Affordable Rental Housing: The Recession-Resistant Inflation Hedge
by John R. Williams, Avanath Capital Management
With today’s Consumer Price Index topping 9%, pension funds, institutional organizations and private investors are scrambling to protect their portfolios from value erosion. As such, many are turning to real estate assets as a potential hedge against inflation and for a higher level of security in the event of a potential economic downturn.
While the success of this strategy depends on asset type and geographic location, multifamily properties can be ideal recession-resistant investments, while also providing a powerful hedge against inflation.
Along those lines, affordable rental housing can offer positive benefits during times of economic uncertainty. While myths and misunderstandings about this property type abound, Affordable housing can be a viable investment strategy to maintain a portfolio’s value and returns during today’s inflationary times and a potential future recession.
Affordable Housing as an Inflation Hedge
Many factors—including consistent rent increases and controlled expenses—contribute to Affordable rental housing as an ideal inflation hedge.
1. The AMI Factor
Multifamily assets score high as a hedge against inflation; as the price of goods and services goes up, rents can be reset as well.
But market-rate multifamily rents are subject to the whim of, well, market rates and what tenants are willing to pay. Affordable rental housing rents, however, are regulated and directly tied to a local region’s Area Median Income. This, in turn, is calculated by the U.S. Department of Housing and Urban Development (HUD).
In April 2022, HUD set the FY 2022 national median income at $90,000, a 12.5% increase over 2021’s $79,900. This means affordable rental housing operators will likely bump their rents by similar percentages, depending on property locations.
The AMI varies, based on region and state. And it’s true that market-rate assets can generate higher rent growth. But AMI generally grows during inflationary times. As a result, affordable housing rents are tied to a specific metric, rather than market volatility. The result is a steady cash flow with rent increases in line with inflation.
2. Knowledgeable Operators
Affordable rental housing investors also benefit when partnering with experienced individuals and companies that own and operate these assets. Experienced affordable rental housing owner-operators have long-term relationships with local and federal housing authorities. This means they can navigate through in-place financing mechanisms and regulations efficiently and quickly.
Additionally, affordable rental housing owner-operators understand how to manage property expenses and improve net operating income. Since most affordable housing assets in high-cost markets have a waiting list for new residents, there’s minimal marketing/advertising costs. Better-managed expenses and costs, along with more efficient operations, may result in higher profit margins.
Affordable Housing as a Recession Investment Strategy
In addition to offering an ideal inflation strategy to investing, other factors make Affordable rental housing a safe place for investment dollars during economic uncertainties and downturns.
1. High Demand, High Occupancies
There is a very high tenant demand for affordable rental housing units—along with very long wait lists—meaning consistently high occupancies. Additionally, affordable rental housing residents pay smaller percentages of their income toward rents, with many using Section 8 vouchers for assistance. Both of these issues mean fewer rental payment defaults, providing ongoing revenues and consistent returns to owner-operators and investors.
2. Barriers to Entry and Supply Scarcity
Affordable rental housing has higher barriers to entry than its market-rate counterparts. Developers and owners must know how to navigate complex financing structures to obtain necessary funds for ground-up construction and/or renovations. Obtaining Low-Income Housing Tax Credits or state/county tax credits requires a great deal more time, effort and knowledge that goes beyond city council and planning and zoning approvals. This extra effort might not appeal to all owners or developers.
Furthermore, increases in land, materials and labor costs means fewer Affordable housing rental units are being built. The lack of housing competition benefits affordable rental housing investors in two ways. First, steady cash flow from rents and rent increases. And second, appreciation in property values (and an increase in capital gains) should the owner-operator decide to sell the asset.
3. Lower Turnover
The combination of high demand and supply scarcity means Affordable housing tenants will likely remain in their units for longer periods of time. This is the case, especially if owner-operators are conscientious about operations, amenities and deferred maintenance. Lower tenant turnover adds to lower costs, reliable income and continuous investor returns.
Adding Affordability to a Portfolio
Affordable rental housing can be a good way to diversify investment portfolios during periods of high inflation and economic downturns, especially when investors partner with experienced owner-operators of this product type. As with any investment, due diligence is important to determine the owner-operator’s track record and the property’s financial and operational performances.
Overall, high quality, well-located, Affordable rental housing benefits from high tenant demand and built-in rent increase mechanisms. Ownership of these assets can provide ongoing cash flow that grows over time, along with asset value increases. As a result, affordable rental housing can be an ideal tool to aid with portfolio diversification and income protection during times of economic volatility.
John R. Williams is President and Chief Investment Officer of Avanath Capital Management, a privately held, vertically integrated investment firm with a focus on affordable and workforce housing investments throughout the U.S.
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