The Luxury Housing Glut: Where High-End Multifamily Reigns Supreme, One Investor Pursues Workforce Housing

Gensler, Forge Development Partners, San Francisco

By Meghan Hall

Historically, multifamily assets have proven resilient at all stages of the market cycle, and across the country investors and developers are keen on creating new product. Gateway economies such as the San Francisco Bay Area and Seattle continue to experience rent growth and the demand for housing continues to increase. However, according to Elie Rieder, third generation owner and operator at Suffern, N.Y.-based Castle Lanterra Properties (CLP), most developers and investors are continuing to produce luxury developments, producing a glut of high-end product that continues to be less stable than market-rate or affordable multifamily properties when the market corrects.

“I think that the last few years, the majority of new construction is targeting the luxury segment for housing, and the reason for that is because the prices of land and labor have grown exponentially from 2012 to date, which makes it not economically sound to build unless the product is commanding a very high rent” said Rieder. “That’s why most new construction pricing is so high.”

Nevertheless, Rieder states that there is unprecedented demand across the country for rental product. In examining U.S. Census data from 2006 and 2016, Rieder and CLP found that the number of households in the country increased by 7.6 percent, and the number of renters —some 43 million in total — increased from 31.2 percent and 36.6 percent, one of the largest increases the United States as experienced in the last 50 years. The rising cost of homeownership, as well as a growing desire among millennials to live in walkable, transit-oriented districts, and baby boomers looking to downsize, have all increased demand for multifamily housing. Additionally, Rieder estimates hundreds of thousands of apartment units come off-line every year due to age, safety and redevelopment.

“There is unprecedented demand for rentals, primarily because there are those who want to rent for flexibility or like the amenities, the hassle-free nature or safety of the communities, whereas others cannot buy a home,” said Rieder. “They cannot get approved, or they don’t have the money for a down payment. Between the want or the necessity, a huge amount of millennials are renting.”

According to Kidder Mathews’ First Quarter Bay Area Multifamily Report, rental rates are up 3.7 percent from a year ago. In a similar report released for Seattle, the brokerage firm reported that the average asking rent rose 2.93 percent. However, construction costs in both regions are some of the highest in the country thanks to development booms in both regions, meaning that new assets rarely cater to the middle-market because investors and developers cannot get such projects to pencil.

However, CLP’s business strategy has been to exclusively focus on workforce housing; the investor owns 22 properties and roughly 7,000 units across the country in markets such as Austin, Texas, Denver, Colo., Everett, Wash., and throughout the state of New Jersey.

“So many Americans who are renting are cost burdened, meaning that they are spending more than 30 percent of their income on housing,” said Rieder. “So we try to focus on that clientele and buy communities that we can improve for the residents and community. It’s a win-win because we’re preserving affordable housing but also making money. That is our business strategy.”

A recent study produced by RentCafe, a commercial real estate blog, found that if renters were to truly live within their means in the nation’s largest markets, most would be subjected to living in units well below each city’s average apartment size. In Oakland, where the average rent is $2,684 per month, if a tenant limits their spending on rent to 30 percent of their income, they would have to live on less than 340 square feet of space. The average apartment size in Oakland is 794 square feet. San Francisco and San Jose were only slightly better. While the average rent in San Francisco is higher, at $3,607 per month, and the average apartment size is only slightly smaller than in Oakland, at 748 square feet. In San Jose, where the average rent is $2,706 per month and the average apartment size is about 885 square feet, spending 30 percent of your income on rent can get you 551 square feet.

Seattle is experiencing a similar trend. Spending 30 percent of one’s income can get tenants 479 square feet of space, whereas the average unit is roughly 698 square feet in size and the average rent is $2,045 per month.

The prices and sizes of the units in such markets highlights the need for middle-income and workforce housing.

“Workforce housing is appealing for those who don’t make enough to be able to afford luxury product, but make more than what would be considered subsidized or affordable housing,” said Rieder. “Supply and demand is showing there is a compounding and increasing need for middle class rents, and the supply is just not there.”

CLP only acquires and repositions, rather than develops, assets in an effort to make its mission to provide workforce and middle market housing feasible. In looking at investment opportunities, CLP, explained Rieder, looks both top down and bottom up, examining fundamentals such as geographical area, income growth and job diversity. Other factors such as transportation, schools and traffic, as well as how the asset has performed historically, impact whether or not CLP chooses to invest in a property. CLP also looks at new product coming online in a submarket, and evaluates how its repositioned product would compare.

“Those are all stress tests that we use when we’re analyzing a market for investment,” said Rieder. “We have a dual approach that focuses on long-term holding and cash-flowing properties but with an opportunistic flavor. Then we’re looking to reposition the properties and add value, bringing them up a notch.”

For CLP, this can mean new amenities, a new leasing center, sponsored activities and updates to the interior of the units.

Additionally, CLP chooses to focus on workforce housing because it is more stable than luxury product as the market continues to mature.

“History dictates that multifamily has been by far the most stable and predictable asset class within real estate,” said Rieder. “Part of that is because people need a roof over their heads; it is a necessity. However, middle market or workforce housing generally is very, very resilient, strong and stable because when people begin to feel the economic pinch in a recession, they’re going to be pennywise. They’re looking to save money on their rents.”

This means, continued Rieder, that Class A and luxury properties are the first to suffer in a downturn as people move from high-end properties to other offerings in an effort to save money. CLP has also found that people will not leave middle-market or workforce housing under the same circumstances, as it would mean a significant decrease in a tenant’s quality of lifestyle.

Rieder also noted the consistent performance of workforce housing means that additional investors are looking to enter the market, as well.

“The global economy, as well as investors, are realizing that it is stable,” said Rieder. “There has been more demand to invest in the space, which has made it harder to find deals that resonate because people are paying top-dollar for a lot of the multifamily product in top locations. It does make our job a little bit harder.”

CLP often finds work-arounds in order to compete, pursuing as many of a third of its deals office market and an additional third when previous properties fall out of contract. CLP’s flexibility as a small business has also helped.

“We have a reputation of integrity and fair dealing and execution, as well as liquidity,” explained Rieder. “We can move through a transaction much faster than the big brand names because we don’t have corporate protocol; there is competition, but we try to go through the side door and the back door. At the end of the day, people will always need a roof over their heads and multifamily will always be necessary.”

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