At Atlas, we focus primarily on acquiring value-add workforce housing. A big part of our investment thesis is that you can’t build new middle-income housing, so supply is capped while the demand for high-quality middle-income housing keeps growing. This is just a fact accepted by most real estate operators and as a result, capital has poured into workforce housing, cap rates have compressed, and returns are squeezed.
Few understand the dynamics at play which make it nearly impossible to build much-needed middle-income housing today.
To better understand why we aren’t building middle-income housing, I recommend this post from Shelterforce. To summarize, restrictive zoning, NIMBYism, and high construction costs force developers to focus on the luxury sector, where rents justify the cost of new development. Let’s dig in a bit deeper.
- Land is constrained and the number of projects a developer can work on at any one time is capped. As a result, developers focus on projects with the highest margins. This tends to be in the niche luxury market.
- Rents in many areas don’t support new development, even if the land was free. See this diagram from ULI showing which areas of Portland can support new development. As a result, we only invest in areas that are wealthy or becoming wealthy.
- Many aspects of the cost of construction are beyond our control (material costs, land costs, developer profits, wages), however, the costs associated with local land use and building codes are significant and can be reduced. I’m seeing this firsthand with our new development in Nashville. Not all regulation is bad, but we need to separate the ‘good and necessary from the bad and discriminatory’.
- NIMBYism is a major challenge to contend with. Homeowners want to maintain the value of their property, the availability of parking and care about the aesthetic quality of other buildings in their community.
Creating an environment where developers can build new middle-income housing is difficult, but not impossible. Several things need to happen.
We need to plan and zone for economically diverse neighborhoods, which means we need to allow different quality standards in different neighborhoods. It’s not a one-size-fits-all approach. We can’t force developers to be constrained to ‘upscale’ design standards in a neighborhood designed for working class consumers. If we designate areas as ‘affordable’ we can curate the regulation to enable developers to build more affordably.
We need to change zoning to allow for more dense housing. In many communities including Minneapolis, LA, and Seattle many single-family lots have been up-zoned to allow for multifamily development. This is a step in the right direction, but building boutique, affordable multifamily buildings on these sites still isn’t feasible today due to regulatory costs and time it takes to construct.
We need continued innovation. Prefab construction, vertical integration of the supply chain, and construction automation have long promised to bring costs down. While the interest and use of prefab and modular construction is growing, we’ve yet to see widespread adoption. This is due to a combination of factors including a public image problem, the stodginess of the construction business, and a shortage of prefabrication facilities. New innovative housing models such as ‘Apt’ promise to make small-scale multifamily development affordable by standardizing the pre-development and construction process. We need to continue to explore the idea of making buildings ‘permanent’, allowing for easy future upgrades or for buildings to be disassembled and reusable.
It’s nearly impossible to build affordable, middle-income housing today for a myriad of reasons, but I believe this is going to change. The need and potential rewards are so great that it must and will happen.
Have you seen any innovative models focused on building middle-income housing?