Smart investors are continually on the lookout for opportunities to earn strong risk-adjusted returns. A fresh, little-known asset class can reward investors who understand its hybrid benefits. In strong markets, projects backed by the Department of Housing and Urban Development provide a unique opportunity to combine bond-like fixed-income properties with the potential for growth through real estate appreciation.
These multifamily projects combine the security of government funding with the potential upside of capital appreciation from well-managed real estate. Some of the most promising investments are those in newly gentrified neighborhoods, where subsidized housing was established many decades ago. Now, many of these properties have increased in value along a comparable trajectory to the co-located, conventional properties next door. The intrinsic value of these projects is substantial, while federal Section 8 subsidies provide significant downside protection.
Under the terms of a Section 8 contract, each resident pays 30 percent of his or her income toward rent, with HUD providing the difference up to the market rent. Typically, HUD pays 80 percent to 85 percent of all rents collected at this type of property. This government backing provides considerable safety and consistency of cash flow to the projects, and through the projects, to investors.
Owners participate in increases in market value over time, thanks to "mark-up-to-market" (MUTM) adjustments of rents every five years to then-current market levels. In the interim years, projects receive automatic cost-of-living increases funded by HUD. With tenants' rent payments capped at 30 percent of their income, it is no wonder that properties of this type attract waiting lists often as long as several years, thereby ensuring minimum vacancies regardless of market conditions.
Since the early 1990s when the oldest Section 8 contracts began to expire, a large number of owners in strong markets began to opt out, taking several hundred thousand previously HUD-assisted units to the open market. As a result, project-based Section 8 contracts have become a depleting resource, the value of which increases daily.
In the past, investments in federally subsidized housing generally have been tax-oriented, focused on either losses or credits, with little regard for, or interest in, cash flow or residual value. Savvy investors in today's real estate markets have begun to appreciate the economic benefits these projects can provide, as they offer the long-term appreciation potential of conventional multifamily real estate while minimizing the effects of short-term cost spikes and virtually eliminating vacancy and delinquency risk.
Sellers, too, are becoming increasingly interested in dealing with "economic" (as opposed to tax-oriented) buyers, as these buyers are positioned to execute swift, clean transactions, without relying on tax credits, grants or subsidies.
By seizing opportunities among tens of thousands of units nationwide, experienced managers can parlay these purchases into exceptional returns on a risk-adjusted basis.