For the better part of the last two decades, urban luxury apartments have gotten the lion’s share of the real estate industry’s attention, capital, and innovation. Developers went wild with new amenities like golf simulators, dog washes, basketball courts, and even apiaries (that is a bee hive BTW) to differentiate and attract discriminating tenants. Venture investors have poured capital into residential technology companies that promised to walk tenants’ dogs, take deliveries for them, and pick up their dry cleaning. This infusion fueled an explosion of luxury residential buildings, brands, and services competing for a small segment of the residential market. Remember, only 20 percent of multifamily housing in the US is “Class A.” Those that live in anything but the top tier apartments likely saw very little innovation coming to their building.
However, despite increased focus and investment in Class A housing, Class B and C buildings (commonly known as “workforce housing”) have had lower vacancy rates since as far back as 2016. The increased need for affordable housing across the country, coupled with the COVID-19 pandemic, in which many renters of urban luxury assets left expensive hub cities, has led to a dramatic increase in vacancy and a decline in rents net of concessions in Class A buildings and have left many of those eye catching amenities to sit empty (presumably the bees have stayed though). What was once a safe asset class, deserving of extremely low cap rates and mediocre yield-on-cost targets for ground-up developments, is no longer a safe harbor in challenging economic times.
Large institutional investors are still hungry for the relatively stable risk and return profile of multifamily assets, particularly as capital flees from the commercial and retail sectors. If anything, investors are looking to put more capital into apartment projects, as it is relatively less risky than other real estate asset types. The end result has been a flood of investor capital into workforce housing. And unlike prior waves of investment in Class B and C assets, this new capital isn’t necessarily betting on the rent increases that come from renovating and re-renting units. Rather, it’s looking for a stable return with minimal risk (in real estate terminology this is called “core” or “core-plus”) with a long hold period, profiles historically associated with Class A urban multifamily.
Where capital goes, innovation is sure to follow and workforce housing offers plenty of opportunities. The PropTech boom of the past decade has yet to meaningfully touch workforce housing, partly due to a lack of lived personal experience among the tech crowd. Technology entrepreneurs, venture capitalists, and commercial property professionals are less likely to have lived in workforce housing. Entrepreneurs like to solve problems they see up-close, so they’re far more likely to address the challenges of living in single-family homes or Class A urban luxury apartments. There is also the antiquated notion that workforce housing residents don’t have access to technology like smartphones, despite the fact that as of 2019 over 81 percent of Americans owned a smartphone. The end result is venture capital-fueled innovation that addresses the small annoyances of tenants living in Related or Avalon Bay buildings, not the challenges facing residents of the 12 million workforce housing units in the United States.
This doesn’t mean we need to reinvent the wheel. Many PropTech innovations of the past decade (keyless locks, leak sensors, community management, mobile rent payment, virtual leasing) apply to workforce housing as well as Class A. The devil, of course, is in the details: per-unit pricing models that work for $4,000 per month class A apartments don’t work for $1,100 per month workforce units. The amenities and “perks” that move the needle for workforce tenants are also different than those demanded by luxury renters.
While value-add PropTech innovations are important, the “holy grail” of workforce housing is making ground-up development financially feasible. Only by building more affordable homes can we start to tackle what is becoming an affordability crisis in many major American cities. Currently, Class B and C properties trade at below replacement cost: if it costs $1 to build a new unit of workforce housing, you can buy an old one for $0.50. While increased investment interest has bid up the price of existing workforce housing assets, prices have yet to approach the levels that would make new, ground-up construction feasible in most markets without subsidies like the low-income housing tax credit (LIHTC), a federal program providing developers tax benefits in exchange for building affordable housing.
New construction technologies could be a game-changer here. New timber construction methodologies, off-site modular construction, and new building materials have the potential to bring construction costs down substantially, making it financially feasible to build market-rate workforce housing from the ground up. This would fundamentally transform the US housing market and our housing crisis.
Workforce housing presents a significant opportunity for PropTech innovators to have a positive impact on peoples’ lives. At my company, Common, we thought that it was both important and profitable to build a workforce housing management platform, to help bring PropTech innovations to workforce housing with a full-service property management offering. Ultimately, the success of new technologies and ideas will require the support of institutional owners in partnership with thoughtful managers. Ignored no longer, workforce owners and renters alike will start to see the same innovations that have become commonplace in many higher end buildings change the way they live as well.