Impact investing—that is investing in assets that can generate an attractive return as well as positive social or environmental impact—can take many forms, but social impact investing in real estate focused on affordable housing is one of the most intriguing applications. This approach shows great promise in easing the epidemic of homelessness and the housing affordability crisis, while providing investors with opportunities to potentially earn attractive returns. In this article, we’ll explain the concept of affordable housing, explore the growing need for it and describe several ways to make investments in affordable housing programs.
The Need for Affordable Housing
Table of Contents
- 1 The Need for Affordable Housing
- 2 Affordable Housing Explained
- 3 Investing in Affordable Housing
- 4 How Policy Affects Impact Investing in Affordable Housing
- 5 Challenges of Impact Investing in Affordable Housing
- 6 Handling Challenges of Impact Investing in Affordable Housing
- 7 Start Impact Investing in Affordable Housing
Housing ranks as one of America’s most pressing challenges. According to the National Alliance to End Homelessness, more than 580,000 people experienced homelessness in 2020. In addition, many people are one job loss or health crisis away from losing their homes. The Harvard Joint Center for Housing Studies estimates that more than 20 million renters pay an unsustainable 30% or more of their income for housing, while more than 10 million dedicate more than half of their income to rent.
Creating affordable housing can help those people, but it can also have a broad positive impact on whole neighborhoods, communities and the nation as a whole. A 2021 study by UCLA’s Elior Cohen found that providing homeless people with targeted housing assistance reduced emergency room visits by 80%, cut jail days by 95% and reduced the probability of committing a crime by 80%. People who participated in housing programs were 24% more likely to be employed than those who did not.
Affordable Housing Explained
What is affordable housing? The federal Department of Housing and Urban Development (HUD) defines housing as affordable if it costs 30% or less of a resident’s income. Because wages vary from state to state and city to city, what’s affordable in one area may be unaffordable in another.
In many areas, the supply of affordable housing has failed to keep up with demand, often because of restrictive zoning and market incentives that favor luxury and upper income development. Impact investing in affordable housing can help maintain, improve and add to the stock of affordable housing.
In addition, investing in affordable housing is good business. Demand is high, so properties tend not to stay vacant for long. Subsidies, like Section 8 housing credits, provide a steady stream of income directly from the Federal Government, further reducing risk.
Investing in Affordable Housing
As a result, social impact real estate investments in affordable housing can potentially offer attractive yields and appreciation for investors. A 2019 study from the Global Impact Investing Network, tracked investment returns on 113 affordable housing impact investments and found that on average, debt investments earned 6% a year and private equity investments earned 9%, in addition to providing measurable positive social impact in the communities they served.
There are a number of different ways to make investments in affordable housing programs, including through public REITS (real estate investment trusts) and private funds. NAREIT recently published a helpful list of public REITS investing in affordable and workforce housing. On the private side, investment managers such as Enterprise, Kimpact and Jonathan Rose offer affordable-housing funds designed for high net-worth investors. These can be structured as debt or equity offerings. Social impact real estate offers many of the same types of benefits as traditional real estate, including the potential for consistent income, appreciation in value and diversification versus other asset classes.
How Policy Affects Impact Investing in Affordable Housing
Governmental policy plays an important role in determining the future of impact investing in affordable housing. The guidelines for such investments are heavily influenced by rules and laws that can directly impact the feasibility and profitability of impact investing in this sector. For instance, these guidelines can include zoning laws and building codes that decide where and how affordable housing can be built. Moreover, tax policies are instrumental in encouraging or discouraging such investments.
For example, tax incentives, like the Low-Income Housing Tax Credit (LIHTC) in the United States, encourage private investment in affordable housing. Public funding and subsidies can also contribute to making these impact investments more attractive by providing direct spending or financial support.
If a government prioritizes issues like reducing homelessness, it may draft favorable policies and invest more in affordable housing projects. Governmental policy can also influence interest rates, which can impact the cost of borrowing for developers and investors, either spurring or discouraging impact investing in the sector. Additionally, governments can stimulate investments through public-private partnerships, where resources and risks are shared to make larger-scale affordable housing projects more viable.
The general stability and predictability of government policy can significantly impact these investments. If a government’s policies are unstable or unpredictable, it can make investors wary of opportunities to get involved with impact investing in affordable housing.
The Low-Income Housing Tax Credit (LIHTC)
The low-income housing tax credit (LIHTC) program is an indirect subsidy provided by the federal government that’s used to fund the building and preservation of affordable housing projects. This legislation was, in part, adopted to encourage private investors to get involved with impact investing within the sector.
Investors are offered a dollar-for-dollar decrease in federal tax obligations for impact investing in affordable rental housing with the LIHTC program. Investors typically receive tax credits paid out over a decade-long period. Private investor contributions help subsidize the building of affordable housing projects, which in turn, allow for rent prices to be offered to lower-income tenants at below-market prices.
Opportunity Zones
Opportunity Zones, established by the 2017 Tax Cuts and Jobs Act, offer a unique pathway for private investors interested in impact investing in affordable housing. These Zones are specific communities, identified by the state and certified by the Treasury Department, that qualify for investment incentives with the aim of spurring economic development in economically distressed areas.
A critical aspect of Opportunity Zones is the creation of Qualified Opportunity Funds. These are investment vehicles that need to invest at least 90% of their assets in Qualified Opportunity Zone property. Private investors who have realized capital gains can invest those gains into these Funds within 180 days of the sale or exchange of the appreciated property.
The Opportunity Zone program provides a significant tax advantage for investors. It allows them to defer, and potentially reduce, taxes on their recognized capital gains, provided they invest and retain their stake in the Qualified Opportunity Fund within the prescribed time frame. Furthermore, if the investment in the fund is held for at least 10 years, the investor can benefit from an exemption from tax on the appreciation of the Opportunity Zone investment.
This tax incentive structure can significantly affect private investors’ decisions when considering impact investing in affordable housing. Firstly, the opportunity to defer and potentially reduce tax on capital gains can make investments in affordable housing within these zones more financially attractive. Secondly, as these zones are located in economically distressed communities, investments can generate considerable social impact, aligning with the principles of impact investing.
Challenges of Impact Investing in Affordable Housing
Impact investing in affordable housing is not without its share of challenges. Several obstacles can stand in the way of a successful strategy. Below are a list of difficulties that can arise when trying to make a difference in this sector:
High Capital Requirements: Affordable housing projects can be capital-intensive. Projects can come with high upfront costs and long payback periods. This obstacle might deter some investors, especially those who are not willing or able to lock their capital for longer periods of time.
Property Location and Condition: The location of the property can greatly affect its value, demand, and the cost of its maintenance. Properties that are poorly located or dilapidated can require significant investments to improve, which can affect the overall profitability of the investment.
Tenants and Management: Ensuring stable tenancy and competent property management is key in retaining a revenue stream. High vacancy rates, problematic tenants, and poor management can significantly impact the financial performance of an investment.
Revenue and Expense: Revenue generated from affordable housing is usually capped due in order to maintain affordability. However, expenses such as maintenance, repairs, property management, and taxes can be high. Balancing capped revenue and critical expenses can pose a significant challenge.
Regulation and Tax Treatment: Affordable housing is often subject to specific regulations related to rent control, tenant rights, building codes, and more. Furthermore, tax treatment can greatly affect the profitability of affordable housing investments. Navigating the current legislation surrounding this sector as well as future changes can be difficult.
Handling Challenges of Impact Investing in Affordable Housing
Addressing the difficulties of impact investing in affordable housing may be challenging, but it’s far from impossible. With the right strategy in place, investors can meet these obstacles head-on as they work to make a difference. Below are some useful strategies to implement when impact investing in this sector:
Pool Resources: Diversify your portfolio to include a range of investment sizes and types. This can help manage risks and maintain cash flow. Additionally, pooling resources with other investors can help cover the higher capital requirement.
Property Due Diligence: Conduct thorough due diligence before investing in affordable housing. Understand factors like the location and condition of the housing you’re investing in. Understand that investing to improve a property and its surrounding area can boost the property’s value and its attractiveness to potential tenants.
Ensure There Are Processes: Make sure strong tenant selection processes are in place to help stabilize tenancy for your properties. Also, ensure there are competent property management professionals or firms with experience in affordable housing involved with your investment.
Understand Current Policy: Understand the tax implications of policies like the LIHTC program and opportunity zones. Know that revenue can be capped for affordable housing projects, and that notable returns on impact investing in this area may come over a much longer time horizon.
Stay Informed: Seek advice from legal professionals and experts in affordable housing regulations and tax treatment. Work with local authorities to understand and navigate the relevant regulations and tax structures. Speak with a financial advisor to regularly receive much-needed insight into how to continuously approach this space.
Start Impact Investing in Affordable Housing
At Colorado Capital Management, we believe strongly in the power of impact investing to transform lives and communities while offering a compelling value proposition for investors. We have seen the significant, tangible effects that affordable housing investments can have, not just for those in need of secure, stable homes, but for entire neighborhoods, cities, and even the broader economy.
The complexities of impact investing in affordable housing can be challenging. You’ll need a thoughtful, informed approach to navigate the regulatory environment, understand the economics of affordable housing, and effectively manage the associated risks. But you don;t have to create a strategy all on your own.
We’re committed to helping our clients stay on top of the intricacies of affordable housing impact investments. Our team of experts is well-versed in the unique characteristics, challenges, and opportunities this sector presents. We remain updated on evolving government policies and the latest developments in the affordable housing space.
Don’t hesitate to reach out to us and start making a difference for the people who need it most! Let’s work together to create a more sustainable future while simultaneously driving value for your portfolio. Contact us today, by clicking the button below.
Editors Note: This article was originally published in December of 2021. It has been updated to offer a more -in-depth overview of Impact Investing in Affordable Housing.
Steve Ellis has spent his career making an impact, so it’s not surprising that Colorado Capital Management’s founder and president launched the firm’s entry into impact investing.
