How Can CRE StakeHolders Make Sense of The Recent Surge in Multifamily Property Values?
Strong demand has pushed rent growth in the multifamily market to highs not seen since before the Great Recession. COVID-19 plays a significant role in this story, and much analysis has focused on the virus’s impact.
However, several factors driving the demand for apartments, condominiums, townhomes, etc., have been building momentum since before the pandemic. According to Jim Newell, MAI, Director of LPA’s Institutional Advisory Group, “urban multifamily growth was stifled in 2020 and has mostly made up for lost time in 2021.”
How high might multifamily property values rise in 2022? More importantly, is this appreciation sustainable? At face value, changes in tenant demographics and the rationality (or irrationality) of the market may seem to offer sufficient explanation for multifamily’s current performance. But understanding which factors are foundational requires deeper analysis.
Keep reading for Jim’s unique insights on what’s happening with multifamily right now — and what that might mean for its future.
1) Americans keep moving to the Sunbelt.
The pandemic unquestionably accelerated migration to the American Southwest. But the most recent decennial census has quantified just how much this trend predates the wave of relocation that began in March 2020. More importantly, what else do we know about these new Texans, New Mexicans, Arizonans, etc.? Who are they, where are they leaving behind, and what are they hoping to find in their new home states?
Baby boomers are among the largest group of migrating Americans. The Sunbelt’s lower cost of living and mild winters promise a more comfortable retirement — a phase of life many boomers have entered during the Great Resignation. Meanwhile, a strong stock market has fattened 401ks and IRAs enough to make early retirement a more viable option.
But seniors aren’t the only ones on the move. Corporations are relocating their operations, and often their headquarters, away from the high cost-of-living, stringent regulations, and tax burdens of coastal urban centers. Plus, they’re finding more business-friendly environments in cities such as Dallas, Austin, and Phoenix. Meanwhile, expanded opportunities to work remotely have prompted many employees to consider quality of life measures over proximity to the office when deciding where to live.
There’s further evidence that investors should look south and west. Demand in these regions and robust transaction volume have driven up property values, attracting investors despite the economic uncertainties of the past year and a half. Dallas, Houston, Atlanta, Miami, and Phoenix now lead the country in multifamily development, delivering more than 44,000 units in 2021. Moreover, nearly 171,000 units are currently under construction in these Sunbelt cities.
Jim adds an important qualitative measurement to these numbers: the weather. Specifically, that extreme summer temperatures have not deterred migration to the Sunbelt. “In 2021,” he says, “markets such as Phoenix defied seasonal trends of years past and experienced tremendous leasing velocity and rent growth.”
2) Single-family home prices are reshaping the American Dream.
Boomers may be on the move, but more and more millennials are nesting. Numbering more than 72 million, these individuals born between 1980 and 1995 make up the largest segment of the U.S. population.
While the majority of millennials — especially millennial parents — identify homeownership as one of their personal goals, the low supply of available houses has radically altered their timetables. According to a 2019 Apartment List survey, the number of millennials that say they prefer to rent was ticking up before the pandemic caused domestic real estate to begin overheating.
“The major push of institutional investors into the single-family rental market has likely contributed to higher home prices,” Jim adds. In fact, more and more new housing starts are build-to-rent units. As the Associated Press recently reported, “[i]n the third quarter [of 2021], builders broke ground on 16,000 single-family homes slated to become rentals. That’s the highest quarterly total of housing starts for built-to-rent homes going back to at least 1990.”
“Trends like these have made it even more difficult for first-time homebuyers to make the jump,” Jim explains. “Growth within the multifamily rental market has been very strong as well, with many young families choosing this route.”
That said, the rising cost of homes isn’t the only factor keeping millennials in their apartments. Stagnant wages and heavy student loan debt have made it harder for them to save up for a down payment or qualify for a mortgage with friendly terms. The current administration in Washington has pledged to address the issue of student loan debt, and some steps have been taken to fix the unwieldy loan forgiveness program.
Even a partial debt-cancellation via executive order or a lowering of interest rates on government loans could free up cash for millennial families saving for a down payment. However, Jim notes that, for now, “the market is likely to continue obeying the rules of supply and demand rather than government policy.”
2) Multifamily cap rates are experiencing dramatic compression.
The trend toward compressed cap rates in the multifamily market is showing in most regions of the U.S. This compression is a sign that both investor confidence and pent-up demand are driving up prices. Suburban multifamily is leading the way, particularly Class B workforce housing.
“The occupancy rate growth we’ve seen in suburban garden-style developments since March 2020 has largely been due to people fleeing urban centers over density fears,” Jim explains. “This was very noticeable in Los Angeles and the California Bay Area — residents relocating from San Francisco to Pleasanton, Walnut Creek, etc. This also occurred in the Seattle area, as people no longer needed to report to offices in the city and preferred the lower rents and larger spaces available in more suburban markets.”
However, urban multifamily property values are also beginning to rise. From Jim’s perspective, this rebound reflects the confluence of several forces. Data from multiple sources indicates that people are moving back to the large metros supposed hollowed out by pandemic migrants. In fact, a recent report issued by the Office of the New York City Comptroller reveals that “[s]ince July 2021, the city has registered an estimated net gain of 6,332 permanent movers, as compared to the same months in 2019, indicating a gradual return to New York City. Nearly 62 percent of the net gain over these three months occurred during August.” This same report also notes that wealthier, Manhattan-based renters were more likely to have moved out of their Class A properties than their less affluent neighbors — regardless of the density of the neighborhood they left behind.
Investors are following these returning tenants and new arrivals. “I would argue that the pricing compression we’re seeing in multifamily is due to fierce competition for lower-risk assets. There just aren’t many low-risk CRE investment alternatives to multifamily,” Jim says. “There is virtually no transaction activity in large retail assets. Office within certain markets is still good (e.g., Amazon buildings in Seattle and Bellevue), but, overall, occupancy is lagging and is predicted to continue lagging into 2022. So there are incredibly high capital inflows into new and existing funds to acquire multifamily properties, especially with debt as cheap as it currently is.” Indeed; the Mortgage Bankers Association (MBA) anticipates that 2021 will generate an all-time record high of $409 billion in multifamily lending.
Although compressed cap rates have excited the market, this trend could moderate in response to other economic developments. Class A and Class B multifamily continue to benefit from inflation as high construction costs make affordable housing starts a less profitable proposition. The scarcity of affordable single-family homes is pushing would-be homeowners into rentals. As the pandemic-caused disruptions smooth out, the housing market should cool down, encouraging more tenants may pursue homeownership.
Moreover, as the world witnessed at the end of November, any unexpected surge in COVID infections or the appearance of new, vaccine-resistant virus strains will likely spark turmoil in stock markets both here and abroad. And that turmoil will eventually have a ripple effect on CRE. “Due to allocation requirements among large institutional funds, the primary risk in multifamily would be if equities markets were to sustain a major impact,” Jim points out. “That might force rebalancing efforts that lead to liquidation of CRE assets. But, right now, fund managers are chasing yield by focusing on a handful of property types: industrial, health sciences, self-storage, and multifamily (including single-family for rent).”
4) Builders and landlords are bullish on multifamily.
In March 2020, as the stock market plunged and unemployment soared, investors took a wait-and-see stance. “Many deals in progress were delayed or abandoned entirely,” Jim adds. “Some investors even abandoned large non-refundable earnest money deposits early on.” Government rent assistance and stimulus checks stabilized conditions for most tenants, and rent payments, which lagged in April 2020, returned to near pre-pandemic levels by the end of the year, according to the NMHC Rent Payment Tracker.
After these initial hiccups, some of the largest apartment management companies moved forward with noteworthy mergers and acquisitions, demonstrating confidence that healthy pre-pandemic growth would resume. Strong demand continued through the first two quarters of this year, driving rent growth and increased sales volume.
But construction delays continue to plague the market. Steel and lumber remain stuck on container ships offshore, forcing builders to source alternate materials or halt construction altogether. According to the results of a June 2021 survey conducted by NMHC, 93 percent of multifamily construction firms reported delays caused by permitting backlogs and shortages of labor and materials.
Even with these delays making markets that were already tight that much tighter, U.S. Department of Commerce data shows multifamily starts increased by more than 20 percent in August 2021. At the same time, single-family starts decreased. Nevertheless, supply chain and labor issues will continue to impact this sector.
In summary, the multifamily market is returning to pre-pandemic norms even as it evolves to accommodate new consumer behaviors and living situations. For example, fears that the end of the eviction moratorium would lead to a sharp drop in occupancy numbers haven’t panned out. Rent payments through November 2021 are near (if still slightly below) 2019 levels. Adds Jim: “I believe many overbuilt markets are taking advantage of current market dynamics to catch up on occupancy. This will probably remain the case while supply chain and labor issues continue to impact the construction industry. The single-family for-rent sector will compete for tenants on some level. But, as long as homeownership remains out of reach for many and more and more Americans are attracted to the more flexible lifestyles associated with renting, demand for multifamily projects should remain high.”