The Guru Is In

The asset class under our noses

By David A. Smith
November 3, 2016 5 min read

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In early October, the Urban Land Institute’s (ULI) Terwilliger Center for Housing and the National Association of Affordable Housing Lenders (NAAHL) co-hosted a day-long symposium/roundtable on what we decided by the end of the day just might be an emerging asset class whose preservation is integral to the success of America’s cities and the urban economy. We called it NOAH, Naturally Occurring Affordable Housing, and using as our base of discussions fantastic big data accumulated by CoStar, we spent six intense hours identifying facts, discovering implications, and contemplating a way forward.

Facts: 70 percent more rentals than the entire affordable inventory?
Of America’s 42.8 million rental units, 3.3 million are what you and I would call ‘affordable housing’ – governmentally influenced with rent regulation or subsidy.  Another 23.5 million (55 percent of the rental inventory) are in 1-4 apartment properties, leaving 16.0 million of what we can call the ‘investable’ rental inventory. CoStar then classifies all these properties using not the traditional market-adjusted

A-B-C-D, but a location-independent physical-attributes star system (analogous to hotels) ranging from 5-star (highest) to 1-star (lowest). While the better LIHTC properties are 3-star, for the sake of comparison CoStar limited its analysis to 1-star and 2-star properties, of which CoStar counts 5.5 million.

That’s right, America has 70 percent more 1-star and 2-star conventional NOAHs than it has all governmentally-affordable housing. Of these, the data showed other striking if explicable findings:

1. The NOAH inventory is old, built mainly in the 60s and 70s and by inference not substantially rehabbed since then.
2. Unlike the luxury (4-star and 5-star) properties, which are concentrated in larger developments, the NOAH inventory is evenly distributed among 5-9 unit buildings, 10-19, 20-49, 50-99, 100-199, and up, with each band representing roughly one million apartments.
3. The NOAH inventory is anti-concentrated; the largest owner CoStar identified has 11,000 apartments (a 0.2% share of the national market), and the 25th largest has 3,000.
4. The NOAH inventory is becoming less affordable. In the three years from 2013 to 2016, rents rose 7.8 percent relative to median income.
5. NOAHs also represent much of the dwindling stock of larger (3-BR and 4-BR) apartments. Four decades of favoring 1-BR’s and 2-BR’s in both conventional and affordable development makes the bigger, older apartments rare, hence in demand.
6. For most big American cities, the aggregate market capitalization of its metropolitan NOAH inventory is substantial: Boston, in tenth place nationwide, has $8 billion of NOAHs; Denver (ranked 19th) has $4 billion, and San Diego (ranked 4th) has $21 billion.

Implications: Essential national infrastructure disappearing under pressure?
Three decades of LIHTC-dominated practice have remade the affordable-housing financial ecosystem to be LIHTC- congenial, and unintentionally uncongenial to NOAH’s, which are materially different in three interlocking ways:

1. Physical configuration. The prevalence of smaller properties assures that even the medium-scale NOAH owner-operators will have multiple discrete buildings, often in clusters of scattered sites. Heterogeneity of street address, shell, HVAC, layout and configuration means these are high-complexity assets even as they are smaller-dollar-value apiece.  A regulatory overlay would smother them in standardization.
2. Owner/operator model. Older, conventional, smaller, anti-concentrated, NOAHs are often operated by people who aren’t just the owners, they’re the principal employees. Though these properties will produce tax losses, they go to waste because the passive loss rules make them largely useless for the owner/operators and impractical to syndicate. In making extinct the older tax shelters, the 1986 Tax Reform Act also unwittingly killed off the professional smaller conventional owner-operators by depriving them of resources.
3. Financing. Because they are older urban properties, NOAHs often have a commercial/retail ground floor and may have an owner-operator living in one of the apartments. Three income sources makes them hard to underwrite, and tends to disqualify them from the triopoly of secondary- market liquidity sources (Fannie Mae, Freddie Mac, FHA).

For NOAH’s to be a proper asset class, all three of these elements have to work replicably, and currently none of them do. NOAH’s are capital-disadvantaged, which goes a long way to explaining why the preservation-related efforts of many national-leading innovators – many of whom were present as highly valuable contributors during the day-long session – are both so urgent and so complex to do.

A way forward: what makes an asset class?
Thirty years ago, when the ink was scarcely dry on the 1986 Tax Reform Act, LIHTC wasn’t an asset class, it was a consolation prize whose viability many of us doubted.  Today it’s not only an asset class, but big business with scaled swift sophisticated capital flowing from the nation’s largest and most visible financial institutions to small-scale, high-touch properties everywhere in the country.

NOAH’s aren’t a national problem: they’re a metropolitan problem occurring nationwide. They’re an endangered species, and for their survival, and the health of America’s cities and our urban economy, they need to become a recognized preservation asset class.