Lenders Favor Workforce Housing Deals

The affordability crisis striking California has spurred demand for workforce housing. Developers and investors alike have answered that call, and in the last year, California has seen a dramatic increase in both value-add workforce housing investment and ground-up workforce housing development. Now, lenders are showing increased interest in workforce housing deals, compared to market-rate multifamily, according to Jonathan Lee, a principal and managing director at George Smith Partners. Lee recently secured construction financing for a 51-unit ground-up workforce housing project in Koreatown on behalf of a joint venture between Index Real Estate Investments and Ketter Construction. We sat down with Lee to talk about the lender demand for workforce housing.

GlobeSt.com: What is lender demand like for workforce housing ground-up development?

Jonathan Lee: Lenders are very keen on workforce housing and tend to be slightly aggressive on these deals when compared to market rate multi-family, provided rents and return on cost stand up to scrutiny. Some banks feel a lot of rental supply has been brought on-line in the past three years, and there could be a flattening of the upward trajectory we have seen in rents. That is a concern in core areas that are trying to achieve rents of $3.00 and sometimes $4.00+/PSF.

True workforce projects, however, are in emerging markets that have seen little to no new development in over two decades. As such, there is pent-up demand for new product and lenders are happy to meet that need. Depending on the area, lenders also have internal metrics as they relate to opportunity zones and underserved markets, as well as providing financing in lower income areas. When projects are located in these markets, lenders are often willing to reach further to make them happen.

GlobeSt.com: Have you seen an increase in workforce housing development?

Lee: In short, yes. There has been a recent push in the workforce space. However, it’s important to frame what that means. For both banks and LP equity partners, there is a difference between low income tax credit deals and workforce housing.

Workforce housing is not a gentrifying neighborhood with third wave coffee shops and hipsters mixed in with a low-income census tract. Rather, true workforce housing is reasonably priced without the distinction of being “affordable.” Los Angeles, for instance, is an area with a wide radius where the median family income is below $65,000. The bench of lenders for full market-rate deals in this market has always been deep, as has the market for tax credit deals. That said, true workforce deals are coming on now because developers are wary of the high-end, and they see pent-up demand for new product in underserved markets.

GlobeSt.com: What are the challenges of workforce housing development deals?

Lee: Pioneers always get the arrows. When a developer wants to build class-A product in a neighborhood that hasn’t had new multi-family projects of scale since the 1980’s, the first question is always focused on rents and demand. While the thesis is strong, banks still don’t feel they are compensated to take rental risk unless the demand is proven out. That takes work. On the equity side, land basis and cost of construction is always a factor when considering workforce deals.

GlobeSt.com: In general, have you seen construction financing rebound?

Lee: Construction financing never really went away, it just shifted. Three years ago, some money centered banks backed off from taking on new clients with new deals. That seems to have been a strategic mistake. Regional banks were more than happy to pick up the slack, and we are still seeing new lenders come into the market as others scale back. If banks cut back leverage, debt funds filled the gap. So again – it shifted. As for equity, there is demand for workforce deals as a hedge against market rate deals in a fund.

GlobeSt.com: Are workforce housing construction financing deals different from a standard construction deal?

Lee: Tax credit deals will achieve more leverage because banks need to place these types of deals to meet their internal metrics. Generally speaking, however, there is not much difference from an underwriting standpoint between the financing of workforce and standard market-rate deals.