Rental Property Owner & Real Estate Investor Podcast Presents: Solving the Need for Workforce Housing with Scott Choppin

As real estate prices increase, and the supply of new construction fails to keep pace with demand, the need for middle income housing is a steadily rising challenge that many communities are experiencing. Today we’re going to discuss Workforce Housing. What is it, who benefits from it, and how is it being developed?

And here to have this conversation is Scott Choppin, a seasoned real estate developer with hundreds of millions of dollars of experience and specialization in workforce housing. He’s also the founder of Urban Pacific, which specializes in the development of a unique type of Urban TownHome.

Scott is going to share the development model that he’s employing in middle-income neighborhoods that cater to co-living and inter-family residents. We’ll discuss the cost saving techniques he’s employing to develop and build these properties without any type of government subsidies. We’ll also discuss the defensive nature of this type of housing against economic downturns and the financial fallout from the coronavirus pandemic.

For full transcript click here Expand

Intro: And so then you go, okay, can I buy land and build, cost and rent for an economic model that makes sense for us to attract families. Everybody who hears the term workforce housing has a different definition of it.

Welcome to the Rental Property Owner and Real Estate Investor Podcast brought to you by the Rental Property Owner Association, providing benefits and services to real estate investors and rental property owners for over 48 years, with your host Brian Hamrick from Hamrick Investment Group. This episode is sponsored by Green Property Management, managing everything from single-family homes to apartment complexes in the West Michigan area. Find out more at greenpropertymgt.com.

Brian Hamrick: Hello, and welcome to Episode 240. As real estate prices increase and the supply of new construction fails to keep pace with demand, the need for middle-income housing is a steadily rising challenge that many communities are experiencing. Today, we’re going to discuss workforce housing. What is it? Who benefits from it? And how is it being developed? And here to have this conversation with us is Scott Choppin, a seasoned real estate developer with hundreds of millions of dollars of experience and specialization in workforce housing. He’s also the founder of Urban Pacific, which specializes in the development of workforce housing. Scott, welcome to the show.

Scott Choppin: Brian, great to be here. Appreciate the invite.

Brian: Why don’t we just start with you explaining to us and our listeners, what exactly is workforce housing and why is it important?

Scott: Great question. So I always love to answer this question, Brian, because everybody who hears the term workforce housing has a different definition of it, right. Like as many people as you ask, you’ll find as many definitions. So really where we focus is on working families that are between 80 and 120% of median income for whatever area that they’re in. And, you know, those incomes are generally published by governmental agencies like HUD and for us, workforce housing also means it’s a rental housing offer. So the way we say it is we’re pairing private capital with a workforce housing model. That workforce housing model we call Urban Town House or UTH for short. And that model is a workforce housing rental model that serves large working urban families. That’s sort of the way that we go at the definition of it.

Brian: You are in the business of developing and building workforce housing. Explain that. What exactly are you building?

Scott: So, yeah, it’s a great question. And we always like, as we go out into the marketplace and particularly talking to investors is differentiating what we do from just standard value-add projects but also workforce housing in some domains is a value-add that happens to be maybe a B or C product where folks would purchase it, you know, upgrade the property, but not raise the rents much or maybe at all. That is one version of workforce housing that’s out there in the marketplace. Ours is differentiated because we’re entirely new construction. So all of our projects are standard real estate development type actions. You know find land, design buildings, finance it, build it, rent it, hold it would be the shorthand that we use for the product. But the main differentiator is that we’re producing new units and differentiated from value-add in the context of we take on the real estate development actions that are different than value-adds. So we have to source land. We have to design buildings from scratch, right. Like, you know, when you do value-add, you buy an existing mix of units or you bought this deal, had one and two bedrooms, right. You sort of live with that choice.

For us we are able to design really any product we want, although we’re very intentional about the product that we do design and the Urban Town House model, just by way of example is a five-bedroom, four-bath townhouse product, two-car garage, private direct access on the ground floor. Then we also make it multi-generational by putting a ground floor, bedroom bathroom. So in-law or grandparent would live there who has mobility issues, ADA accessible. And then a second floor is kitchen, dining, living, bedroom, bathroom. Then on the top floor, we’d have a three-bedroom, two-bath layout with a full-sized laundry room. So we’re able to come into a marketplace, assess what the gaps in the markets are, and then design a product. Now, all developers do that. So that’s not, you know, tremendously different. It’s just that we’re able to design from scratch a product that we think is going to compete in a less competitive space. You know, we always liked the story of high demand, low supply, right, which is not always, you know some markets you may have an oversupply. And particularly where we are in the economic cycle as of March 2020, that’s a real key factor to be tracking.

Brian: I want to make sure I understand what exactly you’re doing because when you say it’s a five-bedroom, four-bathroom home that you’re building, that seems rather large for the average family. Is this a co-living type space or what?

Scott: Yeah.

Brian: What’s the makeup of the people who actually live there?

Scott: We arrived at this product type UTH by experimenting on one specific project locally where we’re based in Southern California in the city of Long Beach. And what we had was the opportunity to buy a site very cost-effectively. I mean we had a great purchase price. The interesting thing about that site was it was limited on the unit count for the zoning but the size of the units was unlimited. So we had this interesting conundrum of limit on units but we could design inside that unit count any unit type we wanted. So I sort of riffed on the idea of, I go, “Okay, so we could do one and two bedrooms, maybe studios, which is the common urban infill product type, you know, predominantly marketed to Gen Z and millennial, right. Singles, young folks, right. But when we started to work on this townhouse project, we could do a really unlimited number of bedrooms, right. Well, like we could have done 15, I’m being a little bit ridiculous there. But we started going, “Okay. Three bedrooms. Okay. That’s good. Well, what about four? Like, you know, what does that look like?”

So we ended up on that particular project, which is actually ultimately becoming the first UTH project. We did a four-bedroom, three-bath two-story townhouse product with a two-car garage. And we had tremendous success with that, Brian. What I mean by that is when we underwrote the deal, our rents were 2650 for a 1600 square foot, four bedrooms, three bath rental townhouse. And when we went out to the market to rent the units, we actually achieve rents between 2950 and 3250. This is in Downtown Long Beach, you know, urban infill. And that really gave us the initial, like a measure of success for what these townhouse units could do. Now we were already in the conversation at that time and part of the reason that we were even experimenting was that we had executed and finished, leased, and sold several large-scale podium and urban infill, sort of standard apartment project. So we had a 453 unit. One and two-bedroom products we did in Denver. We had several podium projects in Long Beach. The podium being four stories stacked on top of a concrete parking structure with cars parked below the unit.

Brian: That’s the actual term. Podium means…

Scott: That’s what we call it. I define it because you know a lot of people go, “what’s a podium?” But it’s basically the units that sit on top of this deck where the garage and cars are parked underneath. We call that podium. We were already at that point, this is, say late 2016, early 2017 already seen oversupply signals in the marketplace and it continued even through up to several months ago or even now, where a lot of people were producing a lot of that podium product. And all that was the studio one and two-bedroom product. By the way, nothing wrong with that. And in fact, coherent with Gen Z and millennial lifestyles, right. Younger folks going to live singly, mobile, urban, right. And, you know, the largest demographic cohort in US history, so perfectly appropriate for any developer to seek it. It’s just for us, we recognize that there were lots of people jumping into that space and so we said, we want to do something different.

So we were already in that conversation of change, right. And looking for the capability to find new niches to exploit. Also I have a background in both affordable rental housing and market-rate rental housing. So I had seen both sides of the spectrum of affordable housing and market-rate housing. And one of the truisms about affordable housing, you know, true government-subsidized housing is it always is limited by the amount of government subsidy that can be found for a project and that source of government subsidy is always finite, right. There’s never enough compared to the overall demand for those units in a marketplace, right. We’re ever undersupplied in true affordable housing. And because I worked in that domain really for most of my career, I recognize that. And I also knew on the market rate side when the market is right and the product is right and the location is right, well, then you should be able to find capital.

Now, obviously, in economic shock periods, you know, that changes the dynamic of investor interests. But we sort of go, well, let’s put those two spaces together. Let’s pair private capital with some sort of affordable. Now I knew it couldn’t be deeply income and rent-restricted, like true governments subsidize affordable housing. Because the subsidy in fact makes up for the shortfall when you lower your rent so much, right. You end up producing a gap in the capital stack that has to be plugged in with this soft money we call it. So I go, let’s look at really middle income or moderate-income. So that was the genesis of UTH and you’re right. Five bedrooms, four baths are completely out of the mainstream and that’s in fact by design. And it’s done that way because in our research, large blue-collar working families that live in these major urban metros, that is our primary demographic. And these families are going to be between 6 and 10 people. They’re going to have two to four wage earners, right. And what’s unique about that, one is the large family size first, but also the two to four wage earners is a real key and we’ll talk about economics cycles later.

But it’s a key for affordability in the context of 30% of income, right. That’s the standard rule of thumb for what everybody would say if somebody is paying 30% of their income to rent that makes it affordable or attainable, right. So there are two to four wage earners. They generally are producing enough income collectively to afford the rents that we produce in our projects. And we’re still in that 80 to 120, you know, space by the way. But it is an economic sharing model. So you brought up co-living before. Our model isn’t co-living per se although you could describe it as co-living, but for a related large family, right.

Brian: Like a multi-generational type family?

Scott: Exactly.

Brian: Grandma, grandpa who is still in the workforce.

Scott: Correct.

Brian: And then their kids and grandkids are all living together.

Scott: Exactly right. So the 6 to 10 people, the way I describe it is mom and dad, maybe an adult child, or two, grandma, grandpa, maybe older in-laws, right. Younger kids, maybe the kids of the parents, or maybe kids of the adult kids, right. They’re already basically living the lifestyle that UTH serves. So what I mean by that is, are they classically and actively share incomes and expenses across the family group, right. So that two to four wage earners is really key there because they’re all basically pitching into the family’s success. And in an environment, like we’re in now, if somebody loses their job, then there’s, you know, two, three, four other people that are producing incomes in the families. So they can adjust and share the responsibility for costs across the family group.

There are a couple of other benefits too, which I’ll just say quickly. So they share incomes and expenses across the family group. Two, is that they’re generally sharing vehicles and these are heavier users of public transportation. And that’s key because that means that they want to live where there is public transportation and they want to live closer to their jobs, right. These are not super commuters. The important part of that is that basically reduces the need for massive amounts of parking. Like if you had a 10-member family in the suburbs at a higher income, well they’re probably got tons of cars, right. Somebody turns 16 and the family gets a car, right. These families are not living that lifestyle. They’re living frugally. They’re buying enough cars to serve the family but use public transportation generally. But also, guess what? When we build in an infill situation and their job is close by then the demand is already built into the marketplace, right. Like we don’t have to try to pull people from, you know, 18 miles away to try to come rent our apartment, which you may do in a bigger project.

And then the last part is, and I’ll finish with this. This doesn’t impact rents at all but it is a great social benefit because these families live multi-generationally, somebody’s generally going to be at home when kids get home from school, right. So the older in-laws, maybe grandma, grandpa, or maybe parent works the night shift and is home. Generally, because they’re living multi-generationally, these kids are coming home to somebody at home. So we almost miss entirely the whole latch key kid you know, type of scenario.

Brian: Yeah. That sounds like an incredibly efficient way for families to live. But it also sounds like there’s got to be a cultural distinction between the types of families that live in that type of situation. Is that the case? I mean, are you seeing more say, Hispanic or Latinx families living in this type of housing?

Scott: Exactly right. We’re based in California. Southern California, LA, and Orange County is our operational area presently. And that makes up almost the entire demographic of who we serve in these UTH projects. Occasionally, if we’re in certain micro-markets, we would have Asian families. But you know, the predominance of demographics is in that larger Hispanic family domain.

Brian: Yeah. This is a fascinating model and I’d like to just take it and apply it here in Grand Rapids, Michigan. I mean, let’s go through an exercise here with me. Will you?

Scott: Sure.

Brian: So what we typically see here are the two models that you just kind of highlighted. You know, the new construction is typically A class construction. It’s definitely not middle income or workforce housing in most cases. And then on the other end of that, you have the affordable housing that’s being built, usually with some form of grants or government subsidy money coming in. How would that work here? Because obviously, we’re not like California where we have such a large Latinx population. Do you see that working in markets like Grand Rapids?

Scott: You know, I’ve done research in Michigan, but, you know, it’s more on the Detroit area. So again, urban and just for clarity, Brian, I mean, as a developer, since really almost the start of my career, we’ve been urban infill or urban real estate development centric. My background says we’ve always been major urban Metro developers and…

Brian: And define what that means for our listeners who might not be clear on that.

Scott: So urban infill basically is a style of development where you’re finding sites that are vacant or under-utilized in the already existing urban fabric. It doesn’t necessarily need to be downtown X, Y, or Z, although it could be. Generally, these would be peripheral neighborhoods to the central business district or CBD. So, you know, Downtown LA would be an example. So this is just a style of development that is finding locations to infill new development in an already built out fabric. So it’s different than the opposite which would be greenfield development, which is you’re building on raw land that’s never been built on before. Maybe has no development around it, right. You’re on the edge of a suburban community pushing outwards. You know, Texas would be an example of where it happens or that happens all across the United States. So this would be maybe urban infill is the opposite of suburban development. Although occasionally in certain built out sort of middle-aged suburban communities, we might find infill sites that are co-located to transit.

An example of that would be, we did a large project in Westminster, Colorado. Westminster sits, you know, directly between Boulder and Downtown Denver, it would be locationally. You know probably started developing in the late forties, early fifties, right. By the time we arrived in sort of the mid-2000s still had a lot of open space, but their zoning was restricting where development could go. So we ended up doing that 453-unit project there and we made it urban style and it was an infill parcel, you know. So there’s a range of definitions of it. But it’s just the opposite of greenfield suburban development and looking for sites where you can build in an already existing community may be another way.

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Brian: And then what are the economics of that? Because I know a lot of construction right now is, or at least pre-coronavirus here was the higher end because the cost per square foot to build is just so high right now. Especially with the lack of construction workers and the cost of materials that you had to get that higher income per square foot in rent to justify it. Unless of course, you were doing subsidized low-income housing. So how does your model fit into that?

Scott: So before I answer that, let me make sure I go back because you were using Grand Rapids as an example of whether this could work there or not. And I’m not sure that I completed that. Do you want to…?

Brian: Oh, absolutely. Yeah.

Scott: Yeah. Sorry.

Brian: We will make it a two-part question.

Scott: I went off on a tangent Brian, but I want to make sure I’m taking care of the great question you had. So relative to a market like Grand Rapids, again, I don’t know Grand Rapids that well, but let’s use any suburban community that’s several layers outside of the central business district of any major urban Metro. Our opinion of it and even its research-grounded is that UTH isn’t going to work in those kinds of markets because once you go far enough out from the job centers or the urban centers, you’re going to have a dramatic fall-off in the cost of land and that price of housing and that’s both for sale and for rent. So like locally, an example would be for us in LA, Southern California would be like Riverside County, right. And so once you get into those markets, when rents for houses or apartments drop enough then our model will not work right. So a different way to say would be, we really work best in urban infill, close end markets because housing costs are very high there. The land is constrained. People have to build podium projects to try to maximize the number of units on a given piece of land, right. So that formula is really where we work best.

With this caveat though, we are seeking land really only in low and lower-middle-income neighborhoods. And the important reason is really two-fold. One is that’s where our demographic already lives, right. They’re usually going to be living in an older apartment, property, maybe an older house. In fact, for a larger family, they may even be occupying two units in an apartment community, like next door to each other, right. They have a big family group. They’re sharing incomes and expenses but they don’t have a housing unit or an apartment unit that serves their family, right. There are no units big enough. So that’s where UTH comes in.

Brian: In relation to Grand Rapids then.

Scott: Yeah.

Brian: Was that applied in some of our areas in Grand Rapids?

Scott: I guess Brian, the answer is I don’t know, Grand Rapids well enough to know what the rents and costs are. The other reason we like low and lower-middle-income communities, not only because the tenants are there, but also we’re not competing for land with the mainstream development community. So if you had an infill condo builder, which is somebody we compete with regularly, or a type of person we compete with in Southern California, they’re going to go into middle income, upper middle income, and upper-income areas to find land there. They’ll pay more for it. And where we go in these low and lower middle income neighborhoods, they’re not looking for land. Like the incomes aren’t strong enough there to qualify or afford the down payment for a for-sale unit. And also those neighborhoods are predominantly rental.

So to answer your question, you know, Grand Rapids might work if you could find a neighborhood like, you know, two or three neighborhoods over the rents are high and high means relative to the incomes that are produced in that marketplace, and could you create a story or find a story where two or three neighborhoods adjacent to that is families want to live in that location because jobs are strong there, right. They don’t afford the high rents for new housing or the new housing doesn’t fit, right. A studio unit isn’t going to fit a large family. So then you go, “Okay, can I buy land and build, cost and rent for an economic model that makes sense for us to attract families, right. If the rents are not high enough in that higher income, neighborhood, then UTH will never work, right. Because we’re looking for the differential between new housing and high priced housing and building a new product that’s new but can be a lower-priced offer or more coherent with a large family lifestyle.

That’s the differential we’re seeking, right. Like that delta between those two. So part of the model is you’ve got to have the high rent area, right. That these families don’t go to, and then we can provide an offer for them that they say, “Great, this is a new unit and it’s five bedrooms that fit our family lifestyle. And oh boy, guess what? Although it’s 3000 or $3,500 a month, a house to rent would be 5,000 a month, right. If I wanted a five-bedroom comparable unit then I couldn’t afford that. Now, the last part I’ll say is what we’re finding is we lease more of these units. A lot of these families don’t think of themselves as renting houses. I mean, I’ve always told my team, my leasing teams, that our comparable are houses. Not other apartments because guess what? Nobody does five-bedroom apartments, right. That’s uncommon by itself. So we say our major competition and I say, what family wouldn’t choose all else being equal to rent a house with a backyard, lots of open space, white picket fence, right. Like more fitting with the American dream, except in the neighborhoods and the markets that we’re in that differential of high rent in the adjacent community drives them to look for other alternatives that are lower cost but are the best fit for their lifestyle. And we’re landing UTH right in that gap between low-income communities with older C product and brand new A in the high-income neighborhoods. We’re in the space in between those.

Brian: Well you’re in California, where I think there’s a lot of creative solutions to housing, or at least there is it kind of because there’s so much demand for housing, you have to create it. And it also seems like you’re sort of pioneering this concept to some degree. How challenging is it for you to find the financing to do these types of developments?

Brian: You know, as much as you’d think. I’m in agreement with you. And our design and our business plan around this UTH model was designed specifically to be contrarian, to be uncommon. We always knew going in that, you know, this would be a higher challenge for debt and equity. I will say this though, because as I said earlier, we’ve always been an urban infill real estate development company, since day one. That was always a challenge, right. We were doing downtown loft housing in 2000 when urban was not cool, right. In fact, we’d bring investors down to Downtown LA or Downtown Long Beach and this was now 20 years ago, but people would be put off by the urban fabric, right. Homeless people, people panhandling, you know, for lack of a better way, you know, older poorly kept up properties in 30 neighborhoods for lack of a better way to say it.

But we always observed that there was a demand for housing by certain parts of the demographic to go into those areas. In that case, it was, you know, young urban professionals. Yeah. I remember the term yuppies. It’s not used much anymore. But that was who was seeking that. Now I happen to be at the time that I started my company, I was 32. And to me, I was like, this is the coolest stuff ever, right. Who wouldn’t want to live in an old red brick loft in Downtown LA? I mean, you know, Holy cow, that’s great. So we were serving that demographic that was seeking that lifestyle, even though it wasn’t mainstream. And so what that caused and answering your question is we were always pioneering and in relative terms to capital and debt, right. I mean, people were looking at Downtown LA, like we were crazy. I mean, literally, like they were looking at us like, are you sure?

Brian: I lived in LA 20 years ago? And I remember a friend of mine moved in to one of those lofts Downtown. That’s exactly why I said.

Scott: And did you go visit? Like did you go down and see it?

Brian: I wish I had, but no.

Scott: I remember we had a funny side story. We were trying to raise capital and we brought a company that was really run by a guy who was from Orange County in finance, predominately like, you know, single-family, home building, you know, master plan type stuff. And he expressed an interest. So we brought him down to 5th on Spring to our security building the last project. And I remember walking around and he looks at me and he goes, “Hey, are you going to put screens on the windows?” Now, these, mind you Brian were windows that were like five feet wide and like 20 feet tall. I mean, they were the most insane windows you’d ever seen, right. An old 12 story office building built in the twenties, just crazy, beautiful, just big, and ornate. Like you, you just, nobody would build that. And I instantaneously knew that was the wrong guy because he was hung up on the fact that we didn’t have screens. The people who rented those lofts didn’t really care about screens. In fact, arguably they didn’t want screens because, you know, they wanted to basically be able to hang out on the fire escape like people do in the city, right, as an example.

Brian: Oh yeah.

Scott: So back to your question. So we’ve always been pioneering on debt and equity. So this UTH model was no different than that, meaning pioneering, uncommon, early, contrarian. But of course, you know, as you’d expect just the same reaction that I think most people have is you go, “Five bedrooms’ rental unit like I’ve never seen that.” And so what we ended up doing was just basically working our institutional capital, institutional equity, you know, networks, our lender networks, and just basically whittled down to a group of people who ultimately we could see from their reaction and our conversations that they were like, “Oh, we get this workforce housing model. We get this middle-income story or missing middle story.” They were on board. In fact, it’s very polarizing the reaction to our model. It’s either people think it’s the craziest wackiest thing they’ve ever seen. It has all these issues, or like, we totally get the workforce housing story. And that’s certainly more mainstream today in the media nationally and particularly coastal markets like California.

People who run those markets, they get it. They go, “Oh yeah. Like I’ve got people who work for me who could use this housing.” Like we had a partner in one of our deals. He worked for basically like a Keller Williams office in Southern California and his team of people who worked for him, were like, “We want to rent that unit. We already live in this neighborhood. My church is two blocks away. My kids go to school. I have a big family. This housing doesn’t exist. Like we want to be there.” And so as we started to experiment with this early stuff and get them out to the market and how people observe it, it just continued to confirm and reconfirm over and over again that we were in the right space. That there were families that were looking for this housing. They’d never seen it. And when they did see it, they were like, “I didn’t even think this existed. I’m an apartment renter.”

This is mentally how people like, you know, the story that they have for themselves. They don’t look at houses, which we’re finding out, but when they see a five-bedroom apartment unit, they immediately gravitate to it. If they’re in that demographic if they have a large family. If they’re in that location where we’re delivering the units. So that’s the real key is that we’re building product into an already existing story of these families that they have about themselves, right. And they just don’t have an offer of housing for which to rent a five-bedroom, four bath unit.

Brian: So I know that this is your focus the UTH right now, Urban Town Houses that cater, you know, five bedrooms, four bathrooms cater to kind of the co-living inner family type situation, which is really targeted and segmented solution to a particular housing challenge that, that demographic faces. Do you have other examples, whether you’re engaged in them or not of how similar types of housing issues are being addressed and some of the creative ways that that’s happening?

Scott: Yeah. Great question. Like I read massive amounts of any kind of information I can get daily on the workforce housing marketplace. So the other offers that we’re seeing, you know, one I mentioned before, which was what I call the workforce housing value-add model. So somebody’s buying a C property. They upgraded to, let’s say a B, B minus. They already have a demographic that’s renting in the community that pays rents that are sort of in this workforce, you know income range. Then those folks will have some sort of a social impact story about their capital going into the deal where they won’t raise rents maybe at all, or much. Like they want to continue to stay coherent with the incomes of the people who already lived there, right. So that’s the value-add story.

We’re seeing another model, which is, I call it a mixed-income model, right, where you might have a range of 30% of income units up to 150%. But if you average across the entire spectrum of those income and rent ranges, then you know, you would land in this middle income and the units will be in that 80 to 120. But beyond that, you really don’t right have much beyond those models. Like I think places like New York have programs where they will I think the way I understand it is they’ll give rent abatement for projects that will serve renters, like from like 100 to 160% of median income. And a lot of people like, you know, in the communities that they are not necessarily New York, but, they look at wait 160% of me, that’s not affordable housing. That’s market rate like people would say.

And it’s interesting because of my background in affordable housing, I have a deep network of people that, you know, continue to work in that space. People, I still do business with really a lot of good people in this true affordable housing space. There’s an interesting dichotomy there because I think when we approach cities and school districts is another sort of group that we present to for providing workforce housing to their specific clients, if you will, teachers as an example. We get a lot of pushback from the true affordable, think nonprofit folks or people who are completely a hundred percent oriented towards affordable housing, meaning at, or below 60%. And they see moderate-income as competition. They see it as competition because they go, “Oh, well that project’s going to compete for subsidy for my project.” And this is why I really, you know highlight the fact that we’re pairing private capital with a moderate income workforce housing business plan.

Brian: Does that mean you are getting some sort of subsidy for what you’re doing?

Scott: No. So no subsidy at all. Very specifically designed to have no subsidy because we know, earlier I said that government subsidy for affordable housing is a finite source, right. There’s always a limit and always will be in my mind, right.

Brian: But it sounds like some of the pushback you’re getting is because they perceive that it’s going to compete for those subsidies.

Scott: They do. Like for them, the way they think about it is completely right. It is a competitive space. It is oversubscribed meaning more projects needing capital soft money than there are soft money sources. So when I hear that, I go, I understand. And that’s why I started to speak more of the narrative about that using private capital part. Really, if I were to say what is the innovation of UTH, it’s putting private capital together with a workforce housing income model, right. That’s the innovation. I mean, people have been doing townhouses. People have been doing large family rental to some degree. People are doing market-rate deals. For us, UTH is a combination of multiple of those different stratifications without subsidy using private capital. And then you go, the next question is, well, how do you produce a return to equity? Like, how do you do that? And, you know, we can answer that assuming that’s a question you want to talk about.

Brian: Well, I do but you bring up a point that maybe we should touch on. And that is how would you describe the need for middle income and workforce housing across the country? Because my understanding is that we have less and less of it, and it’s really become a real problem in a lot of cities and states.

Scott: It is not a mainstream part of the conversation or if it is, people will say, “Oh, those people are, you know, they’re well employed and they’re successful and generating income for themselves.” And their incomes are way above these folks who go into true affordable housing, right. Like better, deeply subsidized, deeply reduced rents, right. Even like in California, the homeless stories is a big, significant part of the affordable housing actions that we’re in today, or at least the market is. But here’s where I go with it. If you look at statistics of middle-income families and their increase in incomes, generally their incomes are stagnant, right. They’re flat.

Over I had a graph that I use going back probably 30 plus years, depending on how far the research is. I use Pew Research for some of this data, incomes are generally flat, right. And then I have a graph that pairs that flat income information overlaid with a rise in housing costs, right. And I’ve got graphs for for-sale. And I have graphs for rental. Incomes are flat, so on that graph, that line is flat. Then if you look at the increase in housing costs, i.e. rents, it’s like a 40 or 45-degree angle, pretty much linearly upwards. So the gap between the incomes and the housing prices is getting ever wider. In fact, we’re at the widest that we’ve ever been. You know that may change a little bit in this economic cycle that we’re starting to go into now. But this is over a 30 or 40-year period, right, Brian. So in other words, even a recession will not fix this issue where housing prices will drop so dramatically that all of a sudden it becomes attainable to middle-income families.

You’ve heard this story. And a lot of people who listen will have heard this story, which is, “Oh, when my parents worked, they said they got an entry-level job, and that was enough income to take care of their family and go buy a house.” That story doesn’t exist anymore. And the reason that story doesn’t exist anymore is that both in rental rates and for-sale housing prices, that cost has gone up relative to incomes to such a degree that middle-income families are deeply outside of their capability to affordably rent or income qualify for housing, right. And that space between average housing costs and average middle-income family rents, that’s exactly where UTH goes. So the way I describe it Brian is, basically these families that are middle income with stagnant incomes are being ever dropped down the food chain in the housing market. What that means is that either they’re paying more as a percentage of their income, meaning their rent burden is the terminology that people use.
So classically, we would like families to rent at 30% of their income, right. But the total annual rent of their unit would equal 30% of the income that they produce. But in California, as an example, I mean, we have families that it’s ever-increasing, right. The rent burden is increasing regularly. So where people are paying, you know, 50, 60, maybe more percent of their income towards housing costs. And so what that does is that crimps the discretion income that these families have to pay for everything else, right. And of course, food costs are rising. Every other, the cost is rising generally, right, at least in this last 10-year cycle that we’ve been in. But even historically housing prices have continued to go up if you look at an average rate over 30 or 40 years. Or if they can’t afford to pay 50% of their income, then they have to choose lower and lower grades of housing, meaning in fear neighborhoods, more high occupancy so they fit a family of eight in a one-bedroom unit, right, as an example. So they get very, very housing constrained, you know high occupancy, right. Which is just not preferable for family health, for psychological health. But people do it because the economics force them to, right. They just don’t have any other choice if they choose to live in this marketplace that has high rents, and they have rents that incomes that don’t afford that appropriately, you know, 30%, then they make other choices.

Now UTH and co-living, and you know, other models are what I call economic sharing models, right. This means that you have multiple different wage earners producing a combined income that then now affords that unit affordably at 30% leaving the family with discretionary income. Co-living, you know, the true co-living model is predominantly millennial and Gen Z. Younger folks that are renting a bedroom, or maybe a couple rents a bedroom and let’s say that costs, you know, 12 to 1600 a month, right. Six bedrooms in a unit, common area, well, that rent for that bedroom, while it sounds high, is affordable compared to renting a one-bedroom, which is, you know, 2000, 2,500 if you rented your own unit. So that economic sharing model, co-living, that’s what that is. UTH is the same economic sharing model. It just happens to be economic sharing in a related family group, right. These two to four wage earners are generally related in some way, either by blood or by marriage. They’re already living in this combined income and expense story and really living that way sharing these things.

Brian: So Scott, let me ask you then because I know you wanted to mention how you’re actually making money and the types of returns if you’re able to get it.

Scott: Yeah, right. How do we make money?

Brian: Because like you said, it’s not subsidized. This is not low-income housing where you getting money from the government to help cover your costs. This is a profit-making model. So how does that work?

Scott: Several unique characteristics about UTH make the model work. And when I say, make the model work means that we have feasible projects, right. They underwrite feasibly, and they have valuations that are sufficient for raising capital and that produce a yield to our private equity investors, our institutional capital partners. And it’s not just one thing that we do that makes the model work. Although there are some things on the range, on the spectrum of things that we do that are more important. I think the first one and I’ll list several in no particular order.

The first one is that where the five-bedroom, four-bath housing unit itself is one of the main things that makes us successful. And what I mean by that is we’re producing a five-bedroom, four-bath housing unit, basically, that produces, let’s say between three and 4,000 a month in rents, right. Now, people may react when they hear. They go, “Oh, 4,000. That’s not affordable.” Except think about it. You’re getting a 1,750 square foot unit, and you’re getting five bedrooms and you’re getting four bathrooms, right. For a big family that four bathrooms are a real key, right. So the value proposition for the rent that you would pay is that you’re getting a lot of value, right. Like you’re getting a lot of space. You’re getting lots of bedrooms, lots of bathrooms. You know you got your own two-car garage. Which by the way, how many apartments have their own private direct access garage? Like not many, right. So that by itself is an amenity. So what makes up the build costs of the unit is predominantly, you know, bedroom space, right.

Most developers would tell you the predominance of your costs to build a unit, as it is in any residential build is going to be your kitchens and bathrooms. So, of course, we have one kitchen, right. We have more than the normal amount of bathrooms. So that weighs into it. But we’re producing very high, gross incomes, whole dollar rents, comparative to the costs that it cost us the build it, right. So there’s one, is the high whole dollar income generator, right. The second part is the build costs which are related. And what we’re doing is we’re building a three-story townhome on-grade product, right. So we’re not doing that podium, you know, parking structure below, multi levels of residential or high-rise even would be the most extreme example of that. We’re building the simplest way we can given a three-story product. And in fact, why we arrived at three stories, by the way, is important because, in our minds, a three story townhouse product is at the intersection of maximum rent generation, still being affordable in that 80 to 120 at the lowest cost at the most efficient density. So if we went to a two-story unit or even a one-story unit, that’s cheaper to build right, more cost-efficient, but the rent generation lessens, right. You don’t have enough square footage or enough bedrooms, right to produce a high whole dollar rent, although it is less expensive to build.

On the other end of that spectrum, you get into a four-over two podium or a high rise project, you’re generating super high rents, right on a per square foot basis, but you have to pay super high prices to buy land and build it. We are at the intersection of what we think is the most efficient bill costs with the maximum rent generation. And we still want to be coherent with this middle-income model, of course. And so why is that? Because basically, three stories allow us to get a little taller, smaller footprint, so we can get a little bit more density, meaning units on a given piece of land. But also from a build standpoint, we’re building in a relatively simple model, right. It’s still stick-built. It’s still type five, right. We don’t have elevators. We don’t have podium parking structures or dig below-grade garages, right. We’re just your standard on-grade slab, stick-built type five, wood framing. And then, you know of course to make it cost-efficient, we have to design well.

So one of the things we do with UTH is we build the same unit over and over again. In fact, we have one, really two unit types. One is our regular five-bedroom. I call it the regular model. Then we have a five-bedroom, I call it a sideways model. So in some site plans, we have to turn the units 90 degrees, right to the drive aisle for the cars to go into the garages. But we build that same unit over and over again. So what happens is like a home builder, we’re getting exceptionally efficient in our design, in our specifications and materials in the appliances that we order, and then the subs because we work with the same subs over and over again. Like a home builder, we get very cost-efficient build costs. And you know, I won’t mention numbers. But I would say that we’re building at the bottom end of costs relative to everything else that goes on around us in California. And that’s going to be true in most urban markets that we would go in because we’re simplifying, right. Now, people will hear this Brian, last point and they’ll say, “Oh, well, what about modular? What about other new technologies?” And we’re totally on board to use those, but right now at least, given the demand for modular housing, that they cannot deliver as cost-efficient a model as we can, even though we’re using the ancient technology of balloon frame buildings, right.

And then the last part of cost efficiency, which I mentioned before is we’re buying land in these low and lower middle income neighborhoods, right. Why is that important is because we’re not competing against a lot of other developers? So we can buy more cost-efficiently land from land sellers because we don’t have a lot of competition. They’re usually lower-income neighborhoods. And so basically, you know, there’s not a high-income housing demand that would go buy that site and take it away from us. But also we buy sites that are only buy right. So in California doing entitlements, zone changes, general plan amendments, site plan review, conditional use permits is a very costly lengthy process. So we only buy, buy right sites, or ones that need low-level design review, but not discretionary. And, you know, so we don’t do any antonymous work generally and we skip that process. We save time, right.

And then also, you know, neighbors in the political process, although we don’t get into it, neighbors love us. They’re like, “Oh man, that empty lot where people are dumping couches for 20 years, you know, you’re finally building on that thing. Great. I love it. You know, you eliminate attractive that nuisance, and oh, by the way, can I get an application to rent.” Which in the development world, you know, usually it’s the opposite. You know, the neighbors want to come and hunt you down. Generally, we’re finding these neighborhoods that, you know, because they’re so fitting with our demographic objective, they welcome it. They go, “Great. New housing in my neighborhood. That’s good for the neighborhood. And oh, by the way, I’ve never seen a five-bedroom. So I’m ready to sign up.”

Brian: That is a fantastic rundown of the cost savings that you’re achieving through your model. Because I think anyone who’s been involved in the development, especially in residential housing, knows that there are so many hurdles to overcome and so many price points that you have to take into consideration. It really seems like your model has minimized as much of that as possible.

Scott: I appreciate that. The way I say it, Brian, is and I’ve learned this over now, you know, close to, it’s now 30 plus years, I won’t say how many years it is. Thirty is enough. Here’s where I go with it. Complexity is the enemy of profits in real estate development. The more complex the land deal, the more complex the build, the more complex the demographic that you need to serve. All those, although predominantly in the land and the build process will defeat profitability. Now it’s not like it’s 100% right. Like one thing, you know, kills your deal. You know, that’s the old death by a thousand cuts, right. This little thing, that little thing, this little inefficiency, that additional complexity. So we’ve really worked and we continue to work to eliminate as much complexity as possible. Now I don’t sit here and say, “Oh yeah, it’s dead simple.” I mean it never will be but like home builders, we’re looking to pick out every little efficiency we can so that we can then just go build these things, production style, and that reduction of complexity, right. That simplicity or simplification, maybe the better way to say it really is the sort of the main thing, if you look at an overarching, fundamental thing that we’re doing is that we’re lessening complexity at every point along the food chain from buying land to leasing units, we’re looking to strip out complexity at every level.

Brian: I’d like to take a couple of minutes to talk about the coronavirus because as we record this, it’s March 19th. We’re kind of in the first week of self-isolating, all that. What challenges do you anticipate from the pandemic that we’re experiencing right now?

Scott: We have always looked at UTH and working families as a defensive space relative to an economic downturn. And the reason I say that was sort of what I alluded to before we’ve got this larger family group sharing incomes and expenses across the family group, multiple wage earners, right. But also these are families that live close to their jobs. They don’t commute long distances. These are not super commuters. And when you apply that, you know what I call stickiness, right. So the propensity for these families to stick in place in a downturn, right. If you look at how they live, they generally are already living somewhat defensively, right. That sharing of income and expenses across the family group is a defensive model, right. It’s protective. It’s meant to be protective of the survival of the family. Like if you look at it just very fundamentally from this survival standpoint. What you don’t get with these families is that they pick up and move across the United States because their job situation changed. Now, I don’t wish that somebody would have to stick or would have to move, right, like if a millennial or Gen Z decided that their job situation changed and they wanted to move back to Texas where they’re from and the LA marketplace doesn’t serve them anymore, I go, “That’s great”.

But our families, these working families are going to be sticky and what that means is they have strong social networks locally. So their kids are in school. Their churches are close by. Their jobs are close by. Their extended family is local. That family that doesn’t live with them, but that surrounds them, right. These all have the effect of keeping these families in place. Like they’re very stable, solidly performing families. I don’t, you know, resist the idea of renting to Gen Z and the millennial demographic against the largest demographic cohort in US history, that is a viable marketplace. I just say I prefer to rent to families that are stable and want to stick around, right. So when you apply that to an economic downturn the model for these families being defensive and protective is perfectly appropriate in a downturn, as much as it is an upturn, right. Meaning that they will adjust for job changes, right. Usually, they’re not, all in the same industry, right. One, you know, works as a barista at Starbucks. One cleans houses. You know, one drives trucks at the Port of Long Beach. And obviously in this coronavirus shut down and sequestering service jobs are the hardest hit, right. Your waiters and waitresses, your folks that work at grocery stores, delivery, I say it, but maybe the delivery people might be busier than usual. And that is a negative for our story, the UTH except here’s where I go with that, as soon as the sequestering is ended, all those jobs are going to come back.

You could argue, yes, there’s economic impact and businesses go out of business. And so maybe there’s no job to return to, but what I mean is the demand for those services, isn’t going away, right. The demand for food servers at restaurants isn’t going to disappear fundamentally because people always have to eat, right. People to stock the shelves at the grocery store. So I think there will be a return, or at least the demand doesn’t go away and people will need to return to service that demand from the economy. So we look at these families as being relatively stable in this downturn.

And I’m grounded in that at least in the last three weeks where we really been concerned about what this impact has on the economic change that we’re experiencing now, relative to our UTH model, it’s interesting, Brian, our leasing rates haven’t changed at all. Like none. In fact, I’m sitting here, as I say it, when our leasing team conveyed that to me now, I don’t sit here and say that it’s always going to be that way. We’re not bulletproof, right. We’re realistic in reality will produce whatever it will produce for us in that marketplace. But I go, I have the best capability for stable, the family that wants to stick around, and that we’re seeing that play out in this economic downturn. Now I do say that people may combine in two families that weren’t living together. You know, mom and dad and. You know mom and dad were living in one household and you know, grandma and grandpa were living in another household. We’ll see families that will come together. And guess what? A five-bedroom, four-bath model is perfect for that.

So people will get roommates, right. They’ll combine families to get into the economic sharing model, even if they weren’t otherwise. So our units are a perfect opportunity for them to do that. So far we’ve been very stable. So we’re in lease-up on a project in Orange County right now. You know, previously, let me say, our rate of inquiries has remained exceptionally stable. We already basically have most of the units pre-leased. We’ve not lost any of the pre-leases. And, you know, mostly because these families continue to work. On occasion, we’ll have kids that are from the local college. We’re not a student housing developer, but of course, if students wanted to approach us because obviously appropriate for five bedrooms in some cases, but our demographic focus always is working family. So right now it’s really stable.

Brian: Scott, if someone wanted to learn more about what you’re doing or how to get involved with it, or just get in touch with you, how would they do so?

Scott: So a couple of different ways you guys can reach out to us. If you go to our website, which is www.urbanpacific.com, we’ve got tons of data for investor education, articles, videos. There’s a contact page where everybody’s got their direct contact info, emails, direct phones. That’s a great way to reach out to us. I would encourage people to go check out our YouTube channel, which is under the Urban Pacific Group of Companies, tons of videos on there. A lot of the same information that, you know, we talked about today. You know workforce housing, but also information about the real estate development process. You know, our observations of the marketplace and those kinds of things. So the YouTube channel is a good source of information as well.

Brian: Fantastic. Well, Scott, it’s been really interesting learning about your creative solution to addressing the middle-income housing problem that we face in this country. The workforce housing that you’re building and the model that you’ve come up with, which I think is pretty creative and unique. Thank you so much for taking the time to talk with us today.

Scott: Thank you, Brian. Appreciate it very much.

Brian: I want to thank everybody for listening to this episode. I’m your host, Brian Hamrick from Hamrick Investment Group. And you can find out more about me by going to higinvestor.com. That’s higinvestor.com. And you can also ask questions and join us on Facebook by going to our RPOA, Rental Property Owner and Real Estate Investor Podcast. This episode was sponsored by Green Property Management, managing everything from single-family homes to apartment complexes in the West Michigan area. Find out more at greenpropertymgt.com.

Outro: You’ve been listening to the Rental Property Owner and Real Estate Investor Podcast brought to you by the Rental Property Owner Association. You can find out more at rpoaonline.org. If you enjoyed this podcast, please go to iTunes to subscribe, rate, and review.

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