Soft Landing Or Bumps Ahead For Multifamily Investment?

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The Editors's picture
Multifamily investment looking ahead to the next 12 to 24 months by Yardi Matrix

The economic forecast for multifamily investment for the next year or two is that it is good enough to maintain occupancy, but rents may not be what people are hoping for, according to a new report from Yardi Matrix.

Jeff Adler, vice president and general manager of Yardi Matrix, said in a webinar that, “We are coming in for a soft landing – driven by supply. While demand is good, we are in for a busy 12 to 24 months,” he said.

“Things are getting absorbed, but not at rents people were hoping for,” Adler said as multifamily supply will peak in 2017.

“In my view the macro economic conditions are good, not great, but they are pretty good,” Adler said. “And they are generating good job growth with 150,000 to 200,000 jobs per month. This is good enough to maintain occupancy - and decent - but continued deceleration of rent growth is happening.

“You can clearly see we are coming in for what I hope will be a soft landing driven by supply – not by demand. Demand is still solid. It’s mostly on the supply side. Demand is a big tailwind, both short-term and long-term. It is still a fantastic demand story,” he said.

“However, shorter-term, supply is peaking. So we are in for a bumpy 12 to 24 months. Supply surges are focused in major urban hubs. Seeing that, it is coming at the top end which we are seeing through our pre-leasing data. Things are still getting absorbed, but not quite at the rents people were hoping for.

“Higher cost of debt, higher cost of land are there, rents are not going higher to bail you out so all of that has made new construction tighter. Things will get built but the pipeline is peaking,” Adler said.

There is still a housing shortage in mid-priced apartments, he said.

Is this still renter nation, does that hold true?

“Yes, but not in an accelerating way. I think the homeownership rate has stabilized around 63% so I think we still have great demographics because of the age of the group. But I do not think you are going to get more people renting as a percentage of the total.

“So it has stabilized and we said we thought it would stabilize. I think we are in renter nation compared to where we were 10 years ago. I don’t think the rate of homeownership is going to go to 50%.  I think that 63% is about where it is going to be.

“I think we are still in good shape. We don’t have quite as many tailwinds. So that was a tailwind when we had the reduction in the homeownership rate. Each reduction of one percent added about a million households into the renter pool. I don’t think we get this extra tailwind, but it is still pretty good,” Adler said.

Suburbanized urban areas near large cities for multifamily investment

“Depending on your investment strategy and your cost of capital, you are going to have to go one to two tiers down from your comfort zone in order to make deals pencil,” Adler said.

“Wealth is created in this economy on the basis of ideas. And ideas in certain industries aggregate in certain locations where people can share ideas very quickly and knowledge is being generated in that particular industry. And, where the value of place increases.

“If I am a real estate investor, I want to be in a rising tide where wealth is being created and where the value of place improves. That is a fundamental insight you can apply to a lot of different industries and lots of different locations,” Adler said.

Where does an investor go?

“I think it is commercial real estate. I think high occupancy on stabilized properties is sliding. You can see in the data that the markets with high supply are impacted the most. Rents are decelerating. Wage pressures are finally catching up to rent growth,” Adler said.

“So while we have a tough 12 to 24 months ahead, I think we still come out the other side quite positive,” he said..

Rent growth and occupancy have crested

Central business district building is done for a few years, Adler said.

“Leading edges of the millennials are moving out of the central business district to the suburbs, driven by the first kid or the second kid.

“Central business districts have not solved their schools problem,” Adler said which is why this moving out is happening.

Adler outlined the state of the real estate economy with the following:

The state of the real estate economy summary

  • U.S. Multifamily Supply is peaking in 2017; but the next 18 months will be a bit rough
  • Development is buffeted on all sides, demand/rents, costs, financing, labor availability
  • U.S. Multifamily rent growth peaked in early ‘16 and has been decelerating since-with Class impacted more
  • The Deceleration is broad, and most pronounced in area of accelerating supply and/or decelerating demand (Houston, San Francisco)
  • Remaining bright spots are small, niche markets that draft off of larger markets-(Reno, Sacramento, Colorado Springs,, Tacoma)—don’t expect it to last
  • U.S. Multifamily asset price growth has flattened—first time this cycle.
  • Sharks are circling waiting for blood in the water of soon to be broken lease-up deals—don’t bet on too much of it.

“Where the units are going to come online is in these suburbanized urban areas,” he said.” That is where it is reoriented. I think the central business district building boom is done for several years. Everyone’s got what they want. It is great for society to have such wonderful, vibrant urban centers. But I think it’s going to take a pause for a few years.

“Let’s acknowledge the fact that rent growth is decelerating. It is coming down. The ‘rent by necessity’ sector is performing better. But new supply has had an impact.

“There is demand in the market, it is just a question of at what price point is it going to work.

“The markets are all slowing down from where they were. Dallas went from 7% rent growth to 3% rent growth. Not bad, but not 7%.

“I think it’s moving back to the long-term average. Until this supply pipeline gets absorbed. I think it’s a matter of absorbing the supply over the next 24 months, as long as the demand continues. I think it will be higher than the long-term average” for rent growth, “but it’s not 7%.”

You see some of the same things in the Western markets. Salt Lake City being a variance.

“I would call out for example a couple of smaller markets that are doing quite well, but have a lot of volatility:

  • Reno
  • Sacramento
  • Colorado Springs
  • Tacoma

“All of them have rent growth of over 7 or 8 percent, and they are all associated with a larger metropolitan area where there has been significant price discount trouble. Reno is a function of manufacturing coming into the market as a spill-over from the Bay Area – Tesla.

In summary now

“The multifamily supply is peaking. Multifamily rents have peaked and are decelerating. But it’s not bad. It is more a return to normalcy. There are people circling waiting for blood in the water for what they hope soon will be broken lease-up deals. I don’t see it. It’s a possibility. I don’t see a lot falling out of bed, but some people are hoping,” Adler said.

The longer term view for multifamily investment

“If I were an investor, I want to position myself where the tide is rising. Why? Because even if I screw up on some underwriting or other variable, I am going to get bailed out. What I don’t want to do is put myself in a situation where everything has to go right, and I am swimming upstream,” Adler said.

“There is still multifamily supply that needs to be added in the future in big cities, such as Boston, New York, Los Angeles, San Francisco and Chicago. Dallas also has a big supply coming on, but there is a demand there based on the jobs growth and industries across the metro.

“There are areas where the growth is diminishing, and where the cost of housing has gotten ahead of the cost of labor, and so it is an affordability issue. We are seeing that in Denver and the San Francisco Bay area.

“Look at the places where millennials and boomers are leaving. What do they have in common? They are all high tax states. So if someone tells you the high cost of living and taxes do not make a difference, the data says ‘Oh yes it does.’ And, you really have a set of winners and losers. The winners are the West and the Southeast capturing the out flow from the high tax, highly regulated states.

Same story on where people are moving to. Lower tax places fleeing higher tax places, Baby Boomers and millennials.

“In the gateway cities of Boston, New York, Los Angeles, San Francisco, Chicago and the District of Columbia, out flow of domestic people to other parts of the country is being covered by the in-migration or immigrants coming in those cities. So if you are counting on investing in those gateway cities, you are betting on the immigration coming in. It may be a good bet. It may be a bad bet.

“We as a country actually need the immigration if you look at the working age population. We really need immigration to be appropriately legalized. Immigration is not on the Hispanic side that is old news, it is actually from China and India,” Adler said.

If you would like to learn more you can subscribe to Yardi Matrix or call 480-663-1149. You can also find out more about webinars here.

About Yardi Matrix

Yardi Matrix, formerly known as Pierce-Eislen, Inc.®, was founded in March, 2000, and acquired in July 2013 by Yardi Systems, Inc., a Santa Barbara, California software company focused on commercial real estate industry applications. The Yardi Matrix apartment information service is a high-performance system with the sole function of supporting the commercial apartment industry’s dominant participants. The company's services monitor the 50+ unit apartment universe from the property level to the submarket/market level in a form unique within the commercial apartment information industry.

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