The Appeal of Multifamily Projects
The multifamily sector has captured investor attention, positioning itself as a sought-after property type. It is one of the most liquid property types, showcasing resilience across market cycles, and stands as a hedge against inflation. However, the housing industry isn’t without its fair share of challenges, including rising insurance rates and interest rates. The slowing of rent growth will continue for the rest of 2023, as the risk of recession hangs over the economy and many markets are experiencing over-supply conditions. Other temporary obstacles include declining household formations and weakening demand. In this article, we dive into the competitive updates that multifamily owners should be attuned to, exploring the nuanced dynamics and trends shaping the sector.
Beyond Multifamily
Multifamily investment, fueled by pandemic-driven migration and demand surges, marked a remarkable ascent in 2021. Yet, 2022 unveiled a moderation as climbing rent rates triggered a reconsideration of homeownership. The recent surge in the 30-year fixed mortgage rate, crossing 7%, has rekindled interest in renting. This shift has spurred the rise of alternative housing models like single-family rentals (SFRs) and build-to-rent (BTR) communities, offering a sense of home without the weighty mortgage commitment. CoreLogic data reveals that BTR and SFR rent rates now stand at five times the pre-pandemic levels, signifying an evolving landscape.
Dynamics within segments like student housing have similarly evolved, transforming to match modern preferences. Student housing’s modernization aligns with changing preferences and the expansion of the middle class. Independent senior living is also on a transformative trajectory, tailoring options for an aging population. These alternative housing models are not just redefining the market; they’re compelling investors to recalibrate strategies to address the evolving needs of diverse consumer segments.
The Breaking Point
The rapid surge in apartment rents following the pandemic has raised questions about the sustainability of these increases. Recent data from Moody’s Analytics highlights the concerning fact that the average American renter is now spending over 30% of their income on housing, surpassing the threshold for rent-burdened individuals. Additionally, the median U.S. rent has risen significantly, going from $1,629 in June 2019 to $2,029 in June 2022, indicating a substantial increase in a relatively short span. However, the growth in rents has outpaced income growth, which has led to a growing affordability crisis. This divergence is evident in the data provided by Moody’s Analytics, showing that between 1999 and 2022, U.S. rents surged by 135%, while income only increased by 77%. However, there are indications of rent moderation on the horizon. As reported by Multi-Housing News, year over-year rent growth remained on a slowing trend, up 4%, the lowest level since April 2021. While this moderation is a positive sign for renters, it also means that landlords need to carefully navigate the evolving rental landscape to maintain healthy returns on their investments.
CoStar reveals that there are currently around 1.1 million apartments under construction, a pace unseen since the 1970s. The significant increase in apartment construction is both a response to the housing shortage and a potential factor in moderating rent increases. Despite this construction boom, nearly 40% of the new rentals set to be completed this year will be concentrated in a handful of high-job-growth metropolitan areas. As more rental units become available, tenants will have a wider array of options to choose from. Landlords may find themselves needing to offer competitive rental rates and additional amenities to attract and retain tenants. This could lead to a more tenant-favorable market, where renters have the upper hand in negotiations.
As the nation grapples with both the housing shortage and the issue of affordability, the multifamily sector faces a critical juncture. The push for rent control regulations and a focus on apartment construction must be balanced against the complex interplay between supply and demand, as well as the varying dynamics of local housing markets. While the growth in apartment construction presents the potential for more housing options and reduced rent increases, its effectiveness remains nuanced, particularly as luxury apartments dominate new inventory. Landlords, in particular, face the challenge of striking a balance between offering concessions to attract renters and maintaining the financial viability of their properties. The challenge moving forward is finding a sustainable equilibrium that meets the needs of both renters and the real estate industry.
A Glimpse Beyond the Highs
Despite multifamily remaining a top destination for institutional capital, it has undergone a shift from the remarkable highs experienced in the past two years. The sector’s delinquency rates, a critical indicator, have risen for three consecutive quarters, reaching 1.83% according to Multifamily Dive. Comparatively, this marks a notable increase from the 0.94% rate recorded one year ago. Escalating delinquency rates are a cause for concern since they indicate a growing financial strain within the sector, where property owners or borrowers are struggling to meet their debt obligations. Rising delinquency rates can disrupt the cash flow of property owners, making it challenging to maintain and manage multifamily properties effectively. This trend contrasts with senior housing, which boasts the lowest delinquency rates and loan losses across major real estate asset classes, as noted by PERE News. Alongside this, apartment starts encountered an 11.2% year-over-year decline as of June, with permits for commercial multifamily plummeting by a significant 33.1% within the same timeframe.
The multifamily industry is currently grappling with an impending challenge related to maturing loans. Many property developers in this sector secured loans in 2021 to fund new construction and redevelopment projects, capitalizing on favorable interest rates at the time. However, it’s important to note that financing for multifamily residential units often comes with unique terms. Specifically, the interest rates on some multifamily mortgages effectively reset after a certain period, typically spanning two to three years. As a result, a significant portion of these loans is now entering a phase where rates are set to rise. This scenario, combined with the overall increase in interest rates, is raising concerns about the financial stability of these projects.
In the coming months, the multifamily industry is bracing itself for an approximately $8 billion wave of multifamily commercial mortgage-backed securities (CMBS) that will begin maturing, starting in the latter half of the year. This surge of maturing loans has earned the name “Red October” within the real estate industry. The convergence of these maturing loans with rising delinquency rates creates a complex scenario for multifamily property owners and investors. Managing these maturing loans and addressing the potential financial strain they may exert on the multifamily sector will be a significant focus for industry stakeholders moving forward.
The dynamics within the sector have prompted significant shifts, with rising concessions, slowing rent growth, and an unprecedented surge in insurance rates, surging up to 28%. These higher insurance costs can eat into the property’s profitability, especially in a market where rent growth is slowing down. Property owners may find themselves grappling with the challenge of whether to absorb these increased costs or pass them on to tenants through higher rents, a decision that requires a delicate balance to maintain occupancy rates and competitive positioning in the market as the multifamily landscape grapples with these changes, many stakeholders are left contemplating its trajectory for the remainder of the year. Industry experts and market observers are poised to closely monitor these trends, aiming to anticipate potential outcomes and adapt strategies to navigate the evolving multifamily landscape. Amidst these fluctuations, insights and data-driven foresight are crucial for investors, developers, and industry players seeking to make informed decisions within this dynamic environment.
