Cost of living
10 TRENDS FOR 2023
The residential sector has been one of the hottest parts of the property market in most countries around the world in recent years. Most of the attention has been focussed on private housing, developed for sale or rent at market rates. But a growing number of investors are targeting the affordable sector, offering competitive returns with an attractive profile whilst also helping solve the housing crisis.
Increased investment allocations into the residential sector have been one of the strongest trends within real estate over the last ten years. In Europe and the U.K., we are seeing rapid expansion of commercially-rented “multi-family” housing of a type that has long been a feature of the north American market. As we discussed in Operational excellence, this has extended into various residential niches including student and sheltered housing. One area particularly worthy of more attention for various reasons is the affordable sector, which has been estimated to have a global value of over $50 billion and is expected to grow by around 5% per annum through the rest of this decade.1
Estimated global value of the affordable housing sector
GROWTH IN HOUSE PRICES AND WAGES SINCE 2012
Demand is virtually limitless
Most western countries are facing a housing affordability crisis which has been worsening for many years. Very strong house price and rental growth has outstripped wages, particularly since the pandemic, which has worsened an already poor affordability picture in many markets. It has also hit low-income groups hardest.
Low-income households are defined variously around the world as having earnings that are significantly below average, typically below 50-80% of the local or national median. This section of society is particularly affected by the growing differential between incomes and house prices, as a high proportion of their earnings is already taken up by essentials including food, energy and accommodation. OECD recently reported2 that over half of low-income households in the U.K., and almost as many in the U.S., spend over 40% of their income on rent alone. Even in the most affordable states in the US, over a third of renters pay more than 30% of their income in rent.
SHARE OF RENTER HOUSEHOLDS WITH COST BURDENS (2019)
Avant by Avison Young, Harvard Joint Center for Housing Studies5
The situation has been deteriorating in recent years, given that every state in the U.S. has seen a reduction in the number of low-rent units since 2011.3 The U.K. has seen an average of around 50,000 affordable homes supplied to the market each year over the last decade – which is only a third of the 145,000 a year needed for the next decade to clear the current shortfall and meet future demand.4 The scale of the potential opportunity is enormous; but is it an area where the private sector can make money?
LOSS OF LOW-RENT HOMES PRIOR TO COVID-19
Avant by Avison Young, Harvard Joint Center for Housing Studies5
Government incentives to attract capital
The affordable residential sector as a whole comprises various subgroups targeting different segments of the population. These range from private sector provision of housing where the rent is effectively fully funded by state benefits, through subsidised market rentals to shared ownership models which help mid-income buyers to transition into full ownership.
In the U.S., the federal Low-Income Housing Tax Credit (LIHTC) is a long-standing national incentive program for affordable housing development. This has been supplemented recently with the introduction of state LIHTCs, now available in 24 individual states6, with Georgia amongst those offering one-to-one matching with federal programs.7 The affordable housing landscape looks a little different in Canada with various legal protections on affordable properties. Canadian incentives and funding for affordable housing projects – such as the Rapid Housing Initiative – are only available to government bodies, indigenous organisations, and non-profits.8 However, the expansion of low-cost loan financing through the Rental Construction Financing Initiative is providing improved funding for rental housing development.9
Governments across the world are looking for ways to encourage affordable housing development.
In the U.K., provision of affordable housing is a regulated activity with operators required to be “Registered Providers”(RP). There are around 1,600 such providers at present, of which the vast majority are local government or charitable-based organisations, in a market that remains highly fragmented. However, there are now over 50 “For Profit” RPs developing commercial models targeted at the sector. The U.K. Affordable Homes Programme is providing over £7 billion in grant funding for affordable housing development over the next few years10, supporting both registered and private providers in developing social and affordable housing as well as routes to home ownership.
Attractive investment characteristics
Common to most areas of affordable housing is an attractive income and return profile that offers significant advantages to investors.
First, the general shortage of supply in the sector means vacancy rates are low, with tenants staying in occupation for longer than in other types of property. The depth of demand means that absorption of new homes built for affordable rent is virtually instantaneous. In the U.K., the number of people on English Local Authority housing waiting lists has not dropped below 1 million since 1997. In the U.S., there is a shortage of 6.8 million homes available to affordable renters.11 In the U.K., the social-rented sector has maintained vacancy rates below 1.5% over the past five years.12 Voids and bad debts also perform well with average rates below 1% and 5% respectively over the last decade. Similarly, the U.S. reported a 2.2% vacancy rate for tax-credit supported affordable housing in 2021, with municipalities such as Oakland-East Bay experiencing 1.5% vacancy rates.13 Tenants also tend to stay in place longer. In the U.K., 80% of social-rented tenants stay in the same unit for at least three years, with almost half staying put for over a decade - compared to just 10% of tenants in the conventional private-rented sector.14
Second, these demand characteristics lead to relatively stable income flows and reduced risk. Recent U.K. data illustrate the defensive nature of the assets, with around 97% of rent in the social and affordable sector collected despite the Covid-19 pandemic. This is significantly above the average rates for offices, industrial and retail assets (35-85%). This income stream, which is relatively secure as rents are partly or entirely funded through government benefit payments, helped U.K. Registered Providers record operating margins of 20-30% and net margins of 15-20%, between 2004 and 2020.15
Third, affordable housing returns are less highly correlated to the economy than other sectors and have stronger inflation-hedging characteristics. In the U.K. rents in the regulated sector are almost always index linked, enabling housing providers to raise them by CPI +1%. Over the long run (which helps smooth the effect of short periods of policy impact), they therefore show a strong positive correlation coefficient of 0.8 with CPI.16
REGRESSION ANALYSIS VERSUS GDP AND CPI, 1998-2020
* denotes 95% confidence; ** denotes 99% confidence
Source: PFR, Regulator of Social Housing, MSCI, ONS
ANNUALISED NOMINAL RENTAL GROWTH AND VOLATILITY, 1998-2020
Source: PFR, Regulator of Social Housing, MSCI, ONS
Institutional investment growing
The sector is therefore attracting increasing attention from major institutional capital. In 2021, Blackstone Group’s foray into affordable housing began when the non-publicly traded Blackstone Real Estate Income Trust (BREIT) acquired Home Partners of America. This rent-to-own platform held a portfolio of over 17,000 homes in 2021.17 Following this acquisition, BREIT bought AIG’s affordable housing portfolio of 80,000 units for $5.1 billion. BREIT’s expansion into affordable housing assets was mirrored by Starwood Capital’s SREIT purchase of over 34,000 affordable housing units.18 Both BREIT and SREIT cite the ability for affordable housing to deliver positive risk-adjusted returns as a primary motivator for investments in the asset class. Whilst these REITs have seen significant redemptions in late 2022 and early 2023, as investors reposition themselves following the sharp rise in interest rates, affordable housing represents less than 10% of their assets; the redemptions reflect wider trends in the real estate market rather than any particular concerns over the affordable sector.
In the U.K., whilst the scale remains limited, private ownership of affordable housing associations is driving the production and acquisition of new units. This expansion of for-profit housing associations – typically owned and funded by private equity – is attracting further investment into the affordable housing stock. In the U.K. alone, following the introduction of the Housing and Regeneration Act in 2008, the number of For-Profit Registered Housing Providers has increased to 54.19
Blackstone’s 2017 purchase of a majority stock in Sage Homes sparked the development of affordable housing investments from Legal & General and McCarthy Stone. L&G’s for-profit provider – Legal and General Affordable Homes – developed 7,000 homes in 2021 and saw a 250% increase in income between 2020 and 2021. The organization pointed to the ability to draw on L&G capital as a key to their success.20
In addition to the commercial attractions of the sector, enhancing the affordability of housing generates significant wider social value which, as we discuss in Trend 8 – Maximum Impact, is of increasing interest to growing number of major investors. Housing is not only a basic human need, it is also a key contributor to health and economic inclusion. The positive social multiplier effects of affordable housing coupled with the opportunity to generate a commercial return make the sector a key target for many institutions looking to target different areas of the impact investment spectrum.
Enhancing the affordability of housing generates significant wider social value.
Innovative routes to market
Whilst many existing government programs are focussed on providing solutions for groups on the lowest incomes, there are also many households that sit above the upper threshold for state housing assistance eligibility while earning below the Area Median Income (AMI). In the United States, there is a “squeezed middle” segment that earn above the 60 percent of AMI but below average incomes. Some state LIHTCs have expanded eligibility requirements to meet an increased portion of households below the AMI. In New York, the LIHTC expands the upper threshold of eligible income from 60 percent of AMI to 90 percent of AMI. Increasing these incentives motivates the development of housing solutions for a continuously underserved portion of population that does have meaningful income and aspirations to own their own property, but for whom current house prices are unaffordable.
This is a potentially attractive target market for private providers where innovation is being seen in new ‘rent-to-own’ and ‘private shared ownership’ financing models. These approaches incorporate some variation of a homebuyer owning a share of a property of their choice and paying rent to a funder on the remainder that they don’t own. They are then able to ‘staircase’ up and buy additional shares when they can afford to.
PRIVATE SHARED OWNERSHIP
Source: Avison Young
These models can be applied to existing housing stock and therefore bring additional homes into the affordable sector. This is a particular advantage given current construction and finance costs associated with new property development. The model offers a relatively low-risk opportunity for investors as homes are they are somewhat insulated from any fall in asset value and the property acquisition is conditional on the lease, and therefore rental income, being in place. Blackstone explored this route to market with their acquisition of Home Partners of America21 whilst Nationwide Building Society recently invested in U.K.-based rent-to-own platform Kettel Homes.22
Treatment rather than the cure
The commercial provision of affordable housing remains in its infancy, and the sector is not without risks and challenges. Despite increases in government funding programs, there are many situations where it remains difficult to make affordable housing development commercially viable – particularly in the United States. The sector is also typically heavily regulated in most countries, with government involvement in setting rents – which introduces material political as well as commercial market risks. Residential investments have high management costs associated with dealing with multiple small tenancies, such that providers need expertise and experience in running a portfolio at an efficient level of operating costs. Alongside the positive reputational benefits of social value investing are the reputational risks of a market that has high political sensitivity, bringing the likelihood of negative media coverage when things occasionally go wrong. But at a time when investors are focussed on identifying scalable real investment opportunities, one that targets around half the population is likely to attract increasing attention in the years ahead.
2 OECD (2020), “Social housing: A key part of past and future housing policy”, Employment, Labour and Social Affairs Policy Briefs, OECD, Paris, http://oe.cd/social-housing-2020.
4 Bramley, G. (2018) Housing supply requirements across Great Britain: for low-income households and homeless people https://www.crisis.org.uk/ending-homelessness/homelessness-knowledge-hub/housing-models-and-access/housingsupply-requirements-across-great-britain-2018/
16 Colley, N., Fear, J. Is there an investment case for social and affordable housing in the UK?, Impact Investing Institute (2021), Is-there-an-investment-case-for-social-and-affordable-housing-in-the-UK.pdf (impactinvest.org.uk)