Affordable housing is one of the busiest areas of impact investing at present. This study by three Lucerne academics with an entrepreneurial bent is well timed, if perhaps just a first step, writes Christopher Walker.
In brief
- The global affordable housing problem is serious, set to grow to 440 million households by 2025.
- Definitions are shockingly varied across developed markets.
- The most interesting part of this book is the findings on factors influencing returns.
- But it only looks at developed markets and is the result of just eight interviews. It is therefore only just a first step in studying this area.
In 2014, McKinsey predicted that if current trends in urbanisation and financial overstretching continue, the affordable housing gap would grow to 440 million households by 2025. That means 1.6 billion people living in substandard housing or being financially stretched by housing costs.
In Asia, Africa, and Latin America, about 200 million households live in slums, and as the authors note “it would be interesting to know how affordable housing investment opportunities look in emerging markets”.
But this is not this book. The focus is solely on developed markets, and the fear that “good quality affordable housing has not just become out of reach for those with low incomes, but also young people, families with children, and seniors”. The COVID pandemic has only made things worse.
The underlying message of this book is that “the nefariousness of the economic affordability gap highlights why this challenge cannot only be met by one-dimensional solutions such as government subsidies alone”.
Enter the impact investor. Mission-oriented, but also attracted to affordable housing by “an undeniable investment case given its table flow of income through its long-term operational leases…, low tenant turnover rates, and higher degree of diversification”.
What is affordable housing?
One thing clear in this book is the differing metrics used in different markets. Such as ‘the expenditure-to-income ratio’ often using a 30% figure as “the affordability threshold”. A flawed principle since, as the authors note “for a low-income household, spending even 20% of their income on housing may leave little finances left for other key consumption items”. They seem to prefer ‘the residual income measure’ which at least “captures the amount of income a household has left after paying for housing costs”.
I was quite shocked by the differences. For example, Vonovia, one of the interview participants and Austria’s largest developer stated that “the minimum threshold for eligibility is a household earning net €70,000.” I think the authors mean ‘maximum’ but even so that doesn’t sound like poverty.
No wonder the numbers on ‘social housing’ vary so greatly in the developed markets. The Netherlands (36%), Denmark (23%), Austria (24%), and the UK (19%) are clear leaders. Very different to Germany, with 5–10%, and the US with less than 5%.
Factors influencing returns
Otherwise the most interesting part of this book is the findings on factors influencing returns.
Perhaps it is not surprising that location is rated so highly – this is real estate after all. As one respondent said “if you choose the location wrong, you cannot move building”.
Less expected, and perhaps requiring more investigation, is the authors’ finding that government subsidy is a “neutral factor” along with construction costs, project management costs, and speed of planning and building approvals. I guess it’s all a question of proportion, and they are all dwarfed by the apparent predominance of exit value, at least in the DCF Model.
In reality, the exit is often deferred. Because, as stated by interviewee Pierre Jacquot, CEO of Edmond de Rothschild Real Estate Investment Management,
“institutional investors do not necessarily want to exit when they are receiving a stable and constant cashflow”. Moreover, in Germany, “publicly listed companies prefer not to exit because after the required 20- to 50-year period of maintaining affordable or subsidised units, landowners have the ability to step into the free finance market. It is at this point that the benefits are reaped and therefore tie back to having an important location that is rentable to future markets”.
Some fund managers, such as the one American private equity firm the authors talked to, prefer not to exit at all, given “their desire to continue to maintain the affordability of a property which is not guaranteed after exiting.” This company is also the anomaly in the sample with its track record of a stable 15% net return in the subsidised housing industry.
Only a first step
This points to the two key flaws with this study.
Conclusions can appear convincing. “The data indicate that among the study’s firms, the median return of traditional residential real estate is approximately net 5.01%, whereas the median return of affordable housing products is approximately net 3.75%.”
But they are spurious. Firstly, as the authors themselves admit “given the young and emerging nature of this universe, only a handful of impact-focused funds have exited their investments making it difficult to model the full return potential of such investments.”
And secondly, again in their own words “the sample size consists of [just] eight respondents. This is too small a number to make inferential generalization onto the parent population.”
The results are therefore far from conclusive. Rather just a first step.
