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As the affordable housing supply gets squeezed, some worry that private equity firms will scoop up more properties.
Welcome back to Route Fifty’s Public Finance Update! I’m Liz Farmer and this week, I’m taking stock of the affordable housing crisis and the role of private equity.
At a time when affordable housing is already scarce, some are worried that the problem could be further exacerbated by private equity firms and other investors managing real estate portfolios for maximum profit.
It’s a trend that took hold following the Great Recession, when vacant single-family homes were snatched up by investors who flipped them to sell or rented them out—today at a staggering profit.
“The single family home as a rental asset class … was in many ways a result of the 2008 crisis,” said R.J. McGrail, director of the Accelerating Community Investment project at the Lincoln Institute of Land Policy. “It created a rare opportunity of significant supply to make money either building [housing] portfolios from the ground up or in acquiring them. As long as there’s the ability to keep getting returns for shareholders and investors, it’s reasonable to assume they’ll continue to pursue the asset class.”
A full one-quarter of homes sold in 2021, were purchased by outside investors, and many believe their foray into this corner of the housing market has intensified the affordability crisis via higher rents, lower rates of individual homeownership and less affordable neighborhoods.
Making matters worse, an increasing number of properties that receive federal low-income housing tax credits (LIHTC) are due to age out of the nation’s affordable housing stock in the next few years. The program, established in 1987, incentivizes the development of affordable housing by reducing investors’ annual tax liability as long as the project provides affordable rents to low-income families for at least 30 years. According to a joint report by the National Low-Income Housing Coalition and the Public and Affordable Housing Research Corporation, more than 166,000 units—7% of the existing LIHTC rental stock—are at risk of becoming market-rate.
To illustrate private equity’s impact on housing affordability, take Baltimore, where 3.8% of properties sold between 2017 and 2022 were from homeowners to investors, according to data from the Center for Geospatial Solutions at the Lincoln Institute. All told, the share of home sales during that time period that were registered as owner-occupied purchases fell by 14 percentage points to 42% in 2022.
But precisely where investors are buying is even more telling. In the more well-to-do Baltimore neighborhood of Canton, 81% of homes sold in 2022 were owner-occupied sales, down slightly from 84% in 2017. Meanwhile, in the largely lower-income neighborhood just west of downtown, just 19% of sales in 2022 were registered as owner-occupied—down from 22% four years earlier.
Jeffrey Allenby, the center’s director of geospatial technology, said getting property ownership data at the neighborhood level can help policymakers see where lower-cost housing may soon disappear and plan appropriately.
“When you dig into the demographics and economics behind it,” he said, “you see areas that tend to be lower income and majority-minority disproportionately have much higher rates of investor [participation in recent sales].”
A Government Intervention
McGrail suggests that governments can play a more direct role in managing affordable housing stock.
He points to an intervention by the Port of Cincinnati, which jumped in when it got word that a portfolio of 194 single-family rental properties in and around the city were being sold by their investor-owner. The seller, Los Angeles-based Raineth Housing, was known for being delinquent on its property taxes and neglecting maintenance on its properties located in largely low- and moderate-income neighborhoods.
The port, which operates a land bank, had plenty of experience investing in the construction and renovation of single-family homes for sale. But managing rentals was a first. With the blessing of local nonprofits and technical support from the Lincoln Institute, the port secured $16 million in bond financing and was able to purchase the portfolio in 2021.
The first priority is to make the needed repairs to the occupied homes and help those tenants secure a path to homeownership. The port, said McGrail, will renovate and sell the vacant homes that are in better shape and use those proceeds for bond payments.
He believes other land banks and housing finance agencies could replicate this approach as a way to reclaim investor-owned rental properties and is currently writing a case study about the Cincinnati effort.
“We can’t just build our way out of an affordable housing crisis,” McGrail said. “There are a whole series of policy actions governments can take around production incentives, capital market incentives, tax credits and financing. It’s not just zoning and land reform.”
Where Private Equity is Helping
It’s also important to note that private equity isn’t all bad and policymakers need to know the difference, said Roy Swan, director of the Ford Foundation’s impact investing fund and a longtime real estate investor.
The Ford Foundation seeks out like-minded private equity fund managers committed to affordable housing investment. These so-called “evergreen” or “open-ended” funds function differently than the more traditional private equity funds that run on a five- to 10-year turnaround for maximum profit. Among other things, their longer timeline means that the funds target a lower, risk-free rate of return (typically around 4%). They also tend to attract institutional investors such as nonprofits and public pensions.
Swan said that at least one of the fund managers the foundation has invested with launched his private equity fund in part as a way to acquire expiring LIHTC properties and other affordable housing at risk of turning market-rate.
In general, Swan said, properties in the portfolios of these evergreen funds tend to have amenities including on-site access to health-care, services for senior citizens, after school educational programs and/or workforce training. His team also visits properties and talks with residents.
“As one of my colleagues once put it, we don’t want to finance residential buildings that are no better than self storage facilities,” Swan said. “We perform traditional investment due diligence … and spend a significant amount of time to confirm that fund managers are directing capital to quality projects that residents are proud to call home.”