In fact, workers are often priced out of both for-sale and new apartment markets in cities with robust urban cores.
The continuing demand for workforce housing–market-rate housing developments in urban and infill areas, with prices affordable to middle-income households, that provide investors with competitive rates of return–is so strong that it is now viewed as a new asset class by large financial institutions and state and local governments. Several large private equity fund managers are raising billions of dollars from banks, pension funds and insurance companies to provide equity capital to multifamily developers. For the funds managed by Phoenix Realty Group (PRG), the institutional capital is matched with real estate experience and development partners to create successful residential and mixed-use projects with a large multifamily component.
PRG’s business model is designed to provide a bridge between the large pools of capital available from institutional investors–and increasingly state and local governments–and the urban community developers that know how to make this type of housing a reality. This strategy is now drawing the attention of cities and redevelopment agencies eager to tap into more than just capital sources to effectively leverage public dollars set aside for much-needed housing in areas adjacent to job centers and mass transit.
Resolving a major disconnect
The rationale for workforce housing emerged during the housing boom of 2003-2006, when it became an increasing reality that workers earning 80 percent to 200 percent of their area’s median income could no longer afford to buy a home or pay rents close to where they worked. Higher housing prices and rising land costs forced this middle-income group to drive farther and farther into the suburbs to find homes they could afford, despite record low mortgage rates. The unfortunate results were longer commutes, high transportation costs, and separation from family, friends and community.
Private equity fund managers like PRG stepped in during this period to resolve a major disconnect in the market and spark wide-scale development of for-sale and rental workforce housing, including apartments, condominiums, town homes, lofts and single-family homes.
Experienced urban community developers knew how to acquire relatively affordable land for development, including former industrial sites, infill properties, land requiring some environmental clean-up, or abandoned historic buildings, as well as land located in low- and moderate-income redevelopment areas. To obtain construction financing, they usually were required by lenders to invest equity equal to 20 to 30 percent of total project costs. They had not been able to tap the large-scale institutional market for capital because their housing projects were relatively small, requiring equity investments of only $3 million to $10 million. These developers typically had to turn to family, friends and smaller private investors for equity funding.
At the same time, life insurance companies, banks, pension funds, endowments, foundations, and other institutions had hundreds of millions of dollars to invest and were seeking higher yields in a low- interest-rate environment. In the case of the large banks, many of them were also seeking to earn Community Reinvestment Act (CRA) credits by investing in areas that qualify for such credits.
The solution provided by Phoenix Realty Group was to pool large investments from institutional capital sources into urban private equity funds and then make smaller equity investments in multiple workforce housing projects in urban metropolitan areas such as Los Angeles and New York. This approach opens the door for institutions to access opportunistic and diversified developments that take advantage of a workforce housing strategy.
$700 million in capitalization
Over the past three years, Phoenix Realty Group has created funds with aggregate capitalization of more than $700 million from some of America’s leading institutional investors. These include funds focused on creating housing for middle-income families and developing mixed-use, retail and commercial properties in the greater Los Angeles, San Diego, New York/New Jersey/Connecticut areas, in addition to other urban locations nationwide.
The impressive list of investors in these funds includes insurance companies Northwestern Mutual, John Hancock Life Insurance Company, The Lincoln National Life Insurance Company, and MetLife; and commercial banks Citibank Community Development and Washington Mutual. Furthermore, some of the country’s largest public pension funds are investors in these funds, including CalPERS, New York State Common Retirement Fund, New York City Retirement System, Los Angeles City Employees Retirement System (LACERS), Los Angeles County Employee Retirement Association (LACERA), and Los Angeles Fire and Police Pensions (LAFPP).
An expanding market
Initially, workforce housing targeted specific employment groups such as teachers, police officers, firefighters, health care workers and other public-service-oriented professions who struggle to buy homes in the affluent communities where they work. As the homes were built and marketed, however, there was expanding interest from a much wider audience of qualified buyers.
There were workers of all professions and industries who wanted to move from the suburbs to the city to buy or rent middle-income housing to be closer to where they worked. They wanted to reduce commuting time and expense, spend more time with family and friends, and enjoy more leisure time and the amenities of city living. Younger workers early in their careers were living in rental units and just beginning to start families. This group tends to have strong ties to their neighbors and want to buy their first home in the city and to be part of the growth of their community.
Entrepreneurs and members of the entertainment, fashion and arts industries fostered development of live/work lofts that enable owners or tenants to work where they live. This is a particularly attractive form of housing for small business owners and young professionals who are just starting their businesses and careers, require larger working spaces, and need to save on office leasing costs.
And members of the first wave of baby boomers have discovered workforce housing as a way to shed the maintenance and financial burdens of an empty nest in the suburbs and to enjoy the more urban experience of restaurants, galleries, shopping and entertainment within walking distance of their front doors.
Adjusting to market changes
As mortgage money has become more constricted following the 2007 credit crunch, developers of workforce housing have had to adapt to the changing environment in many cases by providing incentives and financial assistance to make the economics work for buyers. In the state of California, there are several programs that make this possible.
A common form of payment assistance in California is the silent second mortgage, where the city or state provides a portion of the home-buyer’s down payment and then may recapture part of the funds by participating in potential profits upon sale or refinancing of the home. These funds come from the City of Los Angeles Housing Department and two State of California programs, CalHome and CalHFA. Stricter underwriting guidelines on these silent second mortgages require borrowers to have high FICO scores and good credit histories.
Also available are BEGIN Program funds (Building Equity and Growth in Neighborhoods), a California state program for first-time buyers of affordable homes that offers up to $30,000 in down payment assistance. The BEGIN funds accrue a simple low-interest rate that is paid upon sale or is transferable if a home is sold to another income-qualified household.
Buyers in preserved or restored historic buildings also can qualify for reduced property taxes under the Mills Act, another tool to help workforce housing’s affordability. Homeowners can receive up to, if not more than, 70 percent off their property tax bills, potentially saving thousands of dollars annually. This makes adaptive re-use of historic buildings well-suited for workforce housing development as it can help to reduce overall cost of ownership for residents.
Finally, most developers select a bank to be the project’s preferred lender, and in return the bank offers special financing packages, discounts on fees and other closing costs, and other incentives to buyers who use their services. This can result in a “win” for all parties–buyer, bank and developer.
Public private partnerships
In the current real estate market, there is a growing opportunity for workforce housing development through city and redevelopment agencies’ interest in spurring growth in the urban core. Municipalities and non-profits are discovering that partnering with private equity funds and their development partners is the best way to leverage public dollars to provide communities with housing affordable to essential members of the workforce. PRG responds directly to government agency RFPs, bringing in seasoned developers who understand the neighborhood, can navigate the regulatory process and have the expertise to make the project happen. The city often supplies the land and looks to the development team to coordinate the financing, market surveys, entitlement, construction and sale or leasing of the finished housing, retail and commercial space. Various sources of supplemental capital come into play including state bond money and housing trust funds at the city and state levels. While the resulting housing meets an urgent need, the entire community benefits from urban revitalization that creates new entertainment and retail destinations, and increased sales and property tax revenue.
In the past year, it has become necessary to be more patient in marketing and selling workforce housing (and all types of housing) in the current credit cycle. But there can be no doubt that this is a still-growing segment of the multihousing market and one that is gaining momentum through the enthusiastic support from buyers, investors, developers and city and state governments. Each of these partners in the process recognizes that the need for workforce housing transcends any short-term market challenges. Through the combination of capital and development expertise, workforce housing can continue to be an attractive investment opportunity, while benefiting the economic health and long-term stability of our cities.