The structural and secular case for investment in workforce housing

The United States’ residential sector is chronically underserved; since 2017, the nation has been experiencing a large and growing shortage of housing. In 2017, this shortage was an estimated 731,000 housing units, but as of 2020 has now grown to between 3.8 – 6.8 million units, according to Kingbird Analysis of Federal Reserve Board of St. Louis, US Census Bureau, ACS IPUMS, and CoStar Data, along with Freddie Mac Housing Supply: A Growing Deficit May 2021 and National Association of Realtors Housing is Critical Infrastructure: Social and Economic Benefits of Building More Housing June 2021. The lack of supply relative to demand in the US residential sector, specifically within the workforce housing segment, has created an ideal, fundamentals driven environment for investing in workforce housing.

The central driver of this shortfall is a lack of development caused by onerous zoning, land use, and environmental regulations, ever-increasing construction costs, labor shortages, and macro demographic shifts.

The result of these interacting factors is a nationwide housing shortage driving historically low vacancy rates and record high rent and home price growth. The current combined vacancy rate for all for-sale and for-rent housing in the US is 2.5%; in 2021 rent and home prices grew on an average annual basis 11.1% and 18.9%, respectively.

Among the most minimally supplied segments is the workforce renter cohort, the largest group of renters. These renters, defined as those earning household incomes between $45,000 and $75,000 annually, are being squeezed from both the bottom and top of the apartment supply spectrum due to apartment supply constraints. This is further exacerbated by a dearth of new workforce housing product since development economics typically justify either luxury apartments, due to higher rents, or affordable housing, due to government subsidies. These phenomena limit the supply of units available to workforce households, driving vacancies down and rents up, which provides durable cash distributions and sustainable capital value appreciation, thus enhancing returns to investors.

This has proven true historically. Private real estate funds focused on workforce rental housing returned an average net IRR of 16.4% between 2009 to 2019 versus luxury housing focused funds’ average net IRR of just 10.7%, according to Kingbird Analysis of Preqin Data. While past performance is not indicative of future results, the outlook for investments in the United States’ workforce multifamily sector is positive, given its favorable demographic and supply/demand fundamentals.

When demand goes unmet, prices rise. Typically, when a market supply/demand void exists and investors see prices rising, they will quickly move into the marketplace, providing additional supply until market equilibrium is reached. Yet, while the unmet demand of the workforce rental sector is clear, the economy has failed to produce new supply at a level adequate to fill the workforce housing shortfall. As such, this supply gap has grown substantially and is poised to continue to do so, rendering the sector an ideal — and sustainable — target for investment.

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