Assessing Investor Interest for Affordable Housing Opportunities

Over the next five years, several federal rent protection programs and subsidies for tenants will be ending, leaving landlords free to set their rent rates without any restrictions. This sets the U.S. on track to lose approximately 188,000 affordable housing units by 2027, Moody’s Analytics reported in June.

According to the National Rent Report for the second quarter of 2023 from data firm Apartment List, a 25% surge in rental rates for market-rate units occurred between January 2021 and the summer of 2022, leading to one of the highest periods of rent growth in recent U.S. history. Not surprisingly, that trend is forecast to continue, with many landlords expected to favor raising rents to market rate over renewing federal tenant subsidy program agreements.

The expected rise in rents, coupled with the fact that more than 400,000 low-income housing units were lost during the pandemic (between 2019 and 2021) due to expiring Low-Income Housing Tax Credits (LIHTCs), according to the National Low Income Housing Coalition, may be creating new challenges for the nation’s affordable housing sector.

But in spite of some falloffs in fundraising for affordable housing this year, equity sponsors ranging from insurance companies and banks to family offices continue to see the sector as an attractive and safe investment option. In fact, some investment firms report increased interest from RIAs and non-institutional money sources that haven’t been as active in affordable housing previously.

“The demand is huge, the supply is way short,” said Mark S. McDaniel, president and CEO of Cinnaire Corp., a community development financial non-profit organization specializing in affordable housing. Cinnaire, founded in 1986 to revitalize Michigan, currently services eight additional states: Wisconsin, Minnesota, Indiana, Illinois, Pennsylvania, New Jersey, Delaware, and Maryland. In addition to the supply/demand imbalance, three post-pandemic economic challenges—inflated construction costs, rising interest rates and investors demanding higher rates of return—“are compounding the problem,” all of which has turned the affordable housing sector into a “strange market,” McDaniel noted.

The U.S. multifamily market relies on the 37-year-old federal LIHTC program as impetus for developers to build affordable housing. According to McDaniel, “I’ve been in this market for a long time, since 1986—I was part of the original LIHTC program getting started, and I’ve never seen these three things [happening] together. It’s all kind of going in the wrong direction.”

In Michigan alone, approximately 190,000 affordable housing units are needed in the next three years, but more than 100,000 affordable apartments are currently being lost there annually, he noted. The affordable units are being taken out of the affordable market and turned into market-rate apartments because they are often in locations that are appealing to potential renters and can bring attractive returns, McDaniel said. “That’s compounding the problem, along with the economic challenges [we’ve been facing] from the last three or four years from the pandemic, which makes it tough to develop units without a lot of GSE [government-sponsored enterprise] financing.”

And yet despite the difficulties developers are facing when it comes to making affordable housing deals work, investment is still flowing into the sector, albeit at a slower pace and with greater economic caveats. “The investor market is not as deep as it was, maybe even a couple of years ago, but the investors are still out there,” McDaniel said, and they fall into two camps: “economic investors” and ones that are driven by the Community Reinvestment Act (CRA), instituted in 1977. For the economic investors, he said, “It’s all about the return, and that they’re going to get a tax credit. For the banks, they’re really serious about the CRA, so it’s as much about getting that benefit as it is about the return they’re going to get.”

With returns in the affordable housing space currently ranging from 4.00% to 7.25%, Cinnaire’s “economic” investor pool includes insurance companies, corporations and regional and community banks, as well as major global banks like Chase and others. However, McDaniel noted, many other investors, including companies needing workforce housing for their employees, as well as a few larger banks are being driven by the CRA. “They’re able to invest in LIHTCs and they’re not in it for the economic return,” he said. “They want to invest in a fund to do development in a community that would serve their workers.”

Because of the variety of investors and their different objectives, Cinnaire’s multi-investor funds feature tiered returns, McDaniel said, “so we can address everybody’s needs and balance it all out at the end of the day—it’s very complicated fund management to make all that work.” In 2022, Cinnaire had its biggest fundraising year on record with $450 million in four different multi-investor funds and a couple of proprietary single-investor funds.

According to McDaniel, “There was significant investor demand, but the deals were tighter because of higher returns demanded and higher construction costs.” This year, Cinnaire is targeting a fundraising total of $300 million to $350 million. “Just yesterday, I got a report on this and it looks like we won’t get our record number, but we will do well,” McDaniel noted. The firm is also keeping a conservative outlook for 2024. McDaniel does expect to start to see a turnaround in sentiment in 2025, based on the data has seen, as well as the fact that new types of investors, like family offices, are catching on to the consistency of profits affordable housing offers.

What many investors miss about affordable housing, financed with a combination of LIHTCs, equity and credit, is that it is very low risk investment option, he said, an especially important consideration in today’s volatile investment market. “Everybody’s afraid of default and foreclosures, but out of all the different categories of real estate where you can put your money, this is the safest. We have never had a foreclosure or a default—I mean zero—and that’s with about $6 billion in equity investment that we’ve raised and managed over the years.”

When Cinnaire was founded, its average investment size ranged from $1 million to $5 million, McDaniel said. Its current investment funds range from $5 million to $20 million. When the company was created, its goal was to get investors to bet on distressed communities with neighborhood-scale deals involving 100-unit, 50-unit or sometimes even 20-unit buildings. Cinnaire’s most recently closed fund was used for an 800-unit, six-property package of deals with the Lansing Housing Commission in Lansing, Mich. Each property was repositioned under the Department of Housing and Urban Development’s Rental Assistance Demonstration (RAD) program, requiring an investment of $11 million to $15 million per property and offering a return of approximately 6.625%.