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Scott Choppin, Founder and CEO of Urban Pacific

The Ultimate Guide to Workforce Housing

Today's Guest - Scott Choppin, Founder and CEO of Urban Pacific

 

On today's episode, I welcome the country's foremost workforce housing expert, Scott Choppin founder of development company, Urban Pacific, known as the creator of the innovative and very successful Urban Town House (UTH) workforce rental housing model.

Scott and I dive deep into the waters of workforce housing. We explore how his model works, how it compares to affordable housing, how developers can get involved, and what makes it so successful. This is an eye-opening, fascinating conversation for developers and investors alike about the underserved workforce housing category of multifamily real estate.

What You're Going to Learn

 

*  What is the Workforce Housing Real Estate Model?

*  How Workforce Housing Is Proving to be a New Model for Success

*  How Workforce Housing Compares to Affordable Housing

*  The Difference Between Workforce Housing and Attainable Housing

*  4 Steps to Increasing Your Profits Using Our UTH Workforce Housing Model

*  2 Different Investment Models of Workforce Housing

*  How Workforce Housing Works in the Broader Market

*  The Social Impact of the UTH Workforce Housing Model

*  And much more!

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Show Highlights

Workforce Housing: A New Model for Success

Adam: And then are there any work force, housing programs or initiatives of any sort?

Scott: You know, there are it's a great question. I think it's it's really a how can I put this? It's an undersupplied market fund in the capital space. And, you know, because traditionally true affordable housing was, I think of it, the most well known need in the marketplace. And the most extreme need, all the government programs are oriented to that marketplace, meaning this true, affordable, the all the nonprofits that serve those communities. And that's in the more mainstream media. If you think of HUD. Right. You know, federal level housing, urban development department, you know, that's who though. That's who that government entity serves. Right. Luxury housing sort of takes care of itself as if the market is sufficiently viable. And we're in a up tick in the market cycle on the economic cycle. Then, you know, there's capital for that. There has been traditionally. But this space in between is really new. And people argue, what do I mean by new? But if you think about it and you hear stories as I do, that people say, oh, in the old days, I could get a you know, I could be have my first job and I could afford to rent a unit, you know, on my own or I could afford to buy a house. Now, what you hear today, particularly amongst the younger folks who are in the beginning of their careers, they cannot.

And so I think that's one piece of evidence. I mean, there's others. One piece of evidence that says basically that housing prices and incomes have diverged. Remember, we talked about this gap in a minute or a minute ago. That is where that middle income space really is starting to expand. Right. If you in fact, there was a stat, I came across the other day, California Housing Partnership writes, a market report on affordable housing and attainable housing and happened to write about moderate income families in L.A. County in 2019.  The fastest growth in housing burdened households, meaning they're paying too much of their income towards rent. The fastest growth was in the moderate income category. It was 56 percent growth in that space. Now that's L.A. County so it’s a very specific set of people in that particular geographic region. But I think it really demonstrates that, you know, that is the highest growth area of burden. Right. That they're having to pay too much and too much really is defined as more than 30 percent of their income. Right. The gold standard in the industry is 30 percent of income is the correct amount of rent to pay as a function of your income so that you can afford the rest of the things that you need to do in your life.

Adam: Is there a banking definition of work force housing?

Scott: I don't think so. I think when I spoke earlier, this 80 to 120 would be the closest to a bank definition. And let me let me be clear. Moderate income housing 80, 120. And there's middle income, moderate income, workforce housing. Those are all used interchangeably in many places, including by myself. There are programs that serve that. And banks that will look for that particular space. But again, it's new. It's developing more sources of capital for that. But if you look at it in comparison to the other, you know, true affordable and the market rate, the amount of capital in that space is much, much lower.

How Workforce Housing Compares to Affordable Housing

Adam: Alright so let's move on to the definition of, or making a distinction between workforce housing vs. affordable housing vs. Section 8 housing. So explain to me the difference between these.

Scott: So let me define the first two first and then I'll tag in Section 8 at the end of that, just because I think it's good to have two reference points to build and define Section 8. So affordable housing in the way that I consider and I think in the industry standard would be any housing that serves families that are at or below 60 percent of median income. Right. So think zero to 60 percent is what I call and this is my own definition of true affordable housing. Right. Where, you know, families, their incomes and the rents associated with those families that have those incomes are affordable at or below 60 percent right. Almost every government program out there basically serves that space generally. And there's a little bit of, you know, bleeding over 60 percent here and there. But just for this conversation, we'll say 60 percent. Right. And then workforce housing, you could argue, really is between then sixty one percent and some upper figure in some marketplaces like New York. They may use one hundred and twenty or one hundred and fifty or a hundred eighty percent of meeting income right. In New York. They have moderate that fits in those, you know, 150 and 180 percent figures. But I think definitionally this 80 to 120 would be considered to be the moderate income space.

Classically, right now, Section 8 fits into both those conversations. And that's why I answered the way I did. Section 8 provides a voucher to a family that, you know, like most housing authorities issue vouchers. They have waiting lists of families that need help with housing through this government. It's really a HUD program that's allocated vouchers through the local housing authority and whatever market that that project is or that where the tenant wants to live. Right. So, you know, in our FULLERTON project, it would be Orange County Housing Authority. It would be the person who issues the voucher. Right. They can go into any unit at all that accepts a voucher. That's really the key. In fact, California just passed a law that says that landlords cannot not now bar Section 8 tenants because of their Section 8 voucher alone. You know, in others, there's other criteria that landlords need to underwrite and can underwrite.. Right. You know, you know, credit history, rental history, that kind of thing. But that California state law as of January 1st, 2020, says no landlord can exclude a Section 8 tenant because of the Section 8 voucher or the fact that they have that..

Adam: How do they work, the Section 8 voucher.

Scott: Actually, Section 8 voucher. So basically the way it works, you know, just high level is, you know, the vouchers issued by the housing authority to the family and then the family will go find a housing unit that will accept the voucher and that the rent is generally coherent with the standards that the housing authority considers to be appropriate. And there's some published figures out, something called the Fair Market Rent or FMR for short, which basically says this is what HUD and the local housing authority consider to be the fair market rent relative to what they would pay for a unit that has a voucher. Right, that the tenant moves in and that's the rent that pays. So like as an example, I'm going to probably not get the numbers exactly correct. But I think one of the markets that we're in the FMR. For a five bedroom unit and these are these rents, these FMRs are based on housing size. So one, two, three, four or five bedrooms our units or five bedroom, four bath. And so that rent for that section 8 FMR is 3,221. That's three thousand two hundred twenty one a month. Right. That when that voucher comes into that unit, that's in essence what the landlord can accept to expect to receive as income from the voucher.

Right, now there's some adjustments and the housing authorities do need to look at Market comparables. But it's based on, you know, published FMR. Market comparables. And then most importantly, the tenant only pays 30 percent of their income, whatever that is, if their income is zero. Then they pay 30 percent of zero. Right. If they make, you know, ten thousand a year, then it's 30 percent. Right. Out of ten thousand. And then the voucher makes up the difference. Right. So let's say every year or every month the tenant can pay two hundred twenty one dollars a month. That's 30 percent of their income that's appropriate for how they what their income level is. Then the housing voucher will make up the difference, which is three thousand a month. Now there's some other adjustments for utility allowances that are deducted from the rent. Assuming that the tenant is paying, you know, gas and electric and those kind of things so that rent is lowered to allow them to have money to pay that and then lowers the voucher rent as well.

Adam: Is that any kind of workforce housing tax credits?

Scott: There is not. There was at one point a one senator put forth the idea of a moderate income tax credit that never ended up going anywhere. In fact, when that idea came out, we were exceptionally excited about it. So at this point, there is nothing active that could be in the future. I think if this divergence of housing prices and stagnant incomes continues to widen, then I think that you will have that. Now there is a proxy or a related capital vehicle, which, you know, we can talk about as needed. But the opportunity zone. Capital space to me sort of allows capital to flow into marketplaces and serve moderate income projects. Right. I mean, they can serve any kind of project that's in a qualified census tract for the opportunity zone. But it's not a tax credit, but it is a tax incentivized investment vehicle. And I think it pairs well with moderate income housing.

Adam: And what about grants for low income? Well, for low income housing development and definitely grants for low income. To my knowledge, I don't see anything for moderate. Every city and marketplace is different. So I just speak to my knowledge base in the western U.S. and California specifically. But there's nothing generally out there in the marketplace at this point of any size.

Adam: I mean, there HUD grant, no HUD grants or anything. And there's nothing there's no similar programs for workforce housing development?

Scott:  For pure workforce housing. There's not. Right. And again, we need to be careful about workforce housing. Some people will say true, what I call true affordable tax credit finance. Some people will describe that as workforce housing. And there is a there is a capability to do income averaging on a tax credit project where you could actually have 80 percent rents. But then the other end of the spectrum, you have to lower rents down to 30, 20, 10 percent of median income, very, very low as long as you achieve a 60 percent or below average rent. Then you qualify under the, you know, the tax credit programs.

Adam: That's really, really technical stuff.

Scott: And so but I will say this, I think that's generally not utilized as much. And I'm not. You know, we don't do we used to do tax cut housing. We don't do that actively. So some of my knowledge may be a little bit outdated, although the income averaging, you know, that does exist. But I think if you look at a true affordable housing, almost all of the programs are set up, particularly in California, to give capital, to allocate capital to the lowest income families. Right. Extremely low, you know, deeply low income. Those are specific terms defined in the industry, because I think particularly in California, where we have a deep, you know, deep need for homeless housing and homeless housing with services or permanent supportive housing, those incomes need to be even more. And so what you get is that you'll have nonprofits and other people that are in that space, that their goal is to get all the incomes across the entire project as low as possible. That requires government capital or subsidy. Right. Which we've talked about as a finite source. Never enough for that. But I think you see that the ethic of that space of true affordable housing really wants to drive rents as deeply down until, you know, low, very low exceptionally, extremely low as possible.

The Difference Between Workforce Housing and Attainable Housing

Adam: So affordable housing. So I've worked on a project some years ago actually in San Luis Obispo, is trying to put together a deal. One hundred and something units. And they were all small units. And the idea was that they were to be affordable. Now, you've used this term as well. Yeah, but affordable with a. The way I defined the difference. Affordable with lowercase a. The uppercase a is as defined by the local municipality. Right. So that I call it right. What I call true affordable housing. What you've called true affordable housing. So in that lower case a, say the untrue affordable housing would be. So I've heard this concept affordable by design and these units actually work. Quite in contrast to the ones that you believed were tiny little micro units basically, affordable by design. Does that also fall into the workforce housing category? Do you think?

Scott: I think it would. Yeah. And there's a term people use called attainable housing, which is the lower case a,  affordable as you describe it. Which means that it's not, you know, government subsidized. It's just by some other mechanism made more affordable, affordable by design. Right. We lower the cost of the unit. So we make it where we don't have to charge as much rent in the proforma to make it viable. We can basically lower the rent by lowering costs. So that's you know, that's what affordable by design basically is. Now, I will say this, that the UTH  model, although it is bigger, five bedroom, four bath, seventeen hundred fifty square feet is a version of affordable by design. It just happens to be that it fits a larger family group with more wage earners. But because they can live in this unit and they can have more wage earners under one roof top, the design has the house be attainable for them or the rental unit be attainable. Right. So this is a version of what I call economic sharing. Right. So in other words, some sharing at some cost of the unit that allows that each individual has a more affordable payment to make. And you could say that your micro units that you describe. That's a different form of economic sharing. It just happens to be that they are you know, they're maybe sharing the common area, sharing the project in a much smaller space.

Right. Their unit is much smaller. And so therefore, they can get more units in. You know, one piece of ground, right. One piece of land.  UTH five bedroom four bath, is just a different version of that in fact, somebody,  Richard Green, who's the director of the USC Lusk Center and a professor in the USC Price Real Estate Development School. He when we talked about UTH, he goes, oh, what you're doing is you're providing density in bedrooms, not density and units. And I go, that's exactly right. And so when you have a wage earner that has their own bedroom because they're living with their family, they may pay five or six or seven hundred dollars a month for that bedroom. Right. And the entire family spreads that cost around all the bedrooms in that particular unit. Micro units are just spreading the cost amongst other units that happen to be unrelated. You know, neighbors in the next unit. Still economic sharing, though.

2 Different Investment Models of Workforce Housing

Adam: what kind of returns do you see?

Scott: So we have really where we have two models, the one we started with, which was our demonstration phase, we were generally in that phase as we're now complete. It now generated twenty two point six percent portfolio average sale IRR. So we sold those projects to investors and the price they paid, given the invested capital would produce at twenty two point six six average IRR in the completion of that demonstration phase. Now we're moving to a long term hold model and that long term hold model has a different orientation because of course, when you invest a dollar a day one and you hold it for 10 years, naturally that IRR is going to lower over time. So we're shooting right now for about a 15 percent average annual rate return on a 10 year hold. But as importantly, we're cash flowing that entire time and we're producing a 3x equity multiple at the end of that 10 year hold. So invest a dollar. And at the end of 10 years, you get $3 back. So your original dollar back plus two in  yield right, to just give you a magnitude of. Just hold all the returns that you get. And then, of course, we're cash flowing in a stablized really safe, you know, recession resistant investment model in this workforce housing over that 10 year period.

Adam: And what's the yield on a what's the current yield during the hold period?

Scott: You know, we're averaging probably about 4 percent, 4 to 5 percent cash on cash. Year 1. And then generally, you know, our models. Of course, this where we're early in the long term hold phase, but we do underwrite conservatively. So we have, you know, a 3 percent income boost each year, although we are conservative, have three and a half on operating expenses. So we're ramping up our expense growth cost right at three and a half. But rents go up at 3. People will argue is 3 the right number? What I do say is we don't trend our rents in the classic multifamily way where hey, where it took us, you know, 16 months to build this, I’m going to bump my rents up by 10 percent. So in 18 months or 16 months, I've got 10 percent higher rents. Right.

Adam: I’m projecting exit at 3 cap.

Scott: Right. Exactly. So, you know, in fact, that's a great point. Yes, exactly. That's going to keep going lower. You know, the magic. It's magic.

Adam: Rents will keep going up.

Workforce Housing in the Broader Market

Adam: So what other models are there of workforce housing?

Scott: So, you know, I think the story in California for rent growth, I think one of the reasons we love this workforce housing space is because it's generally undersupplied for the reasons that we talked about before, which is it's a new idea and it's a new marketplace to respond to. But right now, it's it's deeply undersupplied, those workforce housing families that are being dropped down the food chain of housing. Right. Because there is you know, incomes are stagnant. Housing prices are going up. People either will do one or two things here. They pay more in percentage rent. Right. They become rent burdened or the other choice is they just move down into inferior housing because it's cheaper. Right. Or, you know, we can provide units like are our UTH models. And there's other versions of moderate. Don't get me wrong, it’s not the only one, but ours is the only that I know at scale. That's new construction moderate.

The two food groups that I see in the marketplace are what is mostly talked about in the media today for workforce housing would be people who acquire older apartment assets that are physically obsolete or they're in bad shape or they're in secondary, tertiary markets. And instead of buying those and value add them to the highest market rent, they’ll value add just enough to make it a better project. But they either won't raise the rents at all. Right. So say they have a moderate income average tenant base in a project in, you know, where was I reading and you know, in like Dallas or Houston. And what people are doing is their capital is oriented around keeping the rents similar to what they were when they bought them. But increasing the you know, increasing the physical plant of the apartment building, you know, they're rehabbing the interiors, you know paint, carpet, cabinets. So it's a better lifestyle for the tenant, but their ethic is around holding rents. You know, basically where they're out already. So that's what I call the value add workforce housing model. And that's really it. And then our model of this new construction, you know, naturally, you know, naturally moderate income housing.

The Social Impact of the UTH Workforce Housing Model

Adam: So let's wrap up with a kind of a bigger picture. A discussion about kind of from a societal perspective, why is workforce housing important?

Scott: Yeah. So so I'll go back to that rent burden, part of the conversation that I mentioned previously. So housing is such a fundamental need for human beings, right? Our biology requires that we have appropriate shelter. That's not to say that people, you know, that, you know, die because they move out of housing. But I think homeless populations are at the highest levels that we've seen, as best I can tell in the history of the United States, at least as long as they've been being tracked. The way we track them now in California is the pinnacle of that. Right. We have the highest percentage of population of any state in California -  any state in the United States and we have the most just, you know, people in the United States who are homeless and who live in California. You know, some of those folks are on the street because they have mental health issues. Maybe they have drug addiction issues. But there's a big component. And actually, the highest percentage of growth in the homeless market is people that are homeless by default. They're working families. They're working people. They're students. But they just don't make enough money to afford the housing, the way it's priced in the marketplace in California and many urban areas now. Right. So they just got dropped out. When I said that they’re dropped down the food chain. Right. Eventually they drop off the food chain.

Adam: You know, it's funny you should say that, actually, Scott, because my introduction to affordable with a lowercase a housing and what I tried to replicate in San Luis Obispo, excuse me, was actually in the nineteen eighties, I worked for  a family office that was actually building SROs.  And they were the single room occupancy. These micro units that they'd never, well they have been done. But they were basically fleabag hotels.. But the city was very encouraging of these. And I’m going to comeback to your projects. Specifically, but with the same punch line, if you like. The city liked them, but they wanted them in nice areas. So they they re zoned certain areas because lots of uproar about it. But we built these really nice units. Actually, it's my first contact with Japan was going to Japan and looking at how the Japanese live right in these tiny units. And as a side note, when I lived in Japan, I lived not kidding. I lived in a room a hundred square feet, almost 10 years. It's quite possible and in a way quite therapeutic for the mind to do that.

That's a totally. Yeah. You've kind of shed, you can't afford to have stuff. But here's what was interesting. That's what I want to ask you about workforce housing was that. So we built these things and they were they leased up extremely quickly. They were not like your property, like your UTH model. They were not low cost construction. It wasn't low cost housing, it was very expensive because we had to have a little kitchen and a bathroom in every single one of these units. So you can imagine what that all that cost. But what was interesting was that I actually sold one of these right before the savings and loan crisis. So at the peak of the market, green investor actually bought this, bought one of these buildings that we developed and he was the only person that I knew out of that wave of foreign investors of the 1980s that held onto his asset. Right. And that's because it was a cash cow. And the reason that I actually want to connect the dots with what you were talking about was that you mentioned.

Scott: I'd use the term defensive. Right. Like this is a defensive model.

Adam: Yeah. Exactly. During a during a downturn. Right.

Scott: That's your point about the micro unit project. You describe is that people basically defaulted to those micro units because they're probably on a whole dollar basis, some of the lowest cost rental housing in San Luis Obispo. Right.

Adam: Yes. Well that the point was that it was. Yes. What reminded me of it was you said it brings. What is there If there isn't this kind of housing, you know, you've either got flea pits, or you have no housing, basically. Right.

Scott: So the third option is new innovations like micro units or are our UTH model. They provide a different way of the economic profit sharing model. Right. I mean, that's what allows these units to be. You know, how can we put it allows these units to be affordable to these families or in a micro unit would be a single or a couple possibly. Right. And it basically it changes the way the economics work in the real estate project. Right. And the proforma of that project that allows the rents to be delivered that's attainable to these families or the people, the tenant base that's appropriate for it, like the micro units. Right. And I think that's to me, the future of housing in this particular arena, because basically the way I see a government subsidized housing or true affordable housing we've talked about that's always a limited supply because government subsidy is only ever so much, right. It's a finite supply. It's never enough. And the demand is hugely outstripping the supply of those units. And those units are great. I mean,  hats off to the people who focus on that I have friends and colleagues and, you know, people I used to work for that, do amazing work in that space. But I also say if we're going to solve the housing problem, it can't be by that mechanism alone because it's finite. Right.

Adam: Yeah. And I was gonna say you got that. And the other thing that's nice, how what you build, is you actually want to build it. You're not being, it's not a mandated requirement. Right. Inclusionary housing is not being forced upon you. And squeezed into a spreadsheet or negotiated away to somebody else. You actually want to build this because you can make a lot of money doing it.

Scott: We can. You know, we can. You know, the old the old, you know, idea of doing well by doing good. You know, we’re very encouraged by the social mission of supplying, you know, attainable housing to families or middle income housing to families. It also happens to be a great economic story. To your point, which is, you know you know, another old way of seeing you find a need and fill it. Right. The need is for middle income families to have good housing. Right. If we want to keep our middle class, if we want to have those people be successful. Right. I can't remember the statistic, but there's some huge amount of GDP that's suppressed in the state of California because our housing is so constrained that it all either uses up people's money to spend, if the family uses all their income to pay rent.

You have no money left to pay into the economy otherwise, or people just leave here or don't come here that might otherwise live here because they would like the weather or the lifestyle in California. But they look at housing prices, they go, no. Right. So I can't remember the statistic that, you know, it was a vast reduction in, you know, overall GDP production. And, you know, it's like billions of dollars of suppressed economic activity. And, you know, that's not the only reason to do it. But, you know, if we say that we're going to be successful in our economic planning for the future, then this is an issue that needs to be resolved. Otherwise, we continue to be suppressed and we lose people who drop off the housing food chain into homelessness. Right. That's not a preferable thing. In fact, if you look at the statistics, you know, homeless, taking care of homeless from a government cost standpoint is a very, very high cost endeavor. And in fact, if you get a family that's homeless and get them into housing. Right.

Housing first is a model that people use, that the reduction of load on the government for the cost reduction for that family is massive and the family is so much better. Right. Mental health. Physical health. Right. So I think the social impact story of this is very broad. And in fact, I say, Adam, that, you know, our UTH model is one interpretation of how to innovate in the housing space using private capital, pairing it with workforce housing. But I'm like, we need, you know, thousands and thousands more of these innovations. Right. If we're going to be successful, particularly in California, where we are so housing constrained. You know, we need a lot more of this. So we're encouraging. In fact, this is one of the reasons we get out into the marketplace.  You know, we think the model is great and we're going to continue to be fully focused. In fact, this is all we do now from a real estate development perspective. Is this moderate-income UTH model is our, you know, entire business plan.

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