Multifamily Loses Some Shine Under Harsh Light of Reality

Article originally posted on Globe St. on March 16, 2023

But the Bottom Isn’t Heading to Drop Out.

LightBox recently wrote that a number of factors suggest that CRE professionals avoid overconfidence. Stifel investment banking firm Keefe, Bruyette & Woods (KBW) went further, believing the industry is headed for a hard landing.

But more specifically, each had something to say about multifamily. KBW frames the view investors and developers have had of the sector — one of the two unstoppable darlings of the pandemic period. “For the past 15-plus years, multifamily (i.e., the apartment sector) has been perceived as a safe haven asset class as it offers an inflation hedge and fulfills the essential need of housing,” they said. “Alongside growing institutional allocations to CRE, frothy markets bolstered by low interest rates, and surging rental demand coming out of the pandemic, this sentiment caused multifamily valuations, transaction volumes, and construction pipelines to reach record highs in 2021 and through mid-2022.”

The view is understandable in part because people have to live somewhere, so even when rents skyrocketed into 2022, what would people do? As KBW noted, between March 2019 and July 2022, average national cap rates for the category went from 5.54% to 4.63%, a drop that was roughly equal to a 20% change in value. Cap rate spreads also went from an historical 3.23% to 0.67% because people had come to assume that multifamily was a hedge against inflation and recession.

But cap rates are moving up again, from 3.9% to 4.0% over 2022. REIT implied cap rates shifted similarly from 5./7% to 5.8%.

Units under construction jumped from 658,000 at the end of 2019 to 934,000 in December 2022.

“These are the highest levels seen since the 1970s,” KBW wrote. “The increased supply has the potential to pressure occupancy, especially in geographic markets that have experienced the most inventory growth.” That includes Dallas, Phoenix, New York, Austin, and Atlanta. Rent growth has slowed substantially in many markets. Large banks slowed CRE originations in the second half of 2022, both because of the strength of the first half of the year and a questionable economy.

Then there is maturing debt — more than $430 billion in multifamily specifically expected between 2023 and 2024, according to LightBox. About a third were likely loans that were transactional in nature, with expectations of renewal in an environment similar to the low rates in force when they were originally planned.

But slowing and challenged is still different from crashing, as LightBox noted. There are still “strong demand drivers” and multifamily remains a “top asset class.”

“Double-digit growth is no longer sustainable, but 5% to 7% growth is still a strong indicator and is a realistic projection,” the firm said.