Developers build market-rate units that lease for less.
Since the end of the Great Recession, the hallmark of this apartment cycle has been luxury units, usually located within the urban core, with a slew of amenities including roof-top patios, chill-out lounges in the lobby and a doggie spa wash in the back of house.
Of course, those kinds of communities don’t come cheap, to develop or to lease. The $300,000 per-unit development cost this cycle has been justified by the ability to push rents that have gone through the roof as well. In many markets today, $2,500 a month just gets you in the door. Larger units command $3,000 and up. In cities like New York and Philadelphia, you can live in the newest, most luxe digs for a cool $5,000 to $7,000 a month.
The result has been an attainable housing scourge like no other: 49.7 percent of American renters are now classified as “cost burdened”—meaning more than 30 percent of their income goes to rent—according to the latest data from the U.S. Census Bureau’s American Community Survey. Nearly 300,000 renters were added to those ranks in 2018 alone, the latest period for which data is available.
But a funny thing happened on the way to the apex of the housing crisis in 2019: For-profit apartment developers started to produce more “attainable” or “workforce” housing apartments that lease out for less. Generally targeted at residents making 60 to 120 percent of Area Media Income (AMI), they’ve been developing these communities without using government subsidies.
Why? Because with that many cost-burdened renters—more than 20 million households nationally—that’s where the overwhelming majority of demand is today.
“Developers build based on what we know and whatever’s hot in the market at that point,” says Henry Torres, President of the Coral Gables, Fla.-based Astor Companies. “Right now, attainable housing is hot.”
For Kevin Smith, Senior Vice President of Development for Northern California at Chicago-based 29th St. Capital, which is currently developing 444 workforce units in Sacramento, the rise of ground-up attainable housing projects has emerged to fill the market vacuum left by the singular focus on luxury to date.
“There have been so many higher-end communities built in A++ locations that appeal to the upper echelon of millennials who have the income to support it,” Smith says. “What’s been missing are apartments that are much more tangibly priced for the meat of the market, the people who are maybe radiology techs or phlebotomists at the local hospital, or young couples who together have reasonable starting salaries.”
Big and small strategies for attainable housing
Developers are building ground-up, obtainable apartments today with a variety of strategies, from smaller units at smaller properties that keep per-door costs and lease-up risk down, to larger developments with higher unit numbers aimed at a broader segment of the population to gain economies of scale. They’re going in eyes wide open to only make land deals where they make sense, and on lots that can either accommodate surface parking, or where municipalities will give them abatements on parking ratios. In some cases—but not all—they’re scaling back on amenities and finishes.
Developers also are standardizing designs as much as possible to gain efficiencies with their general contractors, and buying materials and components in bulk via national purchasing programs to keep costs in check. Finally, while they’re not taking government money and all the strings attached to it, they are taking advantage of federal Opportunity Zones, as well as local entitlement allowances and waived impact fees designed to entice the development of attainable housing.
Filling the gap between affordable and luxury
“Workforce gives market-rate developers a unique opportunity in the marketplace today,” says Kyle Bach, CEO of Annex Group based in Indianapolis, which develops affordable and student housing communities, and has taken note of an increasing number of market-rate developers targeting workforce housing today. “It lets them fill the gap between affordable housing [targeted at residents who make below 60 percent of AMI] and luxury apartments.”
Building type and parking are the two most important factors for making these types of deals work. “To trim construction budgets, developers are looking for opportunities to build walk-up style products that offer surface parking,” Bach says. “This allows them to use cost-effective materials, such as wood-frame versus steel or concrete, while avoiding the construction of a parking structure.”
He also sees developers using uniform designs, finishes and in-unit amenities across multiple developments to gain buying power from purchasing in bulk. “In some cases, it makes sense to offer a universal product in all communities nationwide to help reduce overall cost associated with a new build,” Bach says.
“Prototypical” designs nationwide
That’s the approach taken by Milwaukee-based Continental Properties, a developer of 23,000 units. Currently, 57 percent of the firm’s portfolio units, branded as “The Springs,” are attainable to renters making 80 percent of AMI in its markets across Arizona, Texas, Denver, Minneapolis, Michigan, the Ohio Valley, the Carolinas and Florida.
The firm uses what it calls a “prototypical product,” based on a garden-style, two-story design with direct access to most units, which eliminates the need to build and maintain non-rentable space in corridors and breezeways. While elevations may vary across different regions, the guts of the communities remain the same.
“We build the same base product in all of our markets,” says Continental CEO Jim Schloemer, who co-founded the firm in 1979. “We will change the exterior or skin to match the geography, so you might have a Rocky Mountain style in Denver, more of a Southwest style in Phoenix and a Carolina Low Country in Charleston. We make modifications to the exterior materials, but we use the same building prototype in all of our markets.”
Doing so helps the firm leverage its buying power with suppliers nationally. “We know a year in advance exactly how many plumbing fixtures of a particular type we need, and we know the kitchen cabinetry, because it’s all designed to be the same in all of our communities,” Schloemer says.
That approach also enables the builders Continental works with to attain velocity, much as single-family builders do when knocking out the same design over and over again in a suburban subdivision.
“The biggest efficiency comes from repeat construction by our general contractors and their subcontractor base,” Schloemer says. “If we’re on our fifth community in suburban Minneapolis right now, many of those subcontractors have built this product multiple times. They have a very good handle on what their costs will be and how they can most efficiently and productively complete their tasks. And that tends to create cost efficiencies.”
Yet, as important as that repeatable process is to Continental’s business, it’s still not as important as finding the right piece of land to build on. “We typically build around 15 units to the acre, so we need 20 acres of land to get to a 300-unit community,” Schloemer says. “If the site doesn’t accommodate your prototypical plan, you either have to deviate from that plan or reject the site. And we do the latter. We don’t deviate from our prototypical plan.”
Looking for entitlements that enable attainable deals
Land and the easing of entitlements connected to it were major factors for Torres and Astor Companies’ latest project in Miami. Called Douglas Enclave, the 199-unit, 10-story building will have 20 percent of its units fall into the affordable category (for residents making less than 60 percent of AMI), with the remaining 80 percent tailored toward workforce housing (defined here as an AMI of 60 to 140 percent). A $2 million impact fee waiver, as well as an entitlement deal with the city that doubled the project’s density, will help it pencil out without using government money.
“It’s good for the community, because it provides more attainable units,” Torres says. “But on the developer side, it’s good for us because our cost-per-unit goes down, so we can actually put these units out there.”
His parking requirements also were halved, because the building is in a transit-oriented zone, which saved even more. All in, land development costs were around $30,000 per unit, half of what he would expect to pay in Miami for a straight, market-rate deal. “When you multiply that by 200 units, that’s $6 million,” Torres says. “That’s a real impact for the building.”
Inside the units themselves, using materials that require less labor—vinyl floors and fiberglass shower stall inserts instead of tile, for example—allowed Torres to whittle down the numbers even more.
“Vinyl flooring takes about half the time to install in an apartment, versus trying to do marble or porcelain tile,” Torres says. “So, what you try to do is build with less labor-intensive materials. You can save on materials, too, but labor is where you save real money, and time. The sooner you get it done, the better off you are.”
Torres says returns on Douglas Enclave will be in the 20 to 25 percent range, versus the 30 to 35 percent he’d see on a typical luxury market rate housing deal. But his risk is also lower.
“At the end of the day, these attainable housing projects reduce your risk,” Torres says. “You know you’re going to be successful, because the size of your target market is so much larger.”
Targeting a big market with units on the smaller side
Others are finding a niche building attainable apartments by going small—micro, in fact. Take Michael Zaransky, Managing Principal at Northbrook, Ill.-based MZ Capital Partners, a developer of $150 million in assets, which is launching the Vantage at Naperville, a 112-unit community of micro units as small as 380 square feet.
“There’s not a lot of magic to it,” says Zaransky, who estimates his per-unit development cost on the project at $130,000 a door. “It works because of the square footage. It’s about half the cost of a traditional building. An 800-square-foot unit would cost double.”
Zaransky decided to start focusing on micro units when he was priced out of the market himself. After being a seller of assets during the last several years, he was looking to buy replacement properties closer in, but couldn’t do so at a cap rate that penciled out.
“The problem I saw in cities all across America was a lack of attainable housing for even a middle-income person to be able to afford to live,” Zaransky says. “It’s just hard to deliver units at an attainable rent level.”
With rents less than $1,000 for individuals making down to 60 percent of AMI, what makes the project work is the deal he got on the land—he bought and razed a dilapidated hotel for the site—and the broad base of the market, since 40 percent of Naperville’s population is currently considered rent-burdened.
“‘Micro unit’ has become a fancy name for what we used to call plain old studios,” says Zaransky, a third-generation developer. “They’re always the most in-demand apartments because they attract people looking for a low-price entry point.”
They’ll be attainable for individuals making $36,000 or more per year. Like other developers, Zaransky says the fact that he can stick build—Vantage is three stories—and provide surface parking helped the project pencil out. But he says he’s not cutting back on materials or amenities to make it work.
For instance, interiors feature laminate flooring, granite countertops, full-sized appliances and high-end cabinets, “but you don’t need many of them, because the units are smaller,” says Zaransky. Corridors are also downsized to increase the percentage of leasable space. And in the common areas, Zaransky says he’ll provide a state-of-the-art fitness center to help eliminate the need for gym membership, as well as plenty of common area lounge and co-working type spaces, both inside and outside the building.
“Because of the unit size, they tend to also live in the amenity space,” Zaransky says. “We’ll have outdoor fire pits and barbeques and larger kitchens inside the common area.”
Zaransky plans to use the Vantage as a pilot and then launch it in other markets where he’s active, including Tennessee and Texas. He says finding investors has been relatively easy, because his vacancy risk is muted compared to the competition.
“The key is it’s going to fill,” Zaransky says. “There’s just such a demand for it that the numbers are going to work. It’s easy to explain, because everybody knows somebody who can’t afford the rent. So, the market’s there, and there’s a lot less concern on both the debt and the equity side about competing with other projects.”
But somewhat ironically, he also says a final factor that’s needed to make the micro-unit model work is a market that’s already saturated with high rents.
“What you really need to make this work is a high rent community, in order for these to be priced below the market for traditional sized units,” Zaransky says. “I don’t think this would work in a location with moderate rents.”
Lucky for him, finding high rent markets in the current environment shouldn’t be too much of a stretch.
Building attainable apartments at scale
That kind of dynamic—pricing something that’s more affordable than the surrounding area, but at a rate that’s still high enough to turn a profit—is certainly in play at Sacramento’s Broadway Apartments. There, the 444 one- and two-bedroom apartments of 550 to 900 square feet are located within the Mill at Broadway master planned community, as well as a federally designated Opportunity Zone. They will lease out for about 15 percent less than comparable units in Sacramento’s nearby tony Midtown area, where rents start in the low $2,000s and quickly approach $3,000 a month.
“It made economic sense to build smaller, well-designed units that could be leased at a more attainable price,” Smith says. “This is a market opportunity to build at scale in an A-minus location that’s bikeable, but not walkable, to the central city.”
The community will be situated on a nine-acre parcel that was home to an old mill south of Broadway and east of the I-5 freeway. Broadway Apartments residents will be within minutes of Sacramento’s recently revitalized downtown, anchored by the new Golden 1 Center, home to the NBA’s Sacramento Kings and a venue that’s hosted A-list performers from Kanye West to Paul McCartney, Lady Gaga and Blake Shelton.
Units will still have higher-end finishes, such as quartz countertops and islands in the kitchens, but at three stories will be stick built and will feature surface parking. Two factors figured heavily into the project’s feasibility: the fact that entitlements were already in place via the master planned community, and the competitive edge its Opportunity Zone status gives investors.
Since capital gains taxes are eliminated for investors who commit to holding for a 10-year period—which can dramatically increase the overall return on a successful investment—Smith says he’s been able to talk about both the outsized demand of lower-rent units in the city as well as the boost in returns his backers can achieve on an after-tax basis.
“It’s a situation where there’s been a skewing for so long toward the Lexus and Mercedes side of the market, that there’s now a recognition of the lack of production on the Ford and Toyota side of things. That’s just created a lot of pent up demand,” Smith says. “Then, in terms of getting capital from people and institutions that always have multiple opportunities in front of them, the Opportunity Zone provides some another level of competitiveness for new construction in older areas of town which hadn’t been there.”
For developers across the country, it all translates into a bankable strategy that’s easy to sell: Apartments that are truly attainable to the masses.