Freddie Mac expects this growth to continue, with multifamily loan origination volume projected to total nearly $317 billion in 2019, an increase of 3.9% year-over-year.

While many investors focus on Class A multifamily properties, investing in ‘missing middle’ and workforce housing may offer a greater opportunity for above-average returns. Simply put, the demand for this rental niche far exceeds supply. Here’s how you can benefit.

What is workforce housing?

Workforce housing is Class B and C multifamily property that caters to middle-income renters. HousingWire notes that about 13.5 million households currently live in workforce housing. They often rent out of necessity due to the high cost of home ownership in prime city-center locations.

Beginning investors sometimes confuse workforce housing with affordable housing, but the two are quite different. Workforce housing is best described as housing that is affordable to middle-income renters such as teachers, firefighters, and police. The ‘missing middle’ of workforce housing provides real estate investors with an opportunity to supply what the market wants and needs.

What is missing middle housing?

Prior to the 1940s, urban neighborhoods were walkable and transit-oriented, offering residents a diverse choice of housing options and commercial amenities within a few blocks. After World War II, the population expanded as baby boomers were born, and the need for housing rapidly grew. Low-interest, government loans along with the automobile helped fuel the creation of bedroom communities in the suburbs.

Today, the preferred choice of housing has gone full circle. Both baby boomers and millennials are driving demand for smaller residences in the same urban areas where their grandparents grew up.

Known as ‘missing middle housing’, these housing types are comparable in size to small single-family homes but consist of multi-unit and clustered housing types including:

• Carriage house and ADU (accessory dwelling unit)
• Side-by-side duplex
• Stacked duplex
• Threeplex, fourplex, and small multiplex

In essence, missing middle housing includes a range of smaller multifamily units, for which new construction has largely failed to keep up with growing demand.

How to choose a missing middle housing investment property

These housing types are also described as ‘missing’ because very few of them have been built since the 1940s. However, the ones that do exist generally blend right into the existing community.

Smaller multifamily missing middle properties can be found right next to single-family homes. They can provide investors with a higher-value niche product that caters to students, millennials who would rather rent than own, community service professionals, and empty nesters. Combined, these groups make up more than 50% of the population in the U.S.

Common characteristics of missing middle housing types include:

• Walkable location close to amenities
• Small-footprint buildings similar to single-family home sizes
• Moderate density that blends in with surrounding building types
• Simple, well-designed construction with floor plans and finishes often found in single-family residences
• Reduced number of off-street parking spaces and areas
• Some sense of community within the building and local neighborhood
• Potentially marketable for both rent and sale

Benefits of investing in missing middle workforce housing

In The Case for Workforce Housing report, commercial real estate services and investment firm CBRE outlines the opportunity for investing in multifamily workforce housing. The report notes that over 100,000 multifamily units each year are removed from the market due to obsolescence.

By and large, these happen to be the particular units that are best suited for workforce housing. This is creating a classic case of diminishing supply vs. rising demand. While demand for housing from middle-income tenants continues to grow, supply is being permanently taken off of the market.

CBRE goes on to say that, “The redevelopment of older housing units is tremendously valuable to the multifamily sector, providing better-quality and updated units for renters. The physical improvement to the older multifamily housing stock has also made it more attractive for investors.”

In February 2019 Fannie Mae published its market commentary report, “2019 Multifamily Affordable Outlook – An Overwhelming Need for Workforce Housing”. After analyzing data from CoStar and Reis, Fannie discovered that vacancy rates in Class B and C multifamily property reached all-time lows of about 5% and have remained in the low single-digits ever since.

Fannie Mae also cited three other factors to illustrate the demand for middle-income workforce housing over the next several years:

#1 Vacancy rates to remain low

Vacancy rates are expected to remain low through the end of 2020, with Class B at 5.7% and Class C at 4.8%. For comparison, Class A vacancies are projected to increase to over 10% as new inventory comes online amidst a possible recession.

#2 Declining workforce housing stock

In 2009, workforce housing stock made up about 59% of the multifamily real estate market. Last year, that share had shrunk to just 52%. In fact, over the last ten years the market has lost over 140,000 Class B and C units each year due to obsolescence and conversion.

#3 Continuing higher rent growth

Rent growth in available workforce housing units has grown well above the average rate of inflation, due to decreasing supply and increasing demand. In 2018, rent growth in the workforce housing sector increased by an average of nearly 3.2%. Fannie anticipates workforce housing rents to remain strong going forward, projecting an average increase of over 2.5% through year-end.

The opportunity in small multifamily investing

Housing prices across the U.S. continue to rise, especially in high-demand city centers.

Middle-income workers are mostly unable to afford expensive single-family homes in urban and closer-in suburban areas. They’re effectively being priced out of the market and forced to live in less desirable far-flung suburban areas that lack nearby amenities and access to mass transit.

The ‘missing middle’ of smaller, multi-family assets offers rental property investors a unique opportunity to capitalize on the growing disconnect between supply and demand. Missing middle workforce housing is an asset class with strong demand from middle-income tenants looking for smaller housing units in prime city locations where vacancies are low and rents continue to grow.

In summary…

• Workforce housing is housing that is affordable to middle-income renters such as teachers, firefighters and police, and other community service professionals
• Missing middle multifamily housing includes duplex, triplex, fourplex, and smaller bungalow and courtyard apartment buildings
• Demand for missing middle workforce housing comes from students, millennials, and baby boomers alike
• The missing middle workforce housing sector is characterized by limited supply and rising demand
• Vacancy rates in this niche are projected to remain low while rents continue to increase

Source: Stessa.com