Special Report: U.S. Housing Offers Resilient Opportunities
The U.S. is currently experiencing the biggest housing crisis in its existence, and much of the shortfall is in the moderately priced rental housing segment. This gap in essential housing is caused by a demand issue – resulting from a long-lasting shift in demographics – and a constraint in supply caused by the rapidly rising costs to build housing.
Providing essential housing is not just a smart policy and a moral imperative – it’s also a good investment opportunity and strategy. This special report will look at that opportunity and how to access it.
A Solution for Society and Investors
The investment professionals at Grubb Properties have found what they believe is a solution to the housing gap – and it’s one that serves all stakeholders: investors, potential residents, and the broader community. Grubb Properties enacts it through its Link ApartmentsSM brand, which is focused on intelligent design and resident amenities to provide a lower cost, urban infill living opportunity.
In developing Link ApartmentsSM, Grubb Properties focuses on two key differentiators: location and price point. Urban locations are chosen near community amenities, transit options, and major counter-cyclical employment anchors such as research universities and medical centers. Grubb Properties also targets rents that are affordable to residents earning 60–140% of area median income.
How does Grubb Properties achieve such prices in these target locations, where virtually no other multifamily product is being developed at a similar price?
The firm drives value through methods such as innovative site acquisition, shared parking, tax incentives, grants, and more. For example, Grubb Properties focuses on just six highly efficient floor plan types that are replicated across all its communities. This is unique in the industry, where the standard often exceeds more than 25 types of units. This differentiated product does not waste resources on unnecessary components of a unit or community that the resident doesn’t value – driving a better resident experience and potentially enhancing investor returns.
Grubb Properties also looks at sustainability and ESG as an investment tool that can drive down the recurring cost of utilities for residents – and its most recent Link ApartmentsSM community earned a National Green Building Standard (NGBS) Silver designation.
A testament to Grubb Properties’ strategy is that its multifamily communities maintained high occupancy throughout the pandemic, with rent collections that exceeded 98% for every month in 2020 –markedly above the national average. This was due in part to Grubb Properties’ commitment to understand why its end-user customers are struggling and offering solutions that exceed expectations for quality and experience.
Focusing on the customer delivers both a better resident experience and the returns investors expect through a truly differentiated product that addresses a major market gap.
Grubb Properties has organized its vertically integrated company completely around meeting the needs required by the depth and severity of the essential housing gap. Its development program is solely focused on bringing Link ApartmentsSM communities to desirable urban infill markets where this type of housing is desperately needed. Although Grubb Properties has experience and success in value-add housing, it is selling that dwindling part of its portfolio to focus on the development and management of essential housing to drive investment returns.
The current investment strategy at Grubb Properties is born from deep experience in both multifamily and office investment. This plays out in methods such as innovative site selection, which helps reduce costs. For example, in many markets Grubb Properties acquires office buildings in urban infill locations with acres of surface parking. It then develops a Link ApartmentsSM community on that land, with a parking garage that is shared between the office tenant and the new residents. This strategy reduces construction costs and provides a steady non-tenant revenue stream, allowing Grubb Properties to pass the savings on to residents.
Driving down costs
Grubb Properties’ targeted amenity strategy is also aimed at driving down costs through innovations such as its Cycle Centers, which reduce parking demand at each property. Grubb Properties is the first private developer in North America to work with Copenhagenize, the world leader in designing for alternative forms of transportation. This not only allows for sustainability benefits and appeals to residents, but also improves local communities.
At its core, Grubb Properties understands the resident who needs and wants essential housing, and who wants to stay at its properties and build true communities. Grubb Properties’ Long-Term Resident Program caps rents for any resident who lives at any of its properties for at least five years – and more than 8% of its residents are currently part of this program.
Grubb Properties is also creating a Link Innovation Lab to develop and test even more creative approaches and efficiencies that will empower it to deliver more essential housing in the areas that need it most.
The growing need for essential housing and Grubb Properties’ experience and deep expertise in building solutions leave it unequalled in its ability to meet one of the most critical challenges of our day.
Understanding the Investible Properties
So, what exactly is essential housing? Writ large, it’s for households earning more than 60% of an area’s median income (AMI), putting them above the cutoff for a public housing subsidy – but earning less than 140% of that AMI, putting them below the threshold to afford luxury housing. Essential housing should serve about 41 million households in the U.S., offering working professionals affordable and quality housing options in urban markets.
Building essential housing is necessary to address the current housing shortage in America. According to recent statistics from Freddie Mac, the U.S. housing market is 3.8 million homes short of what is needed to meet the country’s demand.2 Freddie Mac estimates there has been a 52% rise in the nation’s home shortage since 2018 – the result of 10 years of underbuilding.
Not workforce or luxury housing
Institutional investors should not confuse essential housing with workforce housing, which largely serves middle-income working families through existing rental properties with two, three, or four bedrooms. This type of workforce housing is typically located in suburban areas close to schools. Workforce housing is a critically important component of the U.S. housing stock; however, the unit configurations and locations largely don’t fit the needs of young people entering the workforce today.
Investors should also differentiate between essential housing and luxury housing, which targets those earning above 140% of the AMI. Luxury housing is currently saturating the market in most cities. Over the last five years, roughly 75% of the new housing product built in the multifamily market has been luxury housing.
Drivers of the essential housing shortage
One issue driving the shortage in essential housing is the growing demographic demand from large Millennial and Gen Z generations who are in or about to enter the workforce. Given that peak births occurred in 2007 (making that population 14 years old in 2021), this demographic force is expected to last at least another decade.
In addition to this overall demand, there is also pent-up demand for housing among Millennials and Gen Z: in February 2020, largely before the COVID-19 pandemic came to the U.S., 47% of 18-29-year-olds were living with at least one parent.3 In 2020, the impact of the pandemic only created more pent-up demand and pushed more than 52% of this age group to be living at home.
Despite this demand, housing supply has remained at historic lows because of the cost challenges in building new housing. Here are some of the factors contributing to rising costs:
- Rising land costs. Between 2012 and 2017, the value of land used for single-family housing in the U.S. rose almost four times faster than inflation. As a result, the median price per acre of land under existing single-family homes rose 27%. This suggests that land costs played a key role in the recent runup in home prices, which climbed nearly 29% over the same period.4
- Rising construction costs. Another significant challenge is the unprecedented inflation in construction costs, something that has affected the entire housing industry. The Turner Construction Cost index found the 10-year average compound annual growth for construction costs is 3.95% – approximately 25% higher than the average wage growth over the same period.
- Pandemic ripple effects. The pandemic caused supply chain problems, which exacerbated the cost and availability of construction material such as lumber, concrete, and steel. For example, lumber, which normally fluctuates between $200 and $500 per 1,000 board feet, recently reached a record high price of $1,700 per 1,000 board feet. This rise in lumber prices caused the price of an average new single-family home to increase by nearly $36,000, according to the National Association of Home Builders.6
Housing costs have outpaced wage and inflation growth for some time. With the coronavirus pandemic and related economic contractions, it’s expected this trend will accelerate precipitously, putting housing out of reach for an even larger swath of younger, employed Americans.
The “missing middle”
The economic pressure described above will expand the “missing middle” – renters who don’t qualify for subsidized housing but cannot afford the luxury housing that constitutes most new construction. For example, Trulia recently found that teachers could afford less than 20% of the homes for sale in 11 of 93 major U.S. metro areas studied. The essential housing gap leaves the “missing middle” without a tangible path to homeownership and, ultimately, to economic stability and mobility. The Financial Times recently found that in 2020, many Millennials, now in their 30s, own just 3% of all household wealth. Comparatively, Baby Boomers had 21% of household wealth when they reached their late 30s in the 1990s.
This “missing middle” population needs quality housing that they can afford in locations that work for them – making essential housing even more essential at this exact moment in time and creating a significant opportunity for investors to be part of a very resilient asset class with little competition.
The Investment Opportunity
For investors looking to increase alternative allocations via real estate, essential housing provides a stronger margin of safety than building luxury apartments because demand is driven by demographics rather than by how well the economy is performing at any given moment. Large Millennial and Gen Z populations in the U.S. already face a housing shortage, and the cost pressures constraining the supply are only going to intensify over the next few years.
By targeting the missing middle population, essential housing can reach a larger audience that is drastically underserved by the product being built today. This provides an opportunity for investors to participate in a resilient, risk-mitigated strategy, with little competing product in urban markets throughout the U.S.
Essential housing is desperately needed in both gateway markets and high growth cities and can be an appealing product for investors looking to enter those markets. Gateway markets like Los Angeles, the San Francisco/Oakland Bay Area, and New York City, for example, have experienced decades of housing challenges, and the problem is worsening. The median home price in the Bay Area has risen an inflation-adjusted 70% since 2012.1
During the worst of the COVID-19 pandemic, there was a unique opportunity for developers to enter these resilient markets at a discount. People temporarily shifted from high-density cities to lower-density areas. This short-term shift in demand for housing created buying opportunities for sites in dense markets, lowering the cost of one of the most critical inputs: land.
High-growth markets, by definition, have a high demand for housing – and that drives construction costs up even further. Cities like Charlotte and Atlanta are struggling to build enough housing, and what they do build is mostly on the luxury end of the scale and therefore unaffordable to many of their residents.
While fast growth makes entering these markets challenging, firms such as Grubb Properties can deploy techniques to drive down effective cost by sourcing land for free through its commercial division or negotiating tax abatements in exchange for moderate-priced housing, among other creative methods. This allows for a diversification of markets in an investor’s portfolio, and an opportunity to invest in some of the most resilient markets with economies and job centers that perform well even during economic downturns.