The redevelopment of vacant properties into affordable housing is an excellent means to create more affordable housing. 

Introduction 

Although COVID-19 may have separated Americans physically for the past 2 years, it has certainly brought them close together in regard to one reality. That reality is the rapidly increasing cost of housing. Covid-19 did not create the housing imbalance that exists today but it has exacerbated it. More and more Americans are finding themselves unable to afford rent without affordable housing measures such as rent control. Some estimates state that there is a shortage of nearly 7 million affordable rental homes within the United States. 

This all comes at a time in which commercial real estate and real estate development as a whole is becoming less attractive to investors. Interest rate hikes have led to massive drops in the demand for commercial real estate across all property types. Office assets have been most affected by this decrease in demand but other traditionally stable and strong asset classes such as residential and industrial have also seen dropping valuations and investor interest to varying degrees. In short, less affordable housing is being developed while more and more people need it. So what do we do about it? Well, the solution may be simpler than you think! 

What is redevelopment?

What is redevelopment? Redevelopment is an increasingly popular trend of taking vacant assets such as empty schools or office buildings and renovating them to be suitable as housing. Jack Bernhard a representative of JP Morgan Chase estimates that 25 percent of all currently available affordable housing assets were created through redevelopment. Redevelopment significantly reduces the cost of the creation of affordable housing. The initial high cost is oftentimes the most challenging aspect of successfully developing and stabilizing an affordable housing asset. Development is often heavily reliant on debt commercial deals can carry a significant amount of debt upwards of 50 percent of the whole investment. Commercial real estate loans tend to be shorter than typical mortgages and require metrics of profitability to be given financing from lenders. Typically a CRE loan will at minimum require a debt to service coverage ratio of 1.20. This means that the property must generate 120 percent operating income relative to the annual debt service, providing the asset holder with a 20 percent cushion on their payments against a downturn in revenue. Debt yields are also highly influential in a lender’s willingness to lend towards an asset or development and target debt yields are at a minimum typically 10 percent. This metric is obtained by dividing your yearly net operating income by the total loan amount. In addition to all of this, the shorter time horizon of CRE loans means that the loans often feature balloon payments meaning a bulk of the loan is repaid as the final payment. This means the asset holder refinances or obtains new sources of debt or sells the asset. All of these challenges are dramatically reduced when you have an asset that needs to be renovated rather than built from the ground up. They become even more mitigated when you introduce tax credit programs such as LIHTC or HTC. With all of these risk mitigating benefits, it comes as no surprise that firms such as JP Morgan Chase prioritize redevelopments when it comes to affordable housing. 

A collective effort

Pension funds have recently been investing out of commercial real estate, but an increased use of redevelopment to create affordable housing may just draw them back in. The past 2 years have seen an increase in investor interest in housing. A notable example is Blackstone’s pioneering of single-family rental assets. As a part of this investing strategy, the firm has dedicated 1 billion dollars in a partnership with rent to own to create 4000 single-family affordable housing homes across the next 2 years. This sounds great on paper, but it ignores the 6 billion Blackstone on single-family assets they intend to raise the cost of. It also is a significant amount but far off the estimated 6.8 million affordable homes we need. Blackstone has also significantly scaled back their commercial real estate operations throughout the course of the year. All in all their approach to affordable housing is not exactly stable. For pension funds stability is key. A great way to generate stability is by investing in less risky assets which affordable housing traditionally has been. As discussed earlier redevelopment reduces the initial risk with affordable housing and would mean that pension funds could begin increasingly investing in the communities of the workers they support. For a teacher’s pension fund in Ohio, it makes a lot of sense to invest in the redevelopment of an old school into affordable housing. You are not only helping the student’s teachers teach to find a safe and comfortable place to sleep at night, but you are also providing their communities with economic development that can have a cascading positive effect that leds to the lives of everyone being improved. While the pension is also generating an ROI that will help teachers be able to retire. The proof of benefit of this model has already been proven via the use of redevelopment by the Califonia teachers pension fund to create affordable housing in the city of Sacramento.      

Drawbacks

Covid-19 has led to a decrease in the use of office space across America. This has led to millions of square feet of rentable space remaining empty across the nation. This has affected all cities big and small to varying degrees. 2 cities that have been hit particularly hard by this are San Fransico and New York City. San Fransico is heavily reliant on tech leasing. As tech firms have been increasingly adopting the WFH model it has left investors with the belief that the risk of a real estate collapse within San Francisco is high. The same can be said to a lesser degree for New York City. New York City’s third avenue has been seeing decreases in office occupancy since before the covid-19 pandemic. This has notably affected third avenue where you can now see dozens of mostly empty inefficient office buildings. So why aren’t they being redeveloped? Well, it is too expensive. Modern office assets especially those of 3rd avenue are not conducive to being coveted to housing and would require a lot of financial commitment to be potentially converted. The second problem lies with that of zoning. Both San Fransico and New York City implement strict zoning laws which means that without the cities changing zoning, a costly producer no redevelopment into housing would be financially feasible. Cities also have incentives not to change the zoning laws as they are often heavily reliant on the tax revenue that office assets generate. Affordable housing or even housing in general would not generate nearly the same amount of revenue. In order for these conversions to take place in the first place they would still need to take advantage of tax credit programs funded federally and at a local level essentially meaning that governments would have to spend money to ensure that make less money. However, there still is an argument to be made for the redevelopment of these buildings into affordable housing. As it currently stands both cities are currently receiving tax payments from a large amount of these empty buildings but that can’t last forever. Redevelopment of these assets would be an opportunity to introduce affordable housing while also converting the assets into usable retail of industrial space. The positive public perception of creating affordable housing may allow for governments to embrace the cost of redeveloping while also allowing for other revenue streams such as industrial storage space to be introduced to these assets to bring in some revenue.   

Conclusion 

Redevelopment may not be a perfect solution and may still introduce costs to the taxpayer in a large number of cases, it still is the best solution we have to create more affordable housing. As more developers take advantage of redevelopment the costs associated with the effort are likely to continue to decrease.