Introduction to investing in the ‘missing middle’ and workforce housing

Freddie Mac expects this growth to continue, with multifamily loan origination volume projected to total nearly $317 billion in 2019, an increase of 3.9% year-over-year.

While many investors focus on Class A multifamily properties, investing in ‘missing middle’ and workforce housing may offer a greater opportunity for above-average returns. Simply put, the demand for this rental niche far exceeds supply. Here’s how you can benefit.

What is workforce housing?

Workforce housing is Class B and C multifamily property that caters to middle-income renters. Some link in the text HousingWire notes that about 13.5 million households currently live in workforce housing. They often rent out of necessity due to the high cost of home ownership in prime city-center locations.

Beginning investors sometimes confuse workforce housing with affordable housing, but the two are quite different. Workforce housing is best described as housing that is affordable to middle-income renters such as teachers, firefighters, and police. Some emphasis in the text in bold. The ‘missing middle’ of workforce housing provides real estate investors with an opportunity to supply what the market wants and needs.

Common characteristics of missing middle housing types include

Smaller multifamily missing middle properties can be found right next to single-family homes. They can provide investors with a higher-value niche product that caters to students, millennials who would rather rent than own, community service professionals, and empty nesters. Combined, these groups make up more than 50% of the population in the U.S.

Common characteristics of missing middle housing types include:

• Walkable location close to amenities
• Small-footprint buildings similar to single-family home sizes
• Moderate density that blends in with surrounding building types
• Simple, well-designed construction with floor plans and finishes often found in single-family residences
• Reduced number of off-street parking spaces and areas
• Some sense of community within the building and local neighborhood
• Potentially marketable for both rent and sale

Common characteristics of missing middle housing types include:

1. Walkable location close to amenities
2. Small-footprint buildings similar to single-family home sizes
3. Moderate density that blends in with surrounding building types
4. Simple, well-designed construction with floor plans and finishes often found in single-family residences
5. Reduced number of off-street parking spaces and areas

Benefits of investing in missing middle workforce housing

In The Case for Workforce Housing report, commercial real estate services and investment firm CBRE outlines the opportunity for investing in multifamily workforce housing. The report notes that over 100,000 multifamily units each year are removed from the market due to obsolescence.

#1 Vacancy rates to remain low

Vacancy rates are expected to remain low through the end of 2020, with Class B at 5.7% and Class C at 4.8%. For comparison, Class A vacancies are projected to increase to over 10% as new inventory comes online amidst a possible recession.

#2 Declining workforce housing stock

In 2009, workforce housing stock made up about 59% of the multifamily real estate market. Last year, that share had shrunk to just 52%. In fact, over the last ten years the market has lost over 140,000 Class B and C units each year due to obsolescence and conversion.

#3 Continuing higher rent growth

Rent growth in available workforce housing units has grown well above the average rate of inflation, due to decreasing supply and increasing demand. In 2018, rent growth in the workforce housing sector increased by an average of nearly 3.2%. Fannie anticipates workforce housing rents to remain strong going forward, projecting an average increase of over 2.5% through year-end.

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Middle-income workers are mostly unable to afford expensive single-family homes in urban and closer-in suburban areas. They’re effectively being priced out of the market and forced to live in less desirable far-flung suburban areas that lack nearby amenities and access to mass transit.

The ‘missing middle’ of smaller, multi-family assets offers rental property investors a unique opportunity to capitalize on the growing disconnect between supply and demand.

By and large, these happen to be the particular units that are best suited for workforce housing

By and large, these happen to be the particular units that are best suited for workforce housing. This is creating a classic case of diminishing supply vs. rising demand. While demand for housing from middle-income tenants continues to grow, supply is being permanently taken off of the market.

CBRE goes on to say that, “The redevelopment of older housing units is tremendously valuable to the multifamily sector, providing better-quality and updated units for renters. The physical improvement to the older multifamily housing stock has also made it more attractive for investors.”