Investing in the ‘missing middle’

19 May 2020

Over the past few years, the number of investments in the multi-unit residential sector has begun to grow. While many property investors focus on Class A apartment buildings, housing investments for the workforce and the “missing middle” can offer an excellent opportunity to generate above average income. 

What is missing middle?

Until the 1940s, urban neighbourhoods were transit and pedestrian oriented, offering residents a wide range of commercial amenities and housing options within a few blocks. After World War II, the population increased as baby boomers were born, and housing demand quickly began to grow. Low interest government loans along with cars helped create dormitory areas in the suburbs.

Investing in the ‘missing middle’ 1
Missing Middle

Today, the preferred housing option has gone through a full cycle. Both baby boomers and millennials are causing demand for small houses.

Such types of housing, known as missing middle, are comparable in size to small single-family property, and consist of several groups and types of real estate. These include townhouses, fourplexes, triplexes, duplexes, bungalow courts and others. They now provide a variety of property options to support recreational communities, local shops, and public transportation. Built in the mid-1940s, they were in the middle of the spectrum between mid-rise buildings and detached single-family homes, with conditions of scale and shape, as well as the number of units and, in most cases, accessibility.

In simple words, missing middle includes a number of small apartment buildings for which new construction is largely unable to meet the growing demand.

How to choose missing middle

These multi-unit missing middle real estate can be found right next to single-family homes and can provide market participants with a more expensive niche product that is designed for students, millennials, who prefer to rent housing. Together, these groups make up more than 50% of the US population.

Today, young couples, single people, teachers, baby boomers and others are among those who are looking for ways to live in a pedestrian area, but without the costs and expenses of maintaining a detached house for one family. The lack of a medium-sized apartments fund helps bridge the gap between changing demographics and affordable US housing, coupled with a growing demand for vacation opportunities.

General characteristics of missing middle types include:

  • Small buildings similar to the size of single-family housing
  • Great location close to amenities
  • A simple, well-designed structure with floor plans and finishes often found in mansions
  • Reduced number of off-street areas and parking spaces
  • Potentially sold for both rental and rental

Benefits of Investing

In a report from The Case for Workforce Housing, commercial housing and investment firm CBRE points out the possibility of investing in multi-unit housing for the workforce. The report notes that due to obsolescence, more than 100,000 units of apartment buildings are removed from the market annually.

We can say that these are precisely the units that are best suited for housing for the workforce. This creates a common case of reduced supply compared to increased demand. As demand for property from middle-income tenants continues to increase, offers are constantly disappearing from the real estate market.

According to CBRE continues, the construction of old housing units is very important for the multi-apartment sector, providing tenants with more updated and better apartments. The physical improvement of the old multi-unit housing fund has also made it more popular among buyers.

In 2019, based on information from CoStar and Reis, Fannie Mae found out that the vacancy rate in class B and C apartment buildings reached a historic low of about 5% and has remained at the same level since then.

She also highlighted other factors in the demand for housing for middle-income workers over the following years:

  • Vacancy rate will be low

Vacancy rates are likely to remain low until the end of 2020: class C – 4.8% and class B – 5.7%. According to forecasts, the number of Class A vacancies will increase by more than 10% as new reserves emerge in a recession.

  • Reduction in housing stock

In 2009, the working class housing stock accounted for 59% of the multi-unit property market. In 2019, this share fell to 52%. In fact, over the past 10 years, the market has lost about 140,000 units of classes C and B each year due to conversion and obsolescence.

  • Rent growth

Rising rents for affordable housing for the working class exceeded the average inflation rate due to increased demand and reduced supply. In 2018, rent growth in the housing sector for the workforce increased by an average of almost 3.2%. Housing rents for the workforce are expected to remain strong in the future.

Opportunity of such an investment

Middle-income workers generally cannot afford expensive single-family property in suburban and urban areas. They are in fact driven out of the market and forced to live in less desirable remote suburban areas that lack access to public transport and nearby amenities.

Explaining missing middle
Explaining missing middle

The “missing middle” of small, multi-family assets provides leased real estate investors with a unique opportunity to take advantage of the widening gap between supply and demand. Missing housing for the workforce is a class of assets with high demand from middle-income tenants who are looking for smaller housing in the best urban areas, where rents continue to rise and job vacancies are low.

Why is Missing Middle coming back?

People are beginning to be squeezed out of their quarters due to the high cost of living of a sharp increase in demand, the problem comes to the fore. City planners are currently reviewing the current zoning system. In addition, research shows that one-third of Boomers and two-thirds of millennials want to live in their neighborhoods, rather than in the city center. More and more people want to live where there are fewer cars.

The current stress of the pandemic regarding the resources of the public economy, health care and our emotions is felt by all. However, the demand for housing for the labor force is coming back, and may even become stronger when the nation recovers from the fight against the pandemic.

Now and during the recovery period, many financially sustainable companies in real estate market will continue to meet the needs of investors and tenants, working in partnership with local governments, the state and capital partners to provide high-quality and long-term housing opportunities for the most “advanced” workers who, as a result of the pandemic, ultimately recognized as critical members of our community.

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