With the real estate development industry struggling to profitably deliver new multifamily product in a price range that more people can afford, an answer to affordability may be found by looking to the past — specifically Class B and C properties built 20, 30 or even 50 years ago. I have focused almost exclusively on non-Class A properties since founding what has become one of the leading multifamily real estate investment companies in Texas. Over the past 11 years, we’ve found ways to breathe new life into thousands of units in older buildings in great locations to deliver budget-conscious alternatives for working individuals and families. Here are a few reasons why carving quality, affordable “new” inventory out of existing or older multifamily properties is a smart move for investors.
Multifamily today faces a sobering supply and demand imbalance, and I feel that affordability is the No. 1 housing issue in the country. According to a recent Harvard study, over 35% of American households rent, but the supply of rental housing has not kept pace with demand. In attempts to close the gap, there were approximately 1.25 million new units completed in 2018. However, construction focuses almost exclusively on Class A apartment buildings. Class A typically equates to high rents due to construction, land, labor and other factors to make these properties financially feasible. The majority of these renters are typically known in the industry as “lifestyle renters.” Class A comes with a steep price tag and long construction timelines. Thus, despite an uptick in construction over the past decade, the share of rental units under the age of 10 has plummeted to an all-time low. The number now sits at 9%, down from 24% in 1980, according to census information compiled by Apartment List. The share of rental units aged 30-plus years has risen from 41% to 66% over that same time frame.
This means there is an abundance of potential opportunity to renovate and innovate older buildings, providing an important source of affordability to meet heavy demand. To take advantage, investors should survey specific neighborhoods, taking care to focus on Class B and C assets in desirable neighborhoods that have enough value-add opportunities to provide rent growth over the holding period. Additionally, it is fundamental that companies that work in this segment are vertically integrated and have a clear set of core values and processes, as these points will be key factors to make these investments successful.
Growing Ranks of Renters by Necessity
More individuals and families are renting today by necessity. Of baby boomers born between 1946 and 1964, recent reporting shows that 45% have nothing in savings, and many underestimate the amount they’ll need throughout retirement. A millennial’s prospect for home ownership paints an even bleaker picture: The generation as a whole struggles with a staggering $1.5 trillion in student loan debt in the United States alone.
With home prices rising at twice the rate of wages, near-term relief is out of reach, and the numbers show it. As of Q3 2018, just 56% of families could afford to buy a home based on their incomes and current interest rates — down from 78% in 2012.
Given these statistics, pursuing a real estate investment strategy that delivers affordable housing for more people can be a bedrock for success. The rental market is going up, not down — and not by choice. The affordability that Class B and Class C options offer sets up tremendous opportunity to meet growing demand. And, at much lower all-in development costs, investing in older properties helps set the stage for better margins and strong return on investment.
Better Margin of Safety
As labor and land costs continue to soar, developers are finding it increasingly difficult to build new units in the $1,000 or lower monthly rent range. Purchasing properties at a discount in today’s market proves equally tricky. Thus, an investor’s margin of safety lies squarely in the ability to create value — or, from a renter’s perspective, increasing a property’s desirability.
Many properties built in the 1970s and 1980s suffer mainly from lack of style. While developers can’t change a neighborhood, they can certainly breathe new life into a property. Light value-add, in which cosmetic renovations are keenly focused to create the most value within a more limited budget, is a growing strategy in this heated market. Older properties in great locations offer multiple avenues for creating value, including simple exterior, interior and operational improvements.
Key to gauging potential is deep due diligence on each submarket — studying what rent levels are doing at market comps by floor plan, level, etc. From that information, a strategy can be developed specific to that project with improvements tailored to that market. Thus, instead of implementing changes designed to push rents as aggressively as possible, the right light value-add approach results in a cost-effective rise in desirability. This allows rent to be adjusted upward, while still keeping rent competitively priced to support stronger investment return potential.
Furthering the American Dream
It can be argued the American Dream isn’t about buying a house; it’s about making the right financial decisions for oneself. One-third of adults in the U.S. are burdened — spending more than 30% of their income — by the cost of roof over their head. Focusing investment dollars on acquiring and maintaining Class B and Class C properties provides middle-class working families safe, attractive options in the “less than 30% of monthly income” range. This focus on affordability helps individuals and families live the American Dream, regardless of where they fall on the price-point spectrum.