By Tim Leber
Apartments rented under the federal government’s Section 8 Rental Certificate low-income housing program are often stigmatized, as are the landlords who own them. But for owners who maintain and manage their properties well, Section 8 housing is a source of dependable income and loyal tenants.
Fluctuations and uncertainty in capital markets and the economy in general have led many investment groups to take riskier positions across all asset classes. One presumed risk that many multifamily investors face is the ability to attract and retain quality renters on long-term leases. To mitigate that risk, many investors look for tenants with higher income in quality markets to anchor their rental portfolios. Counterintuitive as it may seem, just the opposite type of tenant and market can often be much more attractive, however.
Section 8 renters offer investors a guaranteed cash flow and a certainty of tenancy. The lack of low-income housing eligible for the program, and the long waiting list of tenants seeking Section 8 approvals, assures a long-term demand for such rental properties and also offers investors an alternative to the volatility of traditional rental markets.
Section 8 is a federal program that pays a portion of the fair-market rent for qualifying low-income tenants. The amount of rent subsidized is controlled by a U.S. Department of Housing and Urban Development (HUD) survey of market rents in a given area. Originators looking to arrange financing for clients interested in investing in the multifamily market should familiarize themselves with the Section 8 program, given it offers potential borrowers and lenders alike the safety net of a government-subsidized income stream.
The market for Section 8 housing, according to the nonprofit Center on Budget and Policy Priorities, includes some 5 million residents — or more than 2 million families. The low-income housing program, created in 1974, is administered by more than 2,000 state and local housing agencies, although HUD establishes Section 8 rent and income standards.
The government assistance is used to pay a portion of tenants’ rent, and tenants are responsible for paying security deposits. Landlords are barred from requiring larger deposits from Section 8 tenants than from their other renters. Beyond assuring income-eligibility, housing agencies do not screen the tenants, and landlords are free to make their own rental decisions when dealing with Section 8 applicants, as long as they comply with anti-discrimination laws that apply to all tenants.
The arguments against Section 8 property ownership often include the high turnover rate of the tenants. Although true in some urban cores or in large multifamily units, families or individuals qualified for the program often have an incentive to stay in well-maintained Section 8 housing.
Many tenants participating in the program have incomes that fall 30 percent or more below their area’s median-income level. Many also may be elderly, disabled and/or part of single-parent families. A large number of them have obtained Section 8 housing only after enduring a long wait for admission to the program. Once these tenants find a good home to live in, with assistance for a substantial part of their rent, the likelihood of their moving out is low.
HUD-guaranteed income for all or most of a tenant’s rent may quell any concerns over the tenant turnover rate. But properties that do have higher tenant turnover also incur greater expenses, which will be taken into account by loan underwriters. Increasing the standard amount allocated for turnover costs by as little as 25 percent can account for the added wear-and-tear expenses associated with tenant turnover. In addition, for those owners who control a portfolio of Section 8 housing, the savings on properties with long-term stable tenants can more than offset the added expenses for the few properties that require larger turnover reserves.
The certainty of income is an advantage to owning a Section 8 property, but originators and their clients should be aware of some common pitfalls of the program. With the guaranteed rental payments come the expenses of maintenance and capital-expenditure reserves that are required through the life of a Section 8 investment.
Whenever a lease renews, the properties are subject to scrutiny from HUD inspectors. Consequently, there is a need to stay current on essential repairs to the property and also to continuously upgrade and modernize it.
In addition, many times only a portion of the rent is covered by a HUD voucher, so loan originators must present to underwriters an assurance of additional reserves or income streams to account for the revenue lost if tenants stop paying their portion of the rent. Dealing with such tenants also can present an additional longer-term problem because of the arduous process involved in evicting a qualified Section 8 renter.
The challenge many originators will face when representing clients looking to acquire properties that house Section 8 tenants is finding a lender willing to take on the risks associated with those assets. Typically lenders will require larger turnover, maintenance and capital-expenditure reserves for Section 8 properties, compared to their typical straight-down the fairway multifamily deals.
As long as a realistic assessment of the added costs is made, and coverage of those expenses is accounted for in the underwriting process, the only other substantial hit a borrower might take when financing a Section 8 property is from a rate standpoint. Often, lenders will be fine with the absorption of the risk associated with Section 8 tenancy, but will require increased security in the form of a higher interest rate on the loan.
When everything is boiled down, lenders with experience underwriting loans for properties serving Section 8 tenants already see those assets as proven and welcome additions to their lending portfolios. Understanding the Section 8 market and the nature of the neighborhoods where particular properties are located allows originators and their clients to better make their case to experienced lenders — as well as to more effectively control expenses associated with upkeep and turnover.
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Savvy originators who understand the demographics of the Section 8 market and its unique property-financing challenges can better serve clients who are looking for investment opportunities in what is often perceived as a riskier asset class, but one that also offers the certainty of a guaranteed rental-income stream over a long period of time.
Tim Leber is an analyst at CoreVest Finance, a leading financier for real estate investors. Leber has spent his career in real estate finance. Prior to working at CoreVest Finance, he was an associate at Newmark Grubb Knight Frank, a commercial real estate advisory company. He also has held positions at Grubb & Ellis and Morgenstern Property Co. Leber is a graduate of the University of Arizona. Reach him at timothy.cvest.com.