Due to a number of converging economic factors, affordable housing development is harder than even in a lot of American cities. One of those cities is Los Angeles. Currently, around 78 percent of the city is zoned for single family housing. Attempts to change that have been met with strong resistance. Add to that the rising cost of labor and skyrocketing insurance premiums and it makes it hard for any new affordable development to pencil. Despite these setbacks, real estate investors in the city are working hard to create more affordable housing. But rather than building it from the ground up, they are converting old properties into subsidized, affordable ones, providing both a civic benefit and a profitable investment strategy.
I spoke with two investors doing just that. Two brothers, Nathan and Michael Kadisha, founded the investment firm K3 Holdings. They have been busy focusing on converting existing housing stock into affordable units. "From a macroeconomic perspective, there is nearly an unlimited demand for workforce and affordable housing in LA," said Nathan Kadisha. "New affordable housing is nearly impossible to build but the city does have a large amount of older apartment buildings that can be bought for relatively cheap."
The Kadisha brothers prefer not to uproot the people already living in the buildings they purchase, one of the biggest complaints of gentrification. "We want to protect existing housing stock," Kadisha said. In order to do this, one of the most important factors when considering a new investment is the income of the current residents. By applying for tax incentives, investors like Nathan and Michael can convert their buildings over to designated affordable units, leaving the tenants in place while upgrading the property.
Los Angeles has a particularly high median income, around $103,000 for a four person household. That means that many residents qualify as "low income" (meaning they make 80 percent of AMI or less). "Our tenant base is teachers, nurses, and police officers," said Michael, "without these people Los Angeles would be a very different place."
To help them buy, upgrade, and designate older buildings as affordable, K3 uses a number of city incentives, including the newly passed, citizen led build focused on reducing homelessness called Measure A. By creating a new sales tax, the city has amassed over $1 billion to help solve its homelessness problem. That money is dolled out for many different initiatives, including affordable housing conversions. "The city is rather flexible when it comes to how they are able to spend their Measure A funds," Nathan explained. "They want you to come to them with a valid reason that your project can help with homelessness, if you interface with them they will consider it."
One of the ways that K3 has been able to deploy Measure A funds is to improve buildings to help them bring down recurring expenses. "Efficiency upgrades are the most impactful, they help bring down monthly expenses, making it cheaper for the tenant and the building operator," Nathan said. This isn't always as easy as installing smart thermostats. Many of the older buildings that K3 has converted into affordable have antiquated electrical infrastructure. That can often mean bringing more power in from the utility and rewiring the entire building. Los Angeles also has a new cooling mandate that requires AC units be installed in many homes, adding additional strain to already overloaded wires. Despite the federal roll back of many sustainable incentives, California still has plenty of programs to help pay for these important upgrades.
K3's strategy only works for investment teams that are committed to a city. "Everyone tells us we are crazy for investing in affordable housing in LA but we are from this city, we have all of our family here, and we want to try to solve this issue," Nathan said as his brother nodded in agreement. They generally buy properties with the plan to hold them for as long as possible, making capital improvements more feasible since they have a longer time horizon to break even.
Most cities around the country are struggling to build enough affordable housing to keep up with demand. One solution is to turn some of the oldest, least desirable buildings into affordable units. But doing so requires real estate investors with conviction. They need to be in it for the long haul, willing to work through bureaucratic programs and interface with city officials. If purpose driven investors like the Kadisha's are able to prove that converting buildings to affordable housing is a lucrative investment, they will open the door for others to follow the same path. Only with this infusion of capital will cities like Los Angeles be able to provide enough housing to actually help residents afford to live there.