NREB | Not-So-Affordable Housing

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August/September 2017 • Volume 13, Issue 7

PHILADELPHIA HEATS UP

Retail development continues to boom across the Philadelphia metro, from Center City to South Jersey.

By Katie Sloan

T

he retail story in Philadelphia continues to be a good one to tell, according to Jacob Cooper, partner and managing director of MSC Retail. “Following the recession, we have been on a pretty consistent upswing across our economy with job growth, housing growth and population gain.

This is largely due to our relative affordability compared to New York City, Boston and Washington, D.C. It has translated into a wonderful time of steady growth and it has created a vibrant real estate development climate.”

With space becoming scarce on Walnut Street — one of Philadelphia’s premier shopping corridors — local and national retailers are expanding onto adjacent streets and into neighborhoods walkable to downtown.

This migration is transforming the retail offerings on West Chestnut Street, and the landscape in neighborhoods beyond Rittenhouse Square including Market East, Fairmount and Fishtown.

Since 2000, the population between Tasker Street and Girard Avenue in Center City has increased by 17 per-

NOT-SO-AFFORDABLE AFFORDABLE HOUSING

cent, according to the Philadelphia Retail report produced by Center City District and Central Philadelphia Development Corp. Millennials, which are entering their peak consumer spending years, represent 40 percent of the population downtown. This metric rises to 46 percent in the city’s core, driving an influx of food and beverage, wellness, value and experiential retail concepts to appeal to the millennial shopper.

“Center City Philadelphia is changing because of the growing millennial population,” says Joseph Lowry, senior vice president of leasing and acquisitions with Levin Management.

“It’s driving a lot of retailers to the area. Millennials tend to like some-

thing that’s a little different — they like fresh — and they don’t tend to frequent more traditional restaurant chains. Discount and value department stores like TJ Maxx are coming into the market, as are an influx of fastcasual restaurants. [The demographic shift] is definitely driving Center City Philadelphia in general.”

Marcus & Millichap’s Retail Research Market Report for the Philadelphia metro in second quarter 2017 notes that a steady pace of hiring in well-paying sectors is driving an increase in household incomes and fueling retail sales growth in and around Philadelphia. These improving market fundamentals are expected to mosee PHILADELPHIA page 35

Investment demand drives down cap rates and funding challenges impact development in the affordable housing sector across the Northeast.

By Joe Gose

A

lways on the lookout for new yield-producing products, commercial property investors have turned affordable housing into the latest hot alternative real estate asset. Backed by government subsidies and incentives, affordable housing investments provide the relative safety and income of a high-yield Treasury bond or net-lease investment, which is hard to pass up in the crowded field that has driven up conventional property prices.

“A lot of cash buyers and funds have come into the affordable housing market. They see it as a stable asset class,” says Heidi Burkhart, founder and president of New York-based Dane Real Estate, an affordable housing brokerage that has closed some $1.5 billion in transactions since 2008. “It’s a cool time to be in affordable housing; it’s a hot topic.”

It’s going to get hotter. Economic and cultural trends portend a shortage of the product for years to come as college debt, unpredictable job creation, high home prices, rising rents and other variables are blocking home ownsee MULTIFAMILY page 31

PREIT and Macerich are currently redeveloping The Gallery at Market East into Fashion District Philadelphia, a 730,000-square-foot center featuring retail, entertainment and dining space.

INSIDE THIS ISSUE Industrial Real Estate and the Pennsylvania Pangaea page 24

Large Transactions Invigorate the Manhattan Office Market in 2017 page 28

Greater Philadelphia Office Fundamentals Reflect Strength page 26

Maplewood Senior Living Launches Inspir Brand in Manhattan page 38

NOT-SO-AFFORDABLE AFFORDABLE HOUSING MULTIFAMILY from page 1 ership and weighing down renters, according to observers and Affordable Housing: Emerging Asset Class, Global Investment Possibilities, a report issued

by CBRE in July.

In New York City, some 54 percent of renters in 2015 were “cost-burdened,” paying more than 30 percent of their incomes for housing. By comparison, the national average of cost-burdened renters at the time was 50.6 percent, according to research released in late 2016 by ApartmentList, a San Francisco-based apartment rental marketplace. Only 38 percent of renters were considered cost-burdened in 2000.

At the same time, the National Low Income Housing Coalition’s March 2017 report, The Gap: A Shortage of Affordable Homes, found that “extremely low income” households at 30 percent or less of the area median income (AMI) faced a shortage of 7.4 million affordable housing units in 2015, which equated to a supply of only 35 units for every 100 of the households.

Similarly, only 55 units were available for every 100 households with “very low income,” or 50 percent of AMI. “Since the recession, I would say tenant demand for affordable housing has gone up tremendously,” says John Gilmore IV, a vice president with Cleveland-based KeyBank who focuses on affordable housing finance in the Northeast. “It’s hard to build affordable housing, and you can’t build enough to stay in line with demand.”

Overcoming Challenges

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affordable units. The 421-a program, which was renewed and revamped last year, provides a property tax exemption for 35 years for projects of at least 300 units that meet construction wage requirements.

“While budget cuts definitely would hurt, they’re going to create more opportunities for development to take different directions from what we’ve done in the past,” Burkhart says.

New and innovative state and loT:7.25” cal funding programs are critical to

financing new development and preservation projects, Gilmore says. That’s particularly true as affordable housing demand continues to grow among not only low-income households, but also middle and moderate-income earners such as firefighters and teachers, he and Burkhart say.

“It is becoming a national issue now, but New York and the Northeast have had affordable housing needs for decades,” adds Gilmore, who is based in New York. “We have to figure out

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Against that backdrop, concerns surrounding interest rates, rising construction prices, potential funding cuts to the U.S. Department of Housing and Urban Development (HUD), and future fiscal policies have generated caution in the space. According to the CBRE report, for example, the federal government allocates about $46 billion for affordable housing initiatives annually. One of those, the Low Income Housing Tax Credit program (LIHTC), has produced about half of the affordable units in the U.S. In the LIHTC program, a certain number of credits are allocated to states each year, and investors buy the credits to fund development, rehabilitation and preservation of affordable housing. But uncertainty over tax policy has driven down the per-credit price to between 90 cents and $1 from a high of about $1.15 late last year, so individual projects require the sale of more credits to raise the same amount of equity that would have been achieved before the slide in value, explains Alex Viorst, a principal in the affordable lending arm of PGIM Real Estate Finance, which provided funding to preserve 3,142 affordable units last year. Subsequently, fewer deals get done, he says.

Still, the situation is serving as a catalyst for developers, lenders, states and local governments to craft new solutions, says Burkhart. For example, she’s pursuing new affordable housing projects on six sites in the New York metro area after launching a development division two years ago, and equity investors are showing interest, she says. But she’ll also use New York incentive programs, such as 421-a, to build a mix of around 70 percent market-rate and 30 percent

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Northeast Real Estate Business • August/September 2017 • 31 3/1/17 12:27 PM

eled the same yield compression seen in conventional property segments, Levental explains. He estimates that cap rates for project-based Section 8 properties, which were around 10 percent to 12 percent nationally in 2011, are approaching those for Class A multifamily assets in any given submarket, or roughly 5.75 percent in New York or Northern New Jersey.

how to make the projects work, but at the same time, investors and sponsors must consider that the asset class offers a very attractive risk-adjusted return.”

In March, KeyBank’s Community Development Lending and Investment division provided $18.2 million to preserve and renovate the 46-yearold, 104-unit Martin Luther King Revitalization Apartments in Troy, N.Y. KeyBank made a $6.2 million construction loan and is investing up to $12 million in LIHTC to fund the first phase. The bank provided some $1.4 billion in affordable housing financing in 2016, and it plans to boost that to $8.8 billon over the next four years, Gilmore adds.

Cap Rate Compression

To date, growing investment demand for affordable housing has been the most pronounced in the projectbased Section 8 properties. Created in the 1970s, the program directly subsidizes landlords, which typically rent to households with extremely low and very low incomes. Only about 23,000 of those properties exist nationwide, however, and were built in the 1970s and 1980s, says Gene Levental, a managing director with SVN Affordable | Levental Realty, a Cincinnati-based brokerage that focuses on project-

Evolving Dynamics

Early in 2017, SVN Affordable | Levental Realty represented the seller of a sevenproperty, 1,009-unit Section 8 portfolio in Northern New Jersey. The deal fetched $180 million and included the 130-unit Bailey-Holt Tower in East Orange (pictured).

based Section 8 and Section 42 housing.

“You have a lot of old original developers who owned the majority of these assets, and we’re seeing new developers coming in and buying a lot of the existing inventory,” adds Jamie Renzenbrink, a senior advisor with SVN Affordable | Levental. In February the firm and Pryor Cash-

man brokered the $180 million sale of a 1,009-unit Section 8 portfolio owned

by Kline Enterprises in Northern New Jersey. “Everyone wants the guaranteed subsidy,” she continues, “and they feel like there’s strength in the federal programs despite all the talk about budget cuts.”

But the demand for affordable housing over the last several months has fu-

Traditionally, it has been common for developers who buy projectbased Section 8 properties to spend about $40,000 to $60,000 per unit on a renovation and then repeat the process, observers say. Acting as general partner, for example, a developer will find a limited partner to fund the deal by buying tax credits. The developer then operates the building with income restrictions in place for 15 years, as required by tax code. At the end of the 15-year compliance period, the developer will often buy out the existing limited partner, secure another allocation of tax credits and then syndicate the deal to a new limited partner to fund the rehab. That re-starts the clock on a new 15-year period of income restrictions.

But today, aggressive pricing has interrupted that model to the extent

continued on page 34

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32 • August/September 2017 • Northeast Real Estate Business

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NEWARK INVESTOR AIMS FOR ALTERNATIVE TO CONVENTIONAL AFFORDABLE HOUSING A Northern New Jersey investor is taking a different approach to the affordable housing niche, one that doesn’t hinge on subsidies or tax credits and the income restrictions and complexities that accompany them.

Rather, the company, Newark-based One Wall Partners, is focused on what it calls “naturally occurring affordable housing.” It’s a strategy centered on providing a cheaper alternative to New York City rental rates by building a portfolio of older stabilized apartment buildings around transit stations in revitalized Essex County neighborhoods.

After performing deep renovations, One Wall rents the apartments for rates of generally between $800 and $1,200 a month for one bedroom. On average, that’s about $1,500 less than what renters would pay in Manhattan and Brooklyn for comparable housing, states Nate Kline, chief investment officer for the seven-year-old One Wall. Thus, a hotel worker in Midtown Manhattan living in Brooklyn’s Crown Heights neighborhood can not only save money on rent by relocating to Essex County, but also shave about 20 minutes off the commute, he contends.

“There have traditionally been a lot of urban centers in Essex County that have gone through phases of being better or worse places to live, but now they’re on an upswing,” he says. “So we see our properties as a naturally occurring affordable alternative for people working in the metro area that want safe, walkable neighborhoods and access to the city by train or bus.”

Earlier this year, One Wall acquired the 44-unit 75 Prospect in Orange, N.J., a 1920s-era property. The purchase expanded its holdings to more than 20 buildings and 1,050 units. Valued at more than $100 million, the portfolio typically caters to workers in service industries, which have been creating most of the jobs in the region, Kline says. While the properties aren’t income restricted like traditional subsidized affordable housing, One Wall’s tenants include Section 8 voucher holders. HUD bases the vouchers on average fair market rental rates, which in Essex County is around $1,000 a month, he adds.

One Wall typically aims to purchase

Class B and C buildings at capitalization rates ranging from 6 percent to 8 percent. After renovations and improved efficiencies, the company typically boosts its cash-on-cash yields to upwards of 15 percent over time, he says. Key to that performance is the One Wall’s in-house management arm.

“These are management-intensive assets, both from a tenant-relations and maintenance perspective; they are traditionally older building that have not been taken care of,” Kline acknowledges. “We’re able to improve the quality of living for the residents already there and attract new residents.”

While One Wall sees potential opportunities from Washington, D.C., to Boston, it’s likely to remain focused on mining Northern New Jersey for some time. The company has identified some 200,000 properties with more than 20 units in the area that are near rail stations.

“The opportunity is still here because all of these units are cheaper than New York City apartments,” Kline says. “So they all fit our strategy of naturally occurring affordable housing.”

— Joe Gose

One Wall Partners owns 172 William Street in East Orange, New Jersey. The 17-unit apartment building features a mix of two- and three-bedroom units and is located within a 15-minute walk to the East Orange Station, which offers regular access to Penn Station in less than 30 minutes.

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KeyBank’s Community Development Lending and Investment division provided $18.2 million to preserve and renovate the 46-year-old, 104-unit Martin Luther King Revitalization Apartments in Troy, N.Y. KeyBank made a $6.2 million construction loan and is investing up to $12 million in LIHTC to fund the first phase. continued from page 32

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that some long-time industry veterans have been shut out of the final round of bids for project-based Section 8 properties, even after putting as fine a financial pencil to their offers as possible, Viorst says.

“Non-traditional affordable housing investors have cash to spend, and they’re willing to invest at a relatively low yield for Section 8 properties given the certainty of cash flow from these assets,” Viorst says. “Some of the more traditional affordable housing developers are being crowded out.

It’s overly frothy.”

The high prices also limit a developer’s ability to execute robust property renovations, and he and Gilmore maintain that preservation of the existing affordable housing stock remains essential to the market.

“There’s a risk that some buyers are doing just enough to keep the property running, and at the end of the day that may not be the best for the affordable housing space,” Viorst says. “It’s a small component of the market but something to keep an eye on.”

What’s more, the fervent demand is hastening an evolution of the projectbased Section 8 transaction structures.

A few years ago, some developers that didn’t want to wait for the 15-year compliance period to end began selling their general partnership interests in the properties after 10 years. Today, however, they’re selling those interests just a few years after rehabbing the properties, Levental and Renzenbrink say.

“Developers are trying to figure out how they can capitalize on the momentum in this market,” says Levental, whose firm is marketing 13,000 units, some of which are under contract, in 34 states. “Affordable housing is the sexiest space alive right now, and everybody wants in.” n

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