For those in the SoCal/LA area, has there been any movement this year relative to ED-1 projects actually seeing activity, whether that be land sites selling, construction loans funding vertical, or similar?
The lease up play seems to be using HACLA vouchers to section 8 the entire building, where max rents in some cases exceed market rates. 300-400 square foot micro units and little to no parking. I am told HACLA max rents for studios is around 2600-2700 per month, with developers underwriting 100% Section 8 tenants all paying these max rents.
If one were to run the stabilized income/expense scenario using the max rents at 95+ percent occupancy, the ROC looks attractive even at current hard cost estimates.
So whats the counter argument to these deals happening? Shitty locations? Too aggressive to assume every tenant qualifies and uses vouchers? Lack of parking, despite the affordability component?
To begin with, I've got no experience in the SoCal market and any state/local programs are wholly foreign to me.
That being said, there are a lot of reasons people might not want to build affordable. First off, are the vouchers that easily available? Do they stick with the tenant or the unit? Not every market can achieve max rents, for what it's worth, so that might be constraining deals in some geographies.
What is the development/entitlement process like in LA? NIMBYs are notorious for opposing new development, and especially dense low income housing. I don't know the agencies out there, but in many places lease up can be extremely difficult not because of a lack of tenants, but because getting approval takes forever (for example, it takes nearly a year to lease up a newly constructed affordable housing unit in NYC, almost solely because the agencies are a mixture of understaffed and ineffective).
In LA, parking may indeed be a problem. Also, don't underestimate simple prejudice. Lots of people have a bad opinion of affordable housing and poor people in general, and there certainly are lot of bureaucratic hoops to jump through to get this stuff built which many people have neither the patience nor the knowledge for. New developers often aren't interested in deals which don't promise the possibility of huge returns, or which aren't sexy enough to brag about on the conference circuit, or any other "get rich quick, don't do much" mentality that it feels like half the new developers in any given market are interested in. For build to own guys in particular, the prospect of actually having to manage a building (vs what Rise48 or Tides or whoever do) with actual enforcement means that they can't just pass the bag that easily. For established developers, why go do something new when you've got a good thing going?
Affordable housing has been unbelievably lucrative for many, many years, and yet very few people have entered the space, so clearly there is something beyond the dollars and cents aspect which turns people off
Hi Ozy, I wanted to ask a follow up question. Why don't more people go into the development side if the fees are so high? It seems a bit too good to be true, since the dev fee is pretty much guaranteed to be paid out unless something goes majorly wrong. Why don't people at syndicators just do their own deals and make multiples of what their salary would be? I think affordable housing has an amazing value proposition, but I really don't get why more people don't get into the space. If you're able to get a LIHTC job, is the hardest part over (you're already in the industry learning the specialized knowledge that's hard to come by)? Is there something I'm missing?
Well, for one thing, there is rarely all that much back-end value. Yes, your fees can be as high as 20% of TDC (it varies state by state) but a lot of that gets deferred and you generally have very little cash flow and very little residual value at the end of the deal life.
Because being a developer and being a LIHTC syndicator are two very different jobs, very different skill sets, and very different risk tolerances. Developers still put up all sorts of guarantees, and those are just as likely to kick in as any other guarantee (completion, all the bad boys, environmental, operating deficit guarantees, etc). Not everyone is maximizing for salary at the expense of all else - some people prefer a steadier income stream of being a W2 employee, or having less risk, or just like the WLB better. Or maybe they don't think they'd make good developers!
I don't think there is a simple answer, though I happen to agree with you that it's an amazing space if you're willing to put the time in and capable of being an actual real estate owner/developer instead of just a flipper. But I can think of a few things.
- It's really niche, and requires a lot of specialized knowledge, so people feel like (a) they can't learn all that AND do other types of development or (b) feel they'll be pigeonholed once they're in that space
- There are a lot of negative connotations around it, because it's low income tenants and there is a tendency to believe they'll be more disruptive or worse than market rate tenants
- It isn't all that sexy. As I said above, half the new "developers" I see getting into real estate development seem more concerned with being known as a developer as much as actually building a sustainable business. The ability to go to the circuit of conferences and panel discussions and brag about your industrial/self storage/luxury rental empire you plan to build, all while dropping lots of buzzy words and talking about "the markets" is one that I think a lot of people put a lot of value on, despite the fact that it doesn't really mean anything. This is all my opinion, of course, but it's the same as people who post pictures of expensive-seeming vacations that they're not really on, or who take pictures in the fuselage of the fake private jet to post on social media.
- There is genuinely a ton of regulation. This makes it difficult to build and operate efficiently (read: cheaply) and means you need to actually know what you're doing to control costs - there isn't a "just don't spend money on this in Q2" option. This ties into the knowledge/experience piece, but it's intimidating to have to make sure you follow all the rules, even the obscure ones you don't know, lest it come out of your pocket
- It is political. Maybe this is less the case in other markets (I'm NYC based) but you genuinely need to have an understanding of the motivations of the public sector if you want to succeed. What do politicians want? Can you take your own ego out of it, because theirs is going to be in the way? Can you provide what your elected and community official partners want without impacting project viability? At it's most basic level, can you talk to these people? I remember sitting in a meeting where we were pitching a project and our partner was going on and on about all the money they'd made in market rate development, and all I could think was "telling the underpaid bureaucrat or the left wing elected official how much you've made isn't going to make them your friends."
- This is going to sound pejorative and like an old man yelling at the sky, but whatever. I genuinely think there is a lack of understanding of how to build a business for younger people. Everyone wants to get rich quickly, not build something sustainable that really only starts paying 5-10 years down the road, but will last for a generation. The last twenty years people have made stupid amounts of money in tech or crypto or VC for doing really not much at all, and I think that kind of lottery mentality enters the zeitgeist a little bit. Very few people seem interested in starting small and building up, in working out of a closet for a few years to get the first deal done, and then do a second, and really only start accelerating after several years. A lot of people I talk to, especially on the younger side (and you see it on WSO, too) want to start with a $150mm project, or a $250mm fund, and don't even have a good idea for what to do with it. They want something sexy, which if it goes well will net them 8 figures of carry. No one wants to work on a small affordable project that pays a couple hundred thousand of developer fee, even if there is a massive need for that and the ability to expand that into a 9 figure business in a pretty short period of time.
If you're only ever hunting for the deal that'll buy you a private island, you're probably setting yourself up for failure. For every Walker Tower deal, there are two dozen that don't hit the market perfectly
The counterarguments often center on the attractiveness of the location, assuming that all ten- ants will qualify for and use vouchers, and then there are issues of parking and unit size, which could cause problems down the road with long-term demand and tenant satisfaction.
From my understanding the ED1 entitlements are deed restricted affordable housing where you cannot use section 8 vouchers. I think the hope is that this will change and you will be able to get tenants who have section 8, but I don't think thats currently the case, and without section 8 rents, the deals don't pencil. Even with section 8 rents these are in shitty parts of town and the section 8 rents could change at any time. Section 8 tenants can chose to live wherever they want to, not eveyone wants to live in the ghetto when they dont have to because the voucher covers a lot of your rent.
Interesting, so the current law prohibits Section 8 vouchers to be overlayed on an ED-1 development?
Not overlayed, just used in general. Section 8 can be used at market rate apartments if the landlord allows them. Deed restricted apartments section 8 can't be used and tenants have to go through a specific process for approval. Rents are much lower
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