Rising Big-City Income Inequality Presents Challenges to Apartment Developers

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A growing movement to the urban core means new opportunities for the apartment industry, but recent data suggests that the pool of denizens who have the money to attract developers looking to jump into the market isn’t keeping pace.

A Brookings Institution study and data from the U.S. Census Bureau shows that in 2012 income inequality in big cities exceeded the national average. The reasons for the widening gap are not attributed everywhere to increased wealth among the already rich – in most cities the 95th-percentile incomes declined from 2007-12. But, the bottom line is that the big-city rich got richer and the big-city poor became poorer in the 50 largest cities.

The news adds fuel to growing sentiment that urban inequality is getting worse and that the middle class incomes aren’t growing enough. It’s also a reminder to the apartment industry of the challenges of keeping up with increased demand for urban housing amid higher building costs.

The inequality comes at a time when urban living is making headlines. While some data suggests that suburban expansion is still stronger than urban growth, renters who seek amenity-rich living within a quick walk or short commute of downtown attractions are grabbing the attentions of many developers and architects. But the movers and shakers are tasked with building housing on pricey parcels of land and balancing rents for wage earners whose incomes have declined or are growing slowly.

“This is a big deal,” says National Multifamily Housing Council (NMHC) President Doug Bibby. “On an inflation-adjusted basis, there really hasn’t been income growth for the middle class since the mid-1980s. It’s been basically stagnant growth in income. It’s a real problem because other costs have gone up. It’s becoming more and more of a serious problem in this country.”

Fair and Profitable Price Points a Challenge for Apartment Developers

In recent years, the apartment industry has been on a fast track to meet demand for housing in urban areas, and 2014 promises to be a year that new deliveries get closer. This year, nearly 271,000 new units in the nation’s 100 biggest metros are scheduled to open, according to MPF Research.

But they are coming at a price in both time and money for developers who are trying to work within economic conditions and make a reasonable profit at the same time.

“The bad news is that the cost of land is escalating in those markets, and it costs the developers more and more to develop housing,” Bibby said. “So, if you’re a developer and you’re developing in the core markets, you’re going to be looking at a price point that you can profitably develop those apartment communities. And, therefore, the price point is going to be getting more and more out of reach of workforce households whose wages haven’t been growing the same way.”

In many instances, developers are building up on smaller lots with mid-rises and high-rises, many of which are amenity rich and targeted toward middle- and high-income dwellers, to make deals work. From land acquisition to the first turn of dirt, however, the process can take 3-6 years, especially in large urban areas like San Francisco, Washington, D.C., New York City, Boston, and Los Angeles.

Lengthy and complicated municipal entitlement processes often extend project times and drive up costs that sometimes are underestimated in development budgets. Such issues aren’t new to the industry but can further cloud a project’s viability in today’s economy, especially when cities ask for new projects to include more affordable housing or require additional infrastructure improvements.

“That can be a very difficult process,” says veteran developer Stanley W. Sloter, who is president and CEO of Arlington, Va.-based Paradigm Development. “It’s a couple years, as many as five years, to get a project approved, and it can be an uncertain road. It’s really one of the biggest risks of the business. We have to take into account those risks at the front end, which makes the business risky.”

Balancing Affordable Housing Needs with Luxury Apartment Demands

The majority of the projects that Paradigm constructs are high-rise, luxury units aimed at median income renters and situated near public transportation outlets in Maryland, Virginia, and Washington, D.C. Sloter, who founded the company in 1991, has developed more than 10,000 urban and high-rise residential apartments and condominiums by partnering with pension funds, landowners and local governments.

The company is no stranger to affordable housing – it has built many projects in the D.C. metro area – but incorporating affordable units in new communities is inefficient, says the 25-year veteran of the apartment industry.

A project that requires more affordable units than originally anticipated can bog down construction starts and quickly dilute projected profits.

“Where developers really have trouble with local municipalities is when the rules are not clear,” Sloter said. “I calculate how much I can pay for that land based upon certain rules and guidelines. And when I start the entitlement process it changes.”

Despite the potential pitfalls, he says there are ways to work with municipalities to achieve affordable housing mandates without breaking the bank. Sloter credits several that have offered alternatives that enabled Paradigm to successfully develop a market-rate property at one location and meet affordable requirements several blocks away at another.

Another solution is for developers to partner with non-profits to find serviceable, older apartments in the area that could be renovated for a much lower cost.

“You spend the money that is actually more efficient for hitting the target of affordable housing,” he said. “There are lots of ways to do it.”

More Apartment Market Options Needed Beyond Modular Construction

In recent years, the apartment industry has attempted to meet demand and stay within customer budgets in big cities. Modular construction has decreased costs and construction times through virtually pre-building entire developments in a factory and shipping ready-wired units to project sites.

“There are several of my (NMHC) members who are experimenting with this now, and that’s a way of getting your costs down and creating units that are more affordable,” Bibby said. “They’re beautiful. It’s amazing what they can do. The key is getting an assembly depot within a reasonable (transportation) range.”

Smaller units are another way that developers are creating space in urban areas to meet demand by younger workers who likely have better earning potential in the years ahead.

While these advancements are helping bring affordability to the urban core, they are not enough to meet what appears to be growing income inequality in the big cities, Bibby says. The industry must continue to work with city governments to overcome barriers that will enable developers to provide housing that satisfies consumer budgets.

Some progress is being made beyond city limits and county lines. Two years ago. Massachusetts Gov. Deval Patrick introduced a plan to produce 10,000 multifamily housing units a year through 2020 in an effort to keep young professionals from leaving the state. The initiative plan – designed to complement existing state housing initiatives – is to create live-work-play communities near public transportation and city centers.

That’s a step in the right direction, Bibby says, but more work needs to be done. Establishing more public/private partnerships will help the industry create housing that reaches affordability. Still, municipalities need to be more accommodating so that developers aren’t left holding the bag.

“I think people are looking at a variety of things, some are looking at what they can do in enterprise zones, what they can do with tax abatements and buying down the costs of land, donating land,” he said. “But my message is that municipalities have to take it seriously, because you can’t just put all the onus on the developer.”

 

(Image source: Shutterstock)

 

 


Contributing Editor, Property Management Insider
President, Ballpark Impressions, LLC

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Tim Blackwell is a long-time publishing and printing executive in the Dallas/Fort Worth area who writes about the multifamily housing and transportation industries. He has contributed numerous articles to Property Management Insider, and worked as a newspaper reporter in the D/FW area. Blackwell is president of Ballpark Impressions, and publishes the Cowcatcher Magazine. He is a member of the Fort Worth Chapter/Society of Professional Journalists.

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