Impact Investors Should Think Twice Before Investing in NOAH
Investments in Regulated Affordable Housing offer Both Impact & Attractive Risk-adjusted Returns to Investors
There are currently 21 million Americans that are considered “cost burdened” or “severely cost burdened” by their shelter expenses. While this statistic includes those such as young professionals living in high cost of living cities, this article will focus on those families that are forced to make a tradeoff between paying rent and covering other essential expenses.
Families making that impossible choice can be thought of as the bottom of the housing crisis pyramid. For the purposes of this article we define the bottom of the pyramid as those making below 80% of area median income (AMI). In the world of affordable housing, AMI percentages and income levels mask the underlying beneficiaries. A helpful graphic below illustrates the types of people that fall within each range in San Francisco:
The most pressing need in the housing affordability crisis is addressing the supply of housing that is affordable to those at the bottom of the pyramid. Indeed, the data supports that the need for affordable housing is greatest for low-income people.
And yet, a popular trend is developing in impact investing, targeting the middle of the pyramid, also known as the “missing middle” (those making at or above 100% of AMI). Missing middle investments are typically made in “naturally occurring affordable housing” (NOAH) rental properties or “workforce housing,” which do not receive federal subsidies and are therefore unregulated by government entities or LURAs. What’s more, investors in NOAH or workforce projects have no recourse if managers raise rents above what is affordable for the intended beneficiaries. There are no “guardrails” for affordability in non-regulated product unless investors are sophisticated enough to demand them from the outset. Missing middle investments don’t target those most in need of affordable housing and generate only modestly higher returns than comparable investments made in federally regulated affordable housing.
In this article, we examine the trend of investing in NOAH and argue that impact capital is better used by scaling regulated affordable housing programs such as Section 8 and LIHTC.
Regulated Affordable Housing: Lower Impact Risk with Strong Risk Adjusted Returns
Investing in regulated affordable housing can be daunting because it requires expert knowledge of the complex and intersecting world of affordable housing policies. However, investing in this space also provides the opportunity for added social impact and superior risk-adjusted returns and, therefore, shouldn’t be overlooked.
To illustrate, we examine Section 8 housing vouchers in California. Currently around 30% of Section 8 vouchers issued in the state expire unused simply due to a lack of landlords that will accept them.[2] Nationally, 41% of voucher recipients were unsuccessful in using their vouchers in 2003.[3] This administrative shortfall is where impact investors can make a world of difference.
For example, there are opportunities for impact investors to partner with professional property management companies that have the expertise and person-power to support the additional regulatory burden associated with accepting Section 8 vouchers. Increasing the number of units that voucher-holders can apply for would yield social benefits by reducing the number of vouchers that went unused and increasing the number of families in stable housing, all without changing state allocations to the program.
More broadly, Section 8 and LIHTC are both proven models, with low correlation to the business cycle and attractive risk-adjusted returns. As an asset class, regulated affordable housing has high barriers to entry, tax-efficient returns, access to low-cost leverage and, in many cases, federally or supranationally guaranteed revenues.
While some investors view the returns from regulated affordable housing as concessionary, they fail to consider the relatively lower risk of such investments. For example, an apartment building with 100% occupancy by Section 8 voucher holders has approximately 70% of its revenues guaranteed by the federal government, which has never missed a payment under the program, even during government shutdowns. Regulated affordable housing can therefore be viewed as a defensive asset class, and its returns reflect this fact.
The impact case for investments in regulated affordable housing is also compelling. Regulated affordable housing, unlike NOAH, provides guardrails for affordability because it imposes consequences on landlords if they boost rents above affordable levels, thereby guaranteeing stability for tenants and allowing them to budget more reliably.
Conclusions and Takeaways
While some advocate for reimagining the current federal housing ecosystem, there is space for impact investors to help make the current system more efficient.
In our view, impact investors can have the most impact by scaling the number of regulated affordable housing units and by ensuring that any unregulated investments in affordable housing address the needs of the bottom of the pyramid.
At the same time, the climate crisis and other socioeconomic issues need to be addressed. Solving affordability does nothing if it further dooms those renters to a future of an unlivable climate or keeps them in the cycle that left them cost burdened in the first place.
Contributing to solutions for the affordability crisis, economic inequality and climate change in one investment seems daunting, but Align has developed a best in class approach to investing in affordable housing that ensures each issues is addressed and prioritized accordingly. We use a simple framework to determine the most impactful investments in this space by looking for opportunities that:
1. Preserve the supply of affordable housing that currently exists
2. Add to the supply of affordable housing preferably by utilizing existing infrastructure
3. Prioritize serving the lowest income households
4. Address the underlying socioeconomic factors that lead to renters becoming cost burdened by provisioning social programs, wrap around services and ideally, offering a pathway to tenant ownership
5. Contend with the climate crisis
While there are creative non-regulated solutions that are hitting the market and are worthy of consideration, impact investors should think twice before allocating money to NOAH or other non-regulated affordable housing investments.
Investments in regulated affordable housing may require additional expertise, but they support those most in need of assistance and offer attractive risk-adjusted returns to investors.
Reach out to Align today to read our primer on affordable housing and see how we can help you navigate the complex world of affordable housing investments!
[1] https://www.camoinassociates.com/resources/humanizing-data-area-median-income-ami-and-affordable-housing-policy/
[2] Additionally, 1.2 million LIHTC units are set to lose their affordability by 2029. https://preservationdatabase.org/wp-content/uploads/2021/10/NHPD_2021Report.pdf https://www.ocregister.com/2019/09/04/thousands-of-california-renters-with-section-8-vouchers-cant-use-them-what-lawmakers-are-doing-about-it/
[3] Congressional Testimony of Margery Austin Turner, Director, Metropolitan Housing and Communities Policy Center, The Urban Institute, prepared for the Committee on Financial Services, Subcommittee on Housing and Community Opportunity, United States House of Representatives, June 17, 2003. & https://www.huduser.gov/portal/publications/pubasst/sec8success.html