In the world of real estate investing, many people have been advocates of purchasing in the affordable housing area. While we were certainly not unique in that stance, we do believe that now many people are jumping on that bandwagon?.. And we believe that is good for not only investors but also for the general population as well.



Some real estate pundits may say that there is quite a substantial amount of available housing nationwide; however, this available supply, generally, does not reach to low-income earners in the country. The lack of affordable housing indirectly impacts the nation's economy. How? Companies and institutions are not being productive when employees have difficulty coming to work because of the distances of their homes from their work. Employers suffer from having employees coming to work late and may have employee retention issues as well. Employees, on the other hand, also endure some difficulties from taking long commute everyday to go to work, exhaustion from travel and not getting to spend enough time for the family.

To give you an example of what is going on in my backyard, which is the Destin, Florida area, we have a HUGE problem where our area needs lots of moderate wage ($20,000 - $50,000) employees but they cannot afford to live within a 45 minute drive to their jobs. Some employers are going to the extremes of picking their workers up in a town located 35 miles away! Others, without families, are causing havoc with landlords by group 5-15 people in a 2 bedroom apartment/home.

Furthermore, it is becoming more and more difficult now for first time home buyers to secure a home loan primarily because of the continuously rising housing costs. Required down payment increases as well as monthly mortgage payments. Mortgage lenders may have programs that can entice first time home buyers but may still not be affordable for those belonging to the low- and extremely low-income earners. As a matter of fact, homeownership rate in the last quarter of 2005 decreased to 69% from 69.2% of the previous year. Though the decrease is too small, it is the first time in 11 years that the rate did not increase from the previous year according to the US Census Bureau.

SUFFERING FROM A HOUSING CRISIS

Let's take for example the state of Maine. Though Maine's economy is only developing at a moderate pace, property values are rapidly increasing. New jobs being created in the state offer wages that could not even afford the available housing in the area. According to Selinger, a real estate property lawyer in Maine, the lack of affordable housing for Maine's workforce is the reason why businesses do not progress. Workers are stuck in long commutes due to a simple lack of affordable housing.

The housing crisis does not only affect Maine. The issue on the lack of affordable housing encompasses every state in the country, most especially the high-cost cities such as San Francisco, West Palm Beach and Honolulu, as well as the highly-urbanized New York and Boston. According to the US Department of Housing and Urban Development (HUD), almost 12 million households are now spending more than 50% of their income in rent and mortgage payments; THAT IS HUGE!! These households are indeed burdened by the high housing costs and not being able to afford much of the other basic necessities such as food, clothing and medical care.

AFFORDABLE HOUSING OBSTACLES

With all the aforementioned facts, the question now is: Why are developers and builders not addressing this issue if there is such a demand for affordable housing? Well, there is only one answer to that: cost! Not only housing costs are increasing nowadays but the cost of everything else as well. To build housing projects, developers need developable land. Due to the increasing commercialization in most areas, costs of land are skyrocketing; materials and labor costs are also rising, not to mention the increasing property tax to be remitted to the government. If you live in Florida and other hurricane prone areas, then you can also add in a sky rocking cost of insurance. In essence, high construction costs limit the development of more affordable housing in the country.

AFFORDABLE HOUSING DEFINED

According to the US Department of Housing and Urban Development, households spending more than 50% of their annual income in housing costs are cost burdened, i.e. their house is not considered affordable. So what then is affordable housing? One good way to determine affordability is to look at how mortgage lenders evaluate people applying for home loans. Lenders evaluate applicants in different ways including some key ratios to determine the risk level of lending to borrowers. One of these key ratios is the debt-to-income ratio. As the term implies, it is the ratio of a person's debts and liabilities to his income earnings.

Let's take an example of a person with a household annual income of $55,000. He is looking to buy a house with a monthly mortgage payment of $1,800, including principal, interest, taxes, and insurance. With the given amount, the annual cost of paying for his house would be $21,600, which is roughly 40% of his annual income BEFORE taxes. Generally, the lower the debt-to-income or mortgage payment-to-income ratio, the more affordable it is to make the payments for the house. Lenders consider 30% to 36% being a good indication of a debt-to-income ratio.

The US HUD (http://www.hud.gov/offices/cpd/affordablehousing/index.cfm) defines housing affordability to be no more than 30% of a household's annual income. Spending for housing more than this cap is considered unaffordable and households may have problems in spending for other basic necessities. However, the reality is that households spend more than the 30% reasonable amount to cover for the housing costs.

AFFORDABLE HOUSING AS AN INVESTMENT

The issue of affordable housing is well known and there is a lot of investors looking to take advantage of this opportunity. However, it is not as easy as one may think. As mentioned above, there are several obstacles to building affordable housing. Aside from the rising construction costs, there are also other payments that need to be considered such as mortgage payments, property taxes, insurance and HOAs.

Cash flow may be an issue if one will invest in affordable housing. Let's do an example like below:

Purchase Price : $250,000 with 20% down

7% Interest only loan : $1,167 per month

Taxes (1.5% of purchase price) : $312.50 per month

Insurance : $120 per month

Rent : $1,200 per month

With the above figures, the total monthly cost the investor will incur is $1,599.50. The real estate investor needs to make that monthly payment for 12 months plus the loan amount at the end of the loan term. With the rent amount only at $1,200 per month, the investor will then face a negative cashflow of several hundred dollars per month. While this may make sense in some circumstances, the investor then has to do a careful analysis of this negative cashflow versus expected capital appreciation.

Our philosophy on affordable housing has been very simple: buy affordable housing in areas 1) where demand is expected to continue sky rocketing and 2) where quality properties can be purchased with minimal cashflow consequences due to large buying power, and 3) where investors can reasonably enter and exit with safety.

Copyright 2006 Chris Anderson