California’s Plan To Fill The Middle-Income Gap Starts With Market-Rate Housing

In April, a 507-unit, Class-A multifamily building in Glendale called the Altana sold for $300M — a record for the largest multifamily transactions in California this year to date — to a partnership between Waterford Property Co. and the California Statewide Communities Development Authority. 

The partnership’s plan? To lower rents, not raise them.

Using a program available through the CSCDA, partnerships between private entities, the CSCDA and cities can buy newer, high-end multifamily buildings like the Altana, which opened in 2017, and convert the units to moderate-income housing, which is affordable to those making between 80% and 120% of the area median income.

The CSCDA is the largest joint powers authority in the state and is very active in Southern California, but two other JPAs have created moderate-income housing programs that similarly fund this type of project. One, California Community Housing Agency, started in 2019. In total, the three have purchased 6,000 units across 20 buildings, the Los Angeles Times reported.

Though the program has taken off, it isn't without its critics, who are wary that these transactions benefit the private parties involved in measurable ways but that the public benefits are less fixed. 

"The program as it has worked in other locations would present risks and costs to the City, while providing only modest affordability gains," the city of San Jose's director of the office of economic development, director of housing and director of finance wrote in a memo to the mayor and city council following analyses by city staff and third parties of the financing models of CalCHA and CSCDA. 

The purchases are 100% financed by tax-exempt bonds. The joint powers authority issues them and they are bought by investors. CSCDA Managing Director Jon Penkower said buyers are large institutional mutual funds and large holders of tax-exempt bonds, including Franklin, Vanguard, Nuveen and PIMCO. The proceeds fund the purchase of the property that will be converted to moderate-income housing. 

Different private partners, such as Waterford and Standard Communities, team up with the CSCDA to serve as what is called a program administrator on the projects, though the JPA name is on the deeds. Because the JPA is a government entity, it is exempt from property taxes. 

“What we're doing is we're monetizing the property tax exemption. That's what creates the subsidy,” Penkower said.

That allows the partnership to lower the rents for moderate-income tenants at properties in the program and keep them below market rate. Proponents of the program said that without this element, the program wouldn't work. 

In a February 2021 memo from HR&A Advisors, which was hired by the city of Long Beach to evaluate a potential transaction there through the CSCDA's program, HR&A questioned whether the lowered rents were a significant discount from the market-rate ones and noted that the renters with the most extreme needs were those who qualify as low-income. 

But those making use of this program said that there are plenty of funding sources to create low-income housing, such as the Low-Income Housing Tax Credit. Funding sources for moderate-income housing are harder to come by. 

Waterford Property co-founder and Head of Acquisitions and Development Sean Rawson, whose company has dealt in both affordable and market-rate housing, said it has been challenging to find ways to finance moderate-income projects, whether it is a ground-up project or an acquisition.

"What's so unique and fascinating about this program is it's really the first source of capital that we've seen to be able to provide housing to moderate-income households," Rawson said. 

The need for moderate-income housing is real, proponents and critics of these programs agree. A 2021 report from the California Housing Partnership found that statewide, about 42% of moderate-income households were cost-burdened, or paying more than 30% of their income toward rent.

The CSCDA's program was created in 2020 but has already been utilized in some notable sales in Southern California. The CSCDA, partnering with private real estate firms, has transacted $2.1B across 12 properties since the program was created in 2020 and is working on closing a handful of additional transactions across the state. To take advantage of its moderate-income housing program, cities join the CSCDA and then decide whether to sign off on the individual transactions as they are proposed. 

Real estate consultants who have prepared reports for cities considering transactions in the program say that they have received numerous inquiries from municipalities interested in the program, looking to boost their stock of workforce housing. Los Angeles is considering it, and there are CSCDA projects in Carson, Anaheim, Glendale, Pasadena and Long Beach. 

As traditional buyers retreated to the sidelines to see how the market shook out during the coronavirus pandemic, those working on CSCDA-sponsored deals said that the program became more attractive, especially around Los Angeles. Of the 12 properties that the CSCDA has helped convert to moderate-income housing, 11 are in Southern California. 

“That time was a big window of opportunity for this program,” Standard Communities Managing Director of Essential Housing Chris Cruz said.

Class-A projects that had been built anticipating higher rents were leasing up at a discount of 10% or 15%, and there was no conventional or market-rate buyer waiting to buy them, Cruz said. The traditional buyers for these large, market-rate multifamily projects weren't making moves, as was the case in other sectors. 

“That, coupled with low interest rates, allowed us to be able to get pretty competitive out there,” Penkower said.

Of the top 10 multifamily transactions in California this year to date, four were bought by the CSCDA through their moderate-income housing program, according to data and research from CommercialEdge. Of the top sales in LA County for the same time period, five were to the CSCDA through the program. 

CBRE Executive Vice President Dean Zander, who specializes in multifamily and has worked on some transactions through the moderate-income housing program, said that these transactions are having an effect on the overall multifamily market in the LA area, as they are effectively removing those properties from the market-rate housing stock, decreasing the overall supply which, coupled with renter demand, boosts rents. These sales are also setting new pricing benchmarks other owners want to achieve when they sell.  

“In a way, they're benefiting property owners, even those owners who don't participate in the program, by kind of nudging up the prices that they can ask for their properties,” Zander said. 

Uncertainty around the multifamily market has faded, which may make it harder for the CSCDA partnerships to find deals. But those utilizing the partnerships said the program can keep investors competitive.

Zander said there are definitely more aggressive investors in the market than there were six months ago, many of them also looking at the same high-end, larger properties that these programs target. Generally speaking, Zander said, bond buyers can go a little bit further on pricing than a traditional buyer can, but traditional investors can move more quickly than these partnerships can, and sometimes speed is more important to a seller.

Still, Rawson said he was bullish on the partnership's ability to lock down properties.  

"I think for sellers, it's just a function of them finding the right buyer, and we are strong buyers," Rawson said. "We've got a very captive investor base of municipal bond investors that are looking to invest in the workforce housing space."