Helping lower-income households achieve their dream of home ownership can offer private lenders and investors an opportunity to profit while revitalizing neighborhoods.

When most private lenders think about affordable housing, they think of people living below the poverty level. That’s why most private lenders avoid investment in marginalized communities. The problem is most people don’t understand the difference between what affordable housing is and what makes housing affordable.

Affordable housing is an opportunity: It’s possible to create an ecosystem that adds value to the projects you invest in. Before we delve into the ecosystem approach, let’s take a look at why traditional affordable housing projects historically have not been appealing to private investors.

Traditional Affordable Housing

The purpose of traditional affordable housing is to provide options for people with limited financial resources, ensuring they have access to affordable, safe, and adequate housing for their families.

Affordable housing has traditionally been made available through government programs, nonprofit organizations, or private developers participating in affordable-housing initiatives. Income restrictions are in place to ensure it is reserved for those with lower incomes. These restrictions vary by location and program. Financial incentives such as subsidies, tax incentives, and grants are provided to developers or property owners to help offset the high cost of construction or the maintenance of affordable housing units.

Most private lenders would never consider funding traditional affordable housing projects because nothing about affordable housing fits their lending guidelines. The cost of construction for a standard fix-and-flip loan may be $50-$100 per square foot and for ground-up construction about $110-$150 per square foot. By comparison, the average cost to build affordable housing units starts at about $250-$300 per square foot in most urban areas. It can exceed $1,000 per square foot in cities like Los Angeles and San Francisco.

So, the cost to build is extremely high, the NOI is lopsided without government subsidy, and everything says to run away—fast! The majority of traditional affordable single-family residences and multifamily residences are renovated or built for renters. Given this, for the near future, there’s no possibility of homeownership or income-producing real estate investment for the masses.

But this doesn’t have to be the case.

The Ecosystem Approach

Using an ecosystem approach to investing in lower-income communities, you can intentionally and successfully fund the acquisition of lower-cost land for new construction and/or homes needing renovation.

Adopting this ecosystem approach allows private lenders to view these underserved, mostly urban, areas as golden opportunities for generating strong returns on investment while simultaneously positively impacting social and economic change in these communities and their residents. A strategy that works is to acquire and lend in neighborhoods adjacent to prosperous or up-and-coming areas. They contain the necessary resources and infrastructure already needed to support the new growth.

One caveat: It’s important for you to have “boots on the ground” to become a successful private lender in this niche lending space. Many lenders arrive unprepared to urban cities, but they leave with their tails between their legs or feeling wounded.

Why?

Because they weren’t prepared—and they didn’t have the right partner. Building an extensive network of realtors, wholesalers, title companies, appraisers, home inspectors, contractors, local code and building inspectors, and attorneys to mitigate risk is critical to success.

Depending on your agreement with any capital sources you use to fund loans, if you are allowed to handle nonperforming assets on behalf of the loan’s noteholder, you can present many possible workouts to your borrower. In worst-case scenarios, a deed in lieu can be issued and you manage the remainder of the renovation so the asset can be marketed and rented, sold, set up as lease to own, and/or land contract. The noteholder recoups all their principal and makes a profit if they just stick to the plan.

As an added caveat, the note holder/private lender is provided with risk mitigation through underwriting and the vetting process that goes along with it, making your investment in affordable housing even more secure. In short, the ecosystem approach provides borrowers with increased opportunities to get their projects funded and the lender with the opportunity for a strong rate of return, risk mitigation, and endless deal flow. Remember, there will never be a shortage of deal flow, and the rate of return is usually set by the capital provider.

Long-Term Impact

As private lenders begin investing in marginalized communities, asset prices may be low due to their location in what have been identified as “bad areas.” But once private lenders and investors begin to purchase the homes in these communities at a reasonable price and then renovate them or knock them down and rebuild, they also begin to modernize the community.

In the process, residents begin to feel a sense of pride in their revitalized community. Once a few of these renovated homes sell at affordable prices, as private lenders and investors, you are now setting the values within that area/ZIP code that no one once wanted. You are making a profit and serving the high demand for affordable quality housing in underserved communities.

The process feeds on itself. As this process achieves success, more lenders, investors, bankers, developers, builders, contractors, and end buyers follow. The most important value of this system is that the housing becomes modernized and affordable for the end buyer. Usually, the end buyer, a working-class, tax-paying citizen, becomes highly motivated to buy a home in a location that is no longer marginalized. As a result, it becomes easier for investors to deliver quality affordable housing, whereas if the same home was in another part of town, it would be priced two or three times higher, making it unaffordable.

Private lenders and investors all over the country will begin to see that these marginalized communities are now being considered over the suburbs—and people are now fighting for these homes and your private lending dollars.