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The affordable housing sector is showing excellent profits for investors

Things are changing in the affordable housing sector, and the once ugly duckling of investments is showing off its potential.
Experts say there are plenty of opportunities in this sector for  astute investors who do their homework.
Growth in the affordable housing sector has been hampered by perceptions that it is high risk an  investments are undervalued, but that is changing. 
Kiara Suttner, a private equity analyst at RisCura, says there is also a big demand for investment in the sector, where there have been high rental returns. 
This is all happening at time when investors struggle to achieve favourable rental returns in the high-end property market. Research shows current yields for prime location residential property range from 5% to 5.5%, while affordable housing sectors are seeing yields of between 8% and 10%. 
Lightstone’s residential property report for November 2017 indicates the low-value housing sector saw the biggest price inflation at 36% in October 2017, while luxury market prices increased by just 1%.
“Market conditions also currently favour the affordable housing sector.” 
Suttner says figures from Standard Bank’s affordable housing unit show demand is so high that the sector cannot keep up. In 2017 the unit reported a gap of between 60 000 to 70 000 units a year, with only 6 000 units being built annually.
However, the high cost of capital, due to the level of perceived risk in the sector, is preventing investors from reaping high risk-adjusted returns.
“This leaves the market under-served, with lenders, investors and developers cautious to enter, despite the clear demand. While the operating and financing risks and a lack of transparency drive up the cost of capital, the impact of these risks is likely over-stated due to skewed market perceptions.”
Suttner says it is important to consider the difference between the perceived high cost of capital and the actual cost of capital. The main perceived risk of this investment is that tenants will default on their rent because they are short of cash. 
However, in reality affordable housing property Real Estate Investment Trusts (REITs) have reported very low vacancy levels and bad debt write-offs in well-managed, affordable housing developments.
Because non-paying tenants are protected by strong eviction laws, this also creates more risk and ultimately increases the cost of capital. And because most developers build to sell and have no incentive to collect rentals, investors need to use rental agencies to do so. This also heightens the perceived unattractiveness of this market.
“The lack of liquidity poses a risk for developers and investors alike and raises actual costs of capital in the existing market. However, as more investors enter the market, developers will have more exit opportunities. These investors will grow the secondary market, thus resulting in a further reduction in the cost of capital.”
Liquidity is also increasing as REITs aimed at affordable housing are being listed on the JSE, Suttner says. 
REITs such as Indluplace and, more recently, Balwin Properties’ partnership with Transcend, have launched the first funds focused on the affordable housing market. Due to the risk associated with finding numerous investors to sell units to the end of a development, REITs are a guaranteed buyer and provide developers with an exit path. The REITs are incentivised to support efficient development of new stock as this allows them to secure a pipeline of growth in earnings for their shareholders.
“Financial risks pushing up the cost of capital in this market include difficulty in obtaining financing. Debt funding is a crucial aspect of creating sufficient returns to equity, and with stricter lending policies being implemented by the banks, it is harder for new developers to obtain funding to enter the market.”
However, the industry has seen success in investing in affordable housing, Suttner says.
“The global private equity investor, International Housing Solutions, delivered a 24.5% risk-adjusted return in its first successful South African project exit in 2013. Since then, it has seen double digit returns in this market.”

Property360

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