Why you should care
By cross-subsidizing low-rent apartments with earnings from market-rate ones, developers are upending traditional models.
The name might evoke a desperate stab at postapocalyptic agriculture, but the Atomic Orchard Experiment is far more hopeful. When it opens, likely in 2020, the mixed-use project in a rapidly gentrifying part of northeast Portland, Oregon, will offer 18 of its 86 rental lofts for $582 per month in a neighborhood where the average apartment rents for $1,550. But the lower rents won’t depend on public subsidies. Instead, the project is counting on an alternative model for affordable housing taking root across America.
Guerrilla Development, the project developer, says the affordable units will go to those “on the front lines of the homelessness crisis.” All project investors, including Guerrilla Development, will accept a 50 percent cut on their cash-on-cash dividends for these low-rent apartments, obviating the need for any public subsidy. Theirs is no isolated act.
In Minneapolis, real estate developer Thor Living is plowing savings from modular construction into below-market rents in a 44-unit apartment community. Real Estate Equities, a St. Paul, Minnesota–based developer, is building a 164-unit community that will set aside 80 percent of the units for residents earning 60 percent of the local median income. San Francisco charity Kahle/Austin Foundation House, associated with Internet Archive founder Brewster Kahle, discounts nonprofit employees’ rents by about two-thirds using market-rate revenues from most of the 11 units in its existing Richmond district mixed-use building. In Boston, DREAM Collaborative’s 12-unit condo design won a city-led competition to reduce new housing costs by increasing density, with new units likely to sell for significantly less than comparable condos and townhomes nearby. And back in Portland, another Guerrilla Development project, Jolene’s First Cousin, will subsidize 11 single-resident occupancy units — including five set aside for housing-insecure renters — with revenues from two market-rate lofts and three market-rate retail units.
The decision to forgo some profit and turn that into a subsidy is not a decision that every owner is going to make.
Deidre Schmidt, CEO, CommonBond Communities, an affordable housing nonprofit
At the moment, these upcoming projects are rare. Most affordable housing developments in the U.S. rely on state and federal tax credits, such as the Low Income Housing Tax Credit, the New Markets Tax Credit and tax increment financing. Some partner with agenda-driven stakeholders, like nonprofit foundations, city agencies and public-private partnerships.
But these emerging projects led by socially minded developers and investors willing to earn lower returns are showing an alternative approach that could eliminate some of the stigma associated with affordable housing, often because of the public subsidies involved.
“The decision to forgo some profit and turn that into a subsidy is not a decision that every owner is going to make,” says Deidre Schmidt, president and CEO of Minneapolis-based CommonBond Communities, an affordable housing nonprofit.
In 2014, the Urban Institute found just 46 adequate units for every 100 households needing housing assistance, while a 2018 analysis by the National Low Income Housing Coalition found renters needed to earn at least $20 per hour to afford two-bedroom rentals in most coastal states. By relying on the internally subsidized model, smaller developers and landlords can escape the complex construction requirements and expansive reporting mandates required for public subsidies and can insulate projects against threats from fiscally conservative lobbies.
The socially minded developers and investors attempting the alternative model aren’t shunning profit altogether — they’re just willing to use rents from market-rate apartments to subsidize the low-rent ones, and in the process to settle for lower returns than usual.
And they need a range of factors to work for them. Kevin Cavenaugh, principal at Guerrilla Development, carefully vets outside investors to ensure they’re not just interested in maximizing profit. Other developers forgoing public subsidy turn to housing nonprofits with lower return-on-investment demands: Real Estate Equities, the St. Paul developer, tapped Greater Minnesota Housing Fund as lead investor.
Market-rate rents must be high enough to support generous below-market subsidies — a cinch in expensive coastal cities like Portland and San Francisco, but less so in relatively cheap mid-continent metros. This is crucial for project underwriters, who want to see the potential for competitive returns, says Anna Mackay, Guerrilla Development’s marketing and business development lead. “If our actual return was just 4 percent, these projects would be harder to underwrite,” says Mackay.
Favorable zoning helps too. Portland has a permissive “as of right” building regime that frees developers to build as they please. The involvement of vertically integrated developers, who need fewer outside stakeholders, is useful. Thor Living, the Minneapolis developer, is backed by a construction and design firm.
In turn, these projects dull affordable housing’s stigma, Schmidt suggests. Residents of well-known below-market-rate communities sometimes face bias and discrimination. “Internal subsidy programs don’t mark tenants in the same way,” she says. Small subsidized housing projects also don’t pull down neighborhood property values much.
That’s key to Guerrilla’s philosophy of “gentlefication,” says Mackay — setting up longtime neighborhood residents to benefit from, and even lead, the all-but-inevitable gentrification process. As the area welcomes more affluent residents, the subsidized tenant’s revenues — from business there — should rise, and by the time the subsidy phases out, he or she should be positioned to absorb market rate.
“Our ambition is that other folks see what we’ve done and say, ‘Hey, we can apply this in our backyard,’” says Mackay.
But there’s also plenty of risk. Bill Bisanz, president of Real Estate Equities, cites rising interest rates, escalating construction costs and expensive amenities like underground parking and granite countertops. Most tenants accept economical amenities in exchange for affordable rents, but lenders and developers don’t always realize that, he says. “We’ve gotten used to fancier cars, houses, appliances,” he says, “and the market’s assumptions reflect that.”
Meanwhile, formerly red-hot rental markets are showing signs of cooling. In Seattle, rents fell this year for the first time since 2009. Portland saw declines earlier this year too. Lower earnings from market-rent apartments reduce the ability of projects like Atomic Orchard to subsidize the affordable apartments, says Mackay.
But, with patient, socially minded investors and “very conservative” financial assumptions, the project should still work out. There’s more than money on the line. At stake is a new way to tackle one of America’s most fundamental contradictions: the struggle of the world’s richest country to stamp out homelessness.