What would it take to convince you that low-rent apartments “consistently earn significantly higher returns” compared with high-rent apartments? Three researchers who examined property markets in three different countries, including the U.S., came to this key finding in recently published research. But, perhaps anticipating skepticism, they titled their paper with a question mark, “An Alpha in Affordable Housing?” That made us curious.

In fact a few findings in this research challenge intuition, so in this article we’ll dig a little deeper into the conclusions than usual. Still, if these findings are directionally right, they present a clear path to alpha for real estate investors, but our bet is you won’t go down it. We explore at the end why that might be. Let’s get into it…

U.S. properties in the lowest rent deciles generated net yields 60 basis points higher than those in the top tenth decile (see graph below). Regarding annual appreciation, between those two deciles, the difference in average annual price appreciation was nearly 100 basis points in Belgium and 250 in the Netherlands, both based on transaction-level data.

For U.S. appreciation, the researchers relied on modeled rather than transactional data, which seems dubious, and found the lowest-rent decile of properties had a whopping 325 basis points appreciation advantage versus the top-rent decile. That much spread in annual appreciation feels impossibly high - especially if you imagine it compounding over time - but after spending time with this research, the directional finding of a positive spread is plausible.

Regardless of the premium’s magnitude, why would investors earn a premium in low-rent apartments at all? One easy answer: Investors require higher return because there’s higher risk in these assets. That possibility required a few different approaches to dispel.

The researchers analyzed performance across economic cycles and found that low-rent apartments are, in fact, less sensitive to downturns than higher-rent assets: “Low-rent properties’ net cash flows fall by less, or even rise, in recessions.” That fact, if anything, suggests low-rent properties should price for lower returns commensurate with their lower risk, not price for the higher returns actually observed.

The researchers also assessed regulatory risk—a frequent headline concern these days. They folded myriad measures of regulatory risk into their analysis, including tenant protections and rent regulations, and they even sorted for cities with Democratic control. They expected to find that the higher the regulatory risk, the higher the returns on investment, since investors would need to be compensated for the risk, but they found “net yields and total returns tend to be lower for low-rent properties in such areas” which is “the opposite of what the regulatory risk theory predicts.”

The researchers finally examined if these assets were just innately higher risk given tenant demographics. Evidence suggests they are not. Low-income apartment buildings have average mortgage default rates and “only modestly higher” volatility in distributions during three- to five-year holding periods. So idiosyncratic risk does not explain those higher returns.

If not higher risk, something else is behind these persistently higher returns. The authors propose two theories, and these we liked.

First, rents in these assets remain high relative to property values. Said another way, low-rent apartments are actually high-rent apartments for low-income residents. These residents need to live somewhere, they are already in the least-expensive apartments available and they “lack the savings and the income to obtain and service a mortgage.” So landlords push rents as high as this segment will bear. This dynamic is sobering and consistent with the fact that the lowest-income households pay the highest rents as a percentage of their total income.

Second, competition to acquire these assets is severely limited so prices stay low. Large landlords, including those backed by pension funds and public equity investors, avoid the segment. Per the paper, these landlords would be at “risk of being stigmatized as ‘slumlords’” if they moved away from the high-rent tiers of the rental market (“where net yields and returns are the lowest,” the research notes with some snark). And existing low-rent-apartment landlords tend to lack deep access to capital and tend to invest only in one locale.

Those theories felt right to us. Even with a credible case for persistent alpha, most professional investors remain reluctant to pursue the lowest-rent segment. Cultural aversion to owning low-quality, very-low-rent apartments appears to be a significant barrier—distinguishing this segment from workforce housing, despite their similarities.

But a fiduciary that’s trying to optimize returns for a principal should be acutely interested in this structural premium. If we all were purely profit- (and promote-) seeking, there would be no hesitation to invest in low-rent apartments. That such a premium exists suggests a disconnect between optimal returns and investor preferences or reputational constraints. Which is what we loved about this paper: it shines a light on what feels like a fiduciary dilemma, the opportunity to enjoy outsized profits from investments most investors are unwilling to make.

The Rake

Three good articles.

• Why Rents are Rising Again - Axios

  Multifamily housing permits have dropped below both pre-pandemic and pandemic-era levels, as high interest rates make new projects less feasible.

  (Add’l Source: Redfin)

• Banks Tiptoe Back Into CRE Lending, But the Game Has Changed - GlobeSt

  Banks are cautiously returning to commercial real estate lending with tighter underwriting and lower loan-to-value ratios.

• More Than Half Of U.S. Warehouse Space Built In Q1 2025 Is Vacant - BisNow

  More than half of the warehouse space delivered in the U.S. during Q1 2025 is sitting vacant, as a pandemic-era surge in speculative development has outpaced current tenant demand and pushed industrial vacancy rates up to 7%.

The Harvesters

Someone making real estate interesting. They don't pay us for this, unfortunately.

 Who: New Story Capital

What: An impact investment firm that buys land, divides it into parcels, completes horizontal improvements and sells the lots at affordable prices to low-income families in Mexico and El Salvador. Families can leverage the lot ownership for funds to build homes, and those homes can be expanded over time.

The Sparkle: As far as impact investing goes, it’s hard to do better than New Story’s model. They offer competitive returns to investors who fund home-ownership in places where squatting and illicit rentals are the norm for low-income families. After coming out of Y Combinator, they have evolved their model for the last 10 years and now are raising capital to develop more than 12,000 land lots for families.

From the Back Forty

A little of what’s out there.

It’s the time of year for Manhattanhenge, the not-at-all-mysterious phenomenon when the setting sun aligns with the Big Apple’s east-west streets, and you get views like the one below. The next two opportunities to see it: July 11 and 12.

Here’s a link from the American Museum of Natural History with information on when it will be visible and ideal viewing spots in the city.

Link: https://www.amnh.org/research/hayden-planetarium/manhattanhenge

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1  Damen, Sven and Korevaar, Matthijs and Van Nieuwerburgh, Stijn, An Alpha in Affordable Housing? (January 31, 2025). Available at SSRN: http://dx.doi.org/10.2139/ssrn.5121139.