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Cascade: No. 95, Spring 2017

Capital for Communities: Preserving Affordable Rental Housing Through a Nonprofit Real Estate Investment Trust*

Housing affordability is essential for neighborhood revitalization and social and economic mobility alike, but affordable housing units continue to be limited as demand for them climbs. In cities throughout the country, including Philadelphia, market forces in gentrifying neighborhoods place the affordability of many housing units at risk. This article will explore the Housing Partnership Equity Trust (HPET), a nonprofit real estate investment trust (REIT) that utilizes private capital to acquire, preserve, and improve affordable rental housing units across the country.

The Need for Preservation

Research from the Federal Reserve Bank of Philadelphia has shown that gentrification can lead to the loss of low-cost housing units, leaving low- and moderate-income city residents with limited options in terms of available affordable housing. Not only do market rate rents increase as neighborhoods gentrify, but many subsidized units have time-limited affordability restrictions that will soon expire.1 Though some of these units are owned by mission-driven property owners who will likely retain the affordability of units, some are owned by profit-driven property owners who may sell the properties or increase rents in order to reap the benefits of real estate appreciation, possibly leading to the displacement of many long-time residents who would be priced out of the market.

Rental development in Aurora, IL.
Photo credit: Housing Partnership Equity Trust.

Nonprofit affordable housing developers struggle to compete with profit-driven developers to acquire these units. They are also finding it too expensive to develop new affordable housing in these areas. Additionally, the Low-Income Housing Tax Credit, which provides equity for low-income housing developers by encouraging private investment with tax credits, may soon become less favorable to investors if certain anticipated changes to the tax code occur under the new federal administration. The future is also uncertain for other federal housing programs that provide resources to organizations that build and maintain affordable housing.

Housing Partnership Equity Trust

Given these circumstances, it is worth exploring financing mechanisms for preserving affordable rental housing that are less reliant on public subsidy. One such example is HPET. The Housing Partnership Network (HPN), a Boston-based membership organization of more than 100 housing and community development nonprofits throughout the country, launched HPET in 2013 in response to the challenges many housing organizations were facing in preserving affordable rental housing. HPET was established as a REIT, a financing structure that, although unique for nonprofit housing developers, is a commonly used vehicle in traditional capital markets. Some 192 REITs trade on the New York Stock Exchange, with equity market capitalization equal to $941.7 billion.2 HPET is not publicly traded and is only the second mission-oriented and the first nonprofit-sponsored and controlled REIT.3, 4

Real Estate Investment Trust (REIT)

A REIT combines the capital of many investors to acquire or finance income-producing real estate. Similar to a mutual fund, a REIT allows investors to benefit from a diversified portfolio, regular income streams, and long-term capital appreciation. Through a REIT, investors own shares of large-scale properties. A REIT typically pays out all of its taxable income as dividends to shareholders, who then pay income taxes on those dividends.

For more information, see “What Is a REIT?” at www.reit.com/investing/reit-basics/what-reit.

HPN served as the sponsor of HPET, with 12 initial members that made capital contributions and share collaborative management and ownership. Two additional members subsequently joined. Each member invested an initial $200,000, while HPN invested $400,000. HPET’s 14 members include some of the leading nonprofit affordable housing developers and operators across the country, which have combined portfolios of more than $8 billion and employ more than 3,900 real estate professionals in 41 markets. HPET has a staff of seven, a management team with more than 50 years of multifamily housing experience, and a board of experts from the affordable housing and impact investing industries.

The structure of the REIT includes a scalable operating platform from which HPET’s acquisition team of developers, composed of the 14 HPET members,5 can monitor potential deals constantly. Rebecca Regan, executive vice president of HPN, said that HPET’s structure enables its members to “act with the same speed and flexibility as for-profit buyers looking to purchase rental properties and quickly bid on properties without needing to first assemble complex financing packages.” The cost-effective capital that enables HPET to do this is raised by institutional investors motivated by both financial and social returns on their investments. These investors include foundations such as MacArthur and Ford, and financial institutions such as Prudential, Citibank, and Morgan Stanley. To date, HPET has raised more than $150 million and has a current portfolio of 2,605 units totaling $244 million in acquisition value.

Note: HPET member names indicate the member serving as the property manager for the HPET portfolio property.
Source: Housing Partnership Network.

The units in HPET’s portfolio of multifamily rental housing properties are not subsidized or deed-restricted affordable housing. Rather, they are housing units with a regular rental rate that is affordable to someone earning 60 to 80 percent of the area medium income.

A key component of the HPET approach is to strategically acquire properties that are in close proximity to job opportunities, quality schools, adequate transportation, and other community amenities that allow families and individuals to thrive. Properties are typically located in gentrifying neighborhoods and are often in need of significant renovations. HPET strives to increase cash flow through tax abatements, energy improvements, and other operating efficiencies and enhancements without increasing rent for residents. HPET also achieves financial returns by making strategic investments in portfolio properties that improve resident satisfaction, decrease operating costs, and reduce tenant turnover.

Tenant and Property Characteristics Generally Adhered to by HPET Investments

Tenant Profile

Employment status

Hourly, salaried, or part-time workers

Income range

$20,000 to $80,000 per year

Typical employment

Retail, construction, service sector

Average family size

Two to four members per household

Key challenges

Transportation, job stability, family budget

Rent payments

$750 to $1,350 per month

Property Profile

Location

Proximal to employment, transit, schools, community amenities

Unit mix

One, two, and three bedrooms

Number of units

30 to 418 units (217 average)

Acquisition costs

$7 million to $60 million

Economic occupancy* at acquisition

79% to 99%

Economic occupancy* at stabilization

92% to 99%

Monthly rent per unit at acquisition

$627 to $1,316 ($962 average)

Monthly rent per unit at stabilization

$546 to $1,484 ($967 average)

Community facilities

Community room, leasing office, fitness center, pool

* “Economic occupancy” is total possible revenue less vacancy loss as a percentage of total possible revenue.
Source: Housing Partnership Network

Third District Implications and Further Considerations

Although HPET’s portfolio does not currently have any properties in the Third District, there are opportunities to expand in this region. HPN’s goal is not to have others replicate HPET but rather to broaden its portfolio to include properties in additional geographic areas through current members or the addition of new members. There is an opportunity to grow the number of HPN members involved, as needed, although it would only be appropriate for experienced partners with the proper skills and resources. Contributing members of HPET are responsible for managing capital and properties on behalf of sophisticated institutional investors, and thus underwriting needs to mimic that of a public REIT with extensive due diligence and presentations to established investment committees. In fact, since HPET is a mission-driven investment vehicle, both the impact and economic viability of investments need to be underwritten, requiring additional skills than would be needed in a typical REIT (i.e., simply underwriting for financial return without consideration of social and environmental impact). Additionally, all HPET contributing members must be financially stable and reliable in the event of a capital call requiring additional resources.

Lessons Learned

HPET has found that attracting large amounts of capital is imperative since small investments are often too difficult, expensive, and time consuming to be worthwhile. Also, HPET has found that its nonprofit ownership is attractive to socially minded investors. In addition, the cooperative ownership model and the ability to learn from best practices among members improve the property management expertise and enhance the opportunity to create operational savings when compared with a typical REIT.

Since HPET is not publicly traded or rated, its biggest current challenge is creating mechanisms to provide investors confidence in the liquidity of their shares, Regan said. She explained: “We want to hold and operate the properties as affordable housing for the long term. We are not a closed-end fund; our mission is not to liquidate assets on a predetermined date, so it is difficult to show investors how they will sell shares at a specific point on the investment horizon. With a liquidity vehicle or guaranty, they would be able to demonstrate the ability to redeem their investment without actually redeeming it, addressing the most challenging issue in underwriting and allowing the investment to move through the underwriting process.” Credit enhancements from banks or grants from foundations could unlock additional institutional capital by allowing investors to underwrite the liquidity risk. This could potentially lead to increased investment from donor-advised funds or impact investing platforms, said Regan.

HPET is not the only community development finance vehicle that has this need, however. “Lack of liquidity is a common problem in many U.S.-based community development investment opportunities, inhibiting new capital from entering our industry,” Regan said. If this problem could be addressed strategically, Regan believes that significantly more capital could support community development efforts such as affordable housing preservation.

Conclusion

Housing affordability remains a foundational component of neighborhood vitality and household financial stability, although the supply of affordable housing is decreasing in certain areas throughout the country. It is important to consider ways in which private capital can be utilized to support the sustainability of community development efforts and preservation of affordable housing. HPET provides an opportunity for expansion into the Third District states of Pennsylvania, New Jersey, and Delaware, as well as a model for banks, foundations, and developers in the Third District interested in exploring replication. The broader need for liquidity in nonpublic community development finance vehicles also needs further examination.

Additional Resources

For more information, contact Noelle St.Clair at Noelle.StClair@phil.frb.org.

  • * The views expressed here do not necessarily represent the views of the Federal Reserve Bank of Philadelphia or the Federal Reserve System.
  • 1 Seth Chizeck, “Gentrification and Changes in the Stock of Low-Cost Rental Housing in Philadelphia, 2000 to 2014,” Cascade Focus, Federal Reserve Bank of Philadelphia, January 2017; available at www.philadelphiafed.org/-/media/community-development/publications/cascade-focus/gentrification-and-changes-in-the-stock-of-low-cost-rental-housing/cascade-focus_5.pdf.
  • 2 “REIT Industry Financial Snapshot,” REIT.com, December 30, 2016; available at www.reit.com/data-research/data/industry-snapshot.
  • 3 The Community Development Trust (CDT) is the other mission-oriented REIT. Although incorporated as a for-profit and not a nonprofit REIT, CDT provides debt and equity capital to create and preserve affordable rental housing throughout the United States. To learn more about CDT, visit www.cdt.biz.
  • 4 Each shareholder in the REIT is responsible for the tax liability related to their share of dividends or capital gains distributed to them. The managing member is an LLC that is 90 percent owned by nonprofit sponsors.
  • 5 The 14 nonprofit organizations associated with HPET are AEON; AHC Inc.; BRIDGE Housing Corporation; Chicanos Por La Causa, Inc.; Community Preservation and Development Corporation; Eden Housing, Inc.; Hispanic Housing Development Corporation; Homes for America; LINC Housing Corporation; Mercy Housing; Nevada HAND, Inc.; NHP Foundation; NHT–Enterprise; and Preservation of Affordable Housing. AEON and Preservation of Affordable Housing joined HPET after the initial 12 members. For more information about the members of HPET, see http://hpequitytrust.com/investors-members/nonprofit-members.