“Workforce housing” or “affordable housing” are hot topics in today’s private equity real estate investment industry. Prior to the COVID-19 pandemic, this niche within the multifamily sector was increasingly viewed as an undervalued safe haven for real estate investors that produces steady cash flow regardless of economic cycles, with the added social and economic benefits of supporting a basic need for working-class citizens. However, the viability of this strategy has come under scrutiny as the global health crisis has left no corner of the economy untouched. Concerned onlookers speculate that this sector of the housing market will see vast delinquencies as the financial susceptibility of service industry, retail employees, and other hourly wage earners may be exposed.
Birgo Capital acquires and operates workforce housing assets in the Pittsburgh metropolitan area and surrounding regions. Naturally, we’re asking ourselves what key determinants will dictate the ability of these residents to pay going forward. The best way we can think to do this is to understand what the true economic drivers are to tenants’ personal income. We’re finding that their financial durability is perhaps understated, and maybe – just maybe – affordable housing is a very safe place to invest after all.
In April, we observed extremely strong collections from our tenants, ending the month at an astounding 99.5% of budgeted collections. The consensus in the multifamily industry has been that May and June will be worse than April, but this is generally based on intuition and broad market sentiment. In an effort to more accurately anticipate rental income for the coming months and to start to understand how coronavirus should shape our perspective on acquisitions going forward, we recently did a deep dive into sources of income within our tenant base. We rolled up our sleeves and dug back through our tenant files to review rental applications, asking questions like “Will they be able to pay rent if a second wave hits?” and “Will their income go away in a prolonged recession?”
We selected a randomized sample of rental applications from individuals that currently reside in properties owned and operated by Birgo Capital. In total, we reviewed previously approved applications for 15% of our existing tenants and included an approximately equal proportion of tenants from all geographic regions and property types from our multifamily portfolio in the sample. From the applications, we extracted the employer, job title, and other sources of income (retirement, disability, social security, other subsidy, etc.). We then had members of our investment team apply risk scoring to each tenant based on the job title, employer, and source of income. Tenants were scored on a scale from 1 to 5, with a score of 1 indicating little to no risk of reduction in income and a score of 5 indicating reasonable susceptibility to an income reduction. The following are the results of the risk scoring:
After reviewing the applications in detail, we believe that individuals with a risk score of 1 or 2 are highly unlikely to experience a material enough reduction in income such that paying rent would be a challenge as a result of the pandemic or the resulting recession. It’s probable that some proportion of those with a risk score of 3, 4, and 5 will be impacted, with increasing likelihood as the risk score increases. In order to understand the implications of those in categories 3, 4, or 5 on our portfolio, we need to make some assumptions about the probability of an income reduction for those deemed in higher-risk categories. Based on the descriptions above of these categories, we could hypothetically assign the following probabilities to a reduction in income for our tenants:
Obviously, we’re making some significant assumptions here in assuming no major impact on categories 1 and 2, and a 10%, 30%, and 50% impact on categories 3, 4, and 5 respectively. We don’t know to what extent these various risk-scored categories will be impacted, but if we’re anywhere in the right ballpark, this leads us to believe that approximately 95% of our entirely low-to-moderate income tenant base is unlikely to experience a materially negative impact to personal cash flow. This does not give consideration to additional CARES Act governmental support through enhanced unemployment benefits, Economic Impact Payments, and other emergency actions being taken to defend against economic vulnerability; when considering these factors, we actually believe this is a conservative estimate.
In addition to general risk scoring, we applied an industry sector to each tenant based on the primary source of income for rent payment according to the application. This was intended to remove any subjectivity from the risk scoring and provide an objective perspective on what economic engines are behind our residents’ monthly cash flow. Below is a depiction of these industry sectors and the extent to which the sample indicates they are present in our portfolio:
Just as April rent collection data presented the industry with a pleasant surprise, this analysis yields unquestionably reassuring results. When comparing Birgo Capital tenants’ employment composition to the national averages as reported by the Bureau of Labor Statistics(a), there does not appear to be disproportionate employment in industries that are susceptible to the pandemic or prolonged job loss due to recession. The federal government makes up over 30% of the revenue base supporting our residents’ income. Income from industries that support basic needs, such as healthcare, human services, infrastructure, and education, make up another 35%. In our portfolio, only 2.2% of residents of workforce housing properties are employed in leisure and hospitality, which is far below the national average of 10.2%. While the 11.8% of tenants employed in retail trade is greater than the national average of 9.8%, the majority of these are in staple-driven roles with steady and increasing demand — many working for the likes Amazon, Target, and regional grocery chains.
While it can be tempting to assume that all residents of workforce housing will be negatively impacted by the current economic climate, this analysis shows that income sources are highly segmented and largely resilient. Yes, certain sectors of the workforce will undoubtedly be affected, but susceptibility to demand side shocks among workers can hardly be painted with a broad brush — not every occupant of Class B or C apartments is employed by a retailer subjected to forced closures. A look under the hood of income sources reveals that the workforce employment engine is surprisingly resilient, even in the face of a global pandemic. Without a doubt, the road ahead will have unique challenges and workforce investors will not be immune to them, but the enduring nature of income sources for these tenants provides a helpful framework as we move forward.