When analyzing and forecasting growth for the main group of asset classes for commercial real estate: multifamily, office, retail, industrial, self-storage. The multifamily sector offers the most desirable investment opportunities primarily in secondary and tertiary markets in at least 15 metropolitan cities. Many investment management and private equity firms have different risks appetite about these assets and some are completely averse. Some investors prefer office over multifamily properties because of the allure of sophisticated business tenants and longer lease terms. Others prefer retail over multifamily because of different type of leases that are applicable to retail tenants as well as dealing with small businesses or mom and pop shops. The point is real estate investment is about location, diversification, risks rewards, investor appetite, economic trends, and investment strategies just to cite a few.
Shortly after the financial crisis in 2008, the multifamily sector has grown in increasing rents and low vacancies in many top tier and secondary cities: New York, Washington DC, Boston, Chicago, San Francisco, Dallas, Los Angeles, Seattle, etc. Obviously, there are many macro and micro economic factors that have attributed to such staying power in the sector, which will be discussed shortly. The goal of this short piece is to explain briefly about 3 main reasons why multifamily acquisition and lending are still economically strong. This will not be an in-depth multifamily market research or a dissertation report about the property type.
Reason # 1 – Rental Growth
In 2017 inflation grew to 2.2 percent and the multifamily sector fair well outpacing inflation by 3 basis points. According to a few research data (REIS, Dodge Data & Analytics, etc.,) since 2010 rents in the sector remained positive, except for core (Class A) multifamily assets in primary and secondary cities that are slightly affected by: (i) construction delay which slowed down units’ completion in many sub-markets; (ii) strength in the overall economy has catapulted job and population growth, especially millennials continue to surge upward and (iii) higher vacancy rates due to new supply with many apartments coming online. The outlook for the remaining three quarters, 2Q18, 3Q18 and 4Q18 will remain stable in both near and long term, unless some disastrous economic shock, major recession or nationwide natural disaster occur.
Reason # 2- Supply and Demand
On the demand side many drivers remain intact for multi-families. Recently, according to the Census Bureau, the millennials population is 73 plus million, making it the largest U.S demographic age group. Millennials have been a driving force for the multifamily sector since the last Great Recession. Most of this demographic continues to migrate into urban communities and closer to CBDs, central business districts for affordability, only a small percentage are purchasing houses and moving to the suburb. This trend will continue to strengthen the sector for investment and lending opportunities. Although the aging Baby Boomers demographic is declining in numbers, approximately 74 million in 2016, they are also creating high demand for the multifamily sector. No longer are the days where boomers go retire in “sunshine states” or “some remote area.” With higher life expectancy and the population retiring later, many in this demographic are choosing to live in multifamily communities and urban cities.
On the supply front, according to Doge Data & Analytics for 1Q2018, “research showed that new supply is primarily concentrated in approximately 10-12 metropolitan area: New York, Washington DC, Boston, Los Angeles, Dallas, Seattle, Chicago, Miami, Denver, Atlanta, Austin, and Phoenix.” Most of this supply is concentrated in specific sub-markets in these cities, particularly New York, Washington DC and Boston. What this means for the multifamily sector in these cities is that supply will outpace demand for the next 7 quarters due to many units coming online at the end of fiscal year 2018. For instance, the same research firm recently emphasized, “The New York metro has 59,000 units underway, of which 45,000 are expected in 2018 alone.”
Reason # 3 – Capitalization Rate and U.S Treasuries
At the end of fiscal year 2016 I published an article titled, “10 Commercial Real Estate Trends in Review 2016; Expectation for 2017.” There are a couple of paragraphs about how the effect of global political landscape, OPEC (Organization of the Petroleum Exporting Countries), and monetary spending policies will impact both inflation and interest rates. Essentially, the Feds increased rate 3 times as it was predicted in the reading. The 10 years treasury ended around 2.40% at the end of 4Q2017, and as of March 27, entering 2Q18 soon, U.S 10 years treasury is at 2.77%, an increase of 37 basis points. Interest rates and capitalization rate (cap rate) typically run in tandem – meaning when rates increase, cap rates go up as well. This is an indication that many multifamily properties (Class B and Class C) in some secondary and tertiary markets could be trading at a higher cap, hence facilitating the need for investment opportunities and lending.
According to Moody’s Analytics, CPPI (Commercial Property Price Index) and the Federal Reserve Board, “Cap rates ended the last quarter of 2017 at 5.8%, down by 20 bps (basis points) over the year, and it’s poised to remain flat by end of quarter 2018.” For the multifamily sector this is rather good news because (i) capital deployment is still strong from both national and international investors; (ii) interest rate is still low for great investments and financing; (iii) the sector should get a major boost from the recent tax cut legislation and (v) multifamily will remain a favored property type for many investors, owners and investment firms.
The reality is cyclical and economic cycle is part of the real estate sector and a peak is bound to happen to any asset class at some point, thereby causing a slowdown. Typically, a slowdown will be short-lived 6 to 24 months, unless if there is a major recession, a catastrophique disaster or a black swan event. The multifamily asset class, in only 10-12 metros as previously discussed, will certainly take a slow hit over the next 12 months (according to many research firms) due to an onslaught of oversupply coming online outpacing demand, change in rents, vacancies, absorption, etc. Despite of it all, historically when real estate underlying fundamentals and critical driving factors for growth remain strong, the asset class usually fair well rather than plunging into economic despair. Ultimately, due to various investors appetite, risks return, and continued growth of capital injection in multifamily properties, the sector will continue to attract investments and financing.
By: Ibsen Alexandre
Ibsen Alexandre offers his opinions about real estate finance, business, and investment at www.Refivest.Com and other real estate publications. He can be reached at email@example.com
The opinions expressed herein are those of the author(s) and do not reflect the view of a particular firm, its clients, any respective affiliates nor any Media Platform. This article is for educational general purposes only and is not intended to be and should not be taken as solicitation to lend.