest in workforce housing, which is now being viewed as a recession-proof asset class.

Marquette Cos. President Darren Sloniger said the market cycle for workforce housing is only beginning. Marquette's acquisition strategy narrows multifamily to three categories of product: core urban mid- and high-rise product in major infill markets trading at 4% cap rates; Class-B and C apartments coupled together and being sold as either core-plus or value-add product; and workforce housing. Sloniger defines workforce housing as older stock, typically built between the 1970s and early 1980s, that has not been updated in quite some time.

Marquette has spent the post-2008 real estate cycle targeting workforce housing assets, and Sloniger said the field of interested buyers is growing as investors are fed up seeking Class-A and B opportunities. At this stage in the overall cycle, investors are checking down to either secondary markets or different product types to find returns that fit with their investment strategies.

"Workforce housing stock is now trading in a more prevalent way. Investor funds are always looking for yield, and they're finding it in workforce housing," Sloniger said.

Another attraction to workforce housing is that, unlike affordable housing, it has no governmental restrictions like Chicago's Affordable Requirements Ordinance, which mandates that 10% of all new apartments being built be set aside for affordable housing. 

Sloniger said workforce housing can be renovated modestly and repositioned quickly, and meets demand from workers seeking affordable rents in their markets.

Marquette is looking for infill locations with good economic drivers — Sloniger said Chicago and Houston are attractive markets. But Marquette, like other investors, is interested in chasing yield and if it can acquire core product in a secondary market, it will.

"A Class-A building in Indianapolis can be acquired at a better cap rate than in Naperville," Sloniger said.

Developers are also seeking opportunities to build new workforce housing. McCaffery Interests Senior Managing Director Clayton McCaffery said his firm is working on a workforce housing transit-oriented development in Denver's South Santa Fe Arts District, near the Mile High City's light rail system. McCaffery is targeting a workforce rent structure that strikes a balance between market-rate and affordable housing rents.

But McCaffery's Denver development is an anomaly. A confluence of factors — rising construction, land and labor costs, tighter lending standards and restrictions, and differing regulations between markets on affordable housing set-asides — have developers struggling to make affordable housing work within their development budgets.

"The term 'affordable' is really a mathematical equation that tells you the cap on rent. Building affordable housing is great and should be pursued, but it's a real challenge and not because of developers' 'greed,'" McCaffery said.

McCaffery sees workforce and affordable housing as an opportunity to align people's incomes with their desire to live in certain neighborhoods. For new rentals with a mix of incomes, the revenue generated from affordable housing needs to essentially pay for the units itself, while the revenue generated from market-rate housing pays the loans used to build the development. With the costs to build housing rising constantly these days, affordable housing allotments cannot have a negative impact on balance sheets.

Developers have expressed growing concerns that the onus for building more affordable housing is falling on their shoulders. At Lincoln Common, the redevelopment of Chicago's Children's Memorial Hospital site, McCaffery Interests is setting aside 10% of the 538 apartments for affordable housing. That is the minimum amount required under Chicago's ARO.  McCaffery said his company is committed to building affordable housing, but with newer projects it is becoming difficult to pencil. He said  making the numbers work for affordable and workforce housing cannot be the sole responsibility of developers.

"No one wants to build and lose money," McCaffery said.

To learn more about the state of Midwestern multifamily development, attend Bisnow's Big Midwest Multifamily Event, Nov. 29 at the JW Marriott Chicago.