Real Estate
Affordable Housing
January 15, 2023
Executive Summary
Affordable housing encompasses a variety of sectors and touches on various applications. This thesis paints a broad stroke across market dynamics defining the industry, headwinds impeding development, tailwinds driving growth, and opportunities awaiting disruptive innovation. The goal is to expand knowledge among specific applications and approaches within affordable housing by having this thesis serve as a living document of shared knowledge within the Notre Dame community.
1. Market Dynamics
Recent census data reports that more than 19 million renters are burdened by the cost of housing. Compared to baby boomers who spend roughly a third of their income on housing, millennials spend nearly half. Entry-level home construction as a percentage of total new housing is at a 50-year low.
The apartment rental industry in the U.S. was projected to have $229M in total revenue for 2022 (IBISWorld). Over 40% of renters (19 million households) are burdened by the cost of their rent, meaning they spend more than 30% of their income on housing. This results in a total market opportunity of $91.6M, without accounting for homeless individuals or those in alternative living situations.
A huge burden that has historically prevented firms from reaching these Americans has been cost. It costs almost $13M to construct an average 50-unit apartment complex. Nearly 1,800 companies seeking to solve problems related to affordable housing have raised VC financing, with a median deal size of $6.98M. In 2021, $3.08 billion was invested in 83 deals (Pitchbook).
Competitive Landscape
Many urban metropolitan areas have enacted policies that have grown the intensity of competition: rent control, affordable housing minimums, density bonuses, tax credits, and zoning permitting. Three key factors to compete within this industry:
- Relations with local housing regulators
- Building/conversion costs
- Scalability of the model - deal-by-deal basis or same model applied at scale
Primary Submarkets
Prefabricated Homes - Modular, transportable homes built off-site in a factory setting. More affordable, quicker building process, and fit into local zoning laws.
ADU Conversions - Accessory dwelling units converting existing space (garages, basements) into separate living units. Unique to each property and hard to automate at scale.
Shared Ownership Models - Owners grant equity to renters over time. Rent-to-own is the most popular form. Utilizes existing inventory, requiring no building. However, tenant rights and equity stakes are often muddy.
Stakeholders
Real estate is one of the most fragmented industries - the 50 biggest multifamily owners in the United States own just 2% of the total housing market. Stakeholders fall into two segments:
Supply Side - Landlords, investors, developers, property managers, agents, and government agencies. Concerned with capital efficiency and rent extraction.
Demand Side - Homeowners and tenants. Concerned with upward mobility and wealth accumulation via ownership.
External Market Factors
The Low-Income Housing Tax Credit (LIHTC), passed in 1986, is the only supply-side federal subsidy for affordable housing. Developers apply for the LIHTC tax credit and must develop property in line with affordable standards for at least 30 years. There have been calls to expand LIHTC, which would expand the affordable housing market.
2. Industry Headwinds
High Acquisition Costs
In real estate, capital requirements are extraordinary. The cost of land and building materials has been on the rise, making it more expensive to construct new affordable housing units. Limited availability of affordable land in desirable locations drives up costs. Regulatory or zoning restrictions make it more difficult or expensive to develop affordable housing projects.
Establishing Reputation
Real estate relies largely on trust between buyer and seller. Startups will need to establish strong reputation to maintain growth. As the industry continues to adopt technology, maintaining trust with clients can be particularly challenging.
Demographic Risks
Affordable housing is targeted at specific populations (low-income households, seniors). Changes in the size or composition of these populations can impact demand. Tenants may be more likely to experience financial hardship, leading to higher rates of rent delinquency and eviction.
Development Risks
Developing affordable housing is complex and time-consuming - zoning, regulations, permitting issues, construction delays, cost overruns, and resistance from local communities. Aging infrastructure can make supporting targeted populations difficult.
3. Industry Tailwinds
Rising Affordability Crisis
A rising percentage of Americans say housing affordability is a major problem - 49% in 2021, up from 39% in 2018. 70% of Americans said they have found it more difficult to locate affordable housing compared to their parents’ generation. HUD has seen a 13.9% decline in growth in LIHTC mortgages. Housing listings have been rapidly declining - from roughly 1.5M in October 2016 to just 408,922 in January 2022, and the median price rose 25% from Q4 2019 to Q4 2022.
Rising Interest Rates Paired with Rising Rent Prices
Rising interest rates are making mortgages less attractive. When interest rates dropped during the pandemic, people locked into great mortgages, leaving them less likely to sell. 46% of American renters spent 30% or more of their income on housing in 2020. The average rent has risen 18% over the past five years, outpacing inflation at 16%.
Government Incentives and ESG
The rising importance of environmental, social, and governance standards will likely prove to be a strong tailwind. Affordable housing is seen as a social benefit. ESG financial securities are on the rise; perhaps a new securities market could arise specific to affordable housing.
4. Investable Opportunities
The key to innovating in the affordable housing industry is being able to achieve mass production through cost-effective, sustainable methods.
Renewable Energy Integrations
Renewable energy would generate operational cost-savings for property owners and tenants while removing reliance on the energy grid. Technologies include solar panels, EV charging stations, and hydrogen fuel cells. In states like California that incentivize renewable energy, there exist tax credits programs.
Modular Housing
Modular construction takes a standardized approach: components are constructed in a factory before being shipped to the building site. This is an efficient, faster, and cost-effective way to build homes. Companies such as Cloud Apartments and Joe Gebbia’s Samara are applying this model to ADUs in California. Others are planning at scale with multi-family homes such as Rise Modular.
Shared Housing
A growing trend for younger generations driven by rise in travel, work from home, and independence. Startups focus on matching young travelers by interest and background for affordable rent in attractive cities. Notable startups include HomeRoom (YC ‘22) and Outpost Club.
Rent-to-Own Models
A rising trend among first-time homebuyers who may not be able to afford a down payment or qualify for a mortgage. Part of the monthly rent goes towards the eventual purchase. Companies like Divvy Homes are applying this to residential housing, while Adam Neumann’s Flow and Key Homes are applying it to multi-family housing.