One prominent adviser is telling developers and investors to be careful but stay the course.
Negative economic growth in the first two quarters of 2022, a volatile stock market, apartment dwellers stressed about inflation, and interest rate hikes from the Federal Reserve are enough to make developers and investors in the multifamily segment of commercial real estate feel more than a little anxious. Even so, industry experts such are recommending that their clients stick to their long-term strategy and ride out the turmoil, rather than change direction.
“We’re encouraging people in the multifamily sector to stick to doing what you do,” Adam Ducker explained. He’s CEO of RCLCO, a consulting firm that provides strategic advice to clients on property investment, planning, and development. “Keep your eyes open, be cautious, and don’t over-leverage and buy too much.”
“Multifamily is a very resilient sector, or at least has been in the U.S.,” Ducker explained. Although he thinks that the next six to eighteen months could be challenging, “it’s not going to be so tough that we say, ‘let’s figure something different to do.”
Economic conditions are clearly having an impact on the multifamily sector, but the impact so far has been moderate. Demand for apartments, which has been decelerating since its peak last year, “took a pause” in the second quarter of 2022, according to Matthew Vance, a senior director and Americas head of multifamily research for CBRE.
“We didn’t see the kind of absorption of apartment units in the second quarter that we’ve gotten used to over the past couple of years,” Vance said. “And vacancy rose a little bit, 70 basis points, with the combination of that pause in demand, as well as the supply that continues to deliver.” Even so, he notes, vacancy rates remain relatively low, and rents continue to rise.
Vance thinks some of the pause in demand is the result of two things: first, the unprecedented housing demand from last year and early this year likely pulled forward some of the demand we would normally expect this year. Second, falling consumer confidence is likely causing households to make more conservative financial decisions—and housing is just one of those.
Similarly, demand is slowing in sales of apartments.
“Second quarter sales were still very high according to Real Capital Analytics,” Caitlin Sugrue Walter, vice president of research for the National Multifamily Housing Council, said via email in late July. “But our most recent Quarterly Survey of Apartment Market Conditions, which was conducted mid-July, showed that sales volume was decreasing compared to three months prior.”
Meanwhile, multifamily developers and owners are themselves dealing with economic pressures, both on building new projects and operating existing ones.
“The biggest factor is the rising cost overall,” Walter said. “For new construction, you have the rising cost/uncertainty/availability of construction materials and labor, as evidenced in our quarterly construction survey. But now you have the added costs related to higher financing costs. This just makes it even more difficult to get a project to remain financially feasible, and results in higher needed rents. Operators and owners are facing a ton of cost increases as well—insurance costs are rising rapidly, they are facing the same labor and material costs and availability issues that the developers are facing. And if they need to sell or refinance, they’re obviously not immune to the changes in rates.”
Over the long term, Ducker still sees underlying economic conditions as favorable for multifamily real estate. “Even though we’ve built a lot of apartments, most of the inventory in America is still old, and there’s a lot of growth in demand,” he said. “There’s opportunity to upgrade the inventory. Talented owners make money by creating or adding value to their assets, and in tough times the process of adding value can help even out the returns.”
While the financial health and purchasing power of renters is a concern, they may be holding up better than expected.
“The American renter certainly is facing a lot of costs themselves—inflation has made it so that folks are spending a lot more to buy the same goods,” Walter said. “This makes it difficult for many renters, but in the professionally managed world, RealPage recently came out with research that showed the rent-to-income ratio was less than 25 percent for the renters in their leasing software portfolio. The assistance from the Federal government certainly was a needed lifeline during the worst of the Covid pandemic, and so far payment rates seem to be holding up from anecdotal reports.”
Ducker remains confident that multifamily sector will remain resilient, in part because even if renters cut back on discretionary purchases, a roof over their heads remains an essential. “People in the market will make different decisions,” he explained. “Somebody won’t move to a nicer apartment next year, or maybe somebody who was living with a roommate and thinking about getting their own place will delay. That may well happen, and it might lead to slower rent growth, and new projects might be a little less likely. But those are changes on the margins.”
And in some ways, a tough economy may actually benefit owners and investors in multifamily properties. Ducker notes that rising home mortgage rates and economic uncertainty may cause some apartment renters who were thinking of buying homes to remain where they are. “That may offset things, to some degree,” he said.
Walter thinks the economic stress also may lead to some positive change.
“There is now widespread acknowledgement both from the policymaker and mainstream angles that there is a housing supply issue that has exacerbated the affordability crisis,” She said. “Policymakers also seem to be acknowledging that operators and developers are not immune from inflation and materials availability, so my hope is that this will help us get some needed assistance to develop at some of those harder-to-pencil income levels.”
