Greg Cooper J.D.
July 5, 2022
We often talk about how the multifamily sector made it through the worst of the pandemic with astonishing resilience—in fact, the expected Covid discount turned into the Covid pricing surge. The market has continued to thrive and is fundamental to rebuilding the economy as we move forward into the new normal. However. . .there are challenges and headwinds out there, and it’s important to acknowledge them in the current environment.
In particular, there’s a raft of doom-and-gloom predictions around rising inflation, the spike in interest rates, and what this will do to multifamily investments as we go into uncertain market conditions.
Some statistics are undeniable: The National Multifamily Housing Council’s (NMHC) latest Quarterly Survey of Apartment Market Conditions reports that apartment markets just tightened (for the fifth straight month) and debt financing became harder to get (for the third straight quarter). And as interest rates keep moving up, the assumption is that cap rates will too. Anecdotal evidence suggests that prices are heading downward, some existing deals are being re-traded to cope with current realities, and more than a few assets are falling out of contract. Brokers calling to tell you that marketed assets are failing to meet pricing expectations was unthinkable just a couple of months ago.
So what’s going on out there from the prospective of a busy multifamily acquisitions firm? There’s no universal truth—it’s a complex situation with many variables, and we need to get the nuance.
First, the multifamily investment market is still awash in money and looking for deals. True, a few groups have paused activities as they wait for the debt markets to settle, but many are also seeing this an opportunity to pounce. While the multifamily market isn’t immune to the pressures on the economy at large and CRE in particular, institutional investors have allocated billions to this sector, and that money will need to land somewhere—indeed, the pressure to put that capital to work is enormous. Even if the CRE market overall is hard hit, the multifamily segment is well poised to come out on top.
Consumer demand for more multifamily options remains strong—sometimes exacerbated by pandemic-driven migration, at other times a result of demographic shifts. We also can’t forget the shortage of units caused by a lack of new supply coming to market, which will take a decade or more to address. On a related note, developers will continue to encounter more hurdles with supply chain disruptions, which will keep demand well ahead of supply.
Next, while prices may be steadying, they’re not falling. The market has had an incredible run, there’s some course correcting going on, and economic jitters are adding to the uncertainty. In the many markets where we’re active, we still haven’t seen any downward pricing adjustment; instead, there’s a slight uptick in the openness to negotiate terms, and ultimately sell at a fair price. When all things are considered, both buyer and seller need to be open and honest about the current and near-term asset and capital markets environments, which have both seen some serious changes over the last year, particularly in the last few months.
Given these factors, it’s hard to make a bear case for multifamily in the next 5-10 years. Even in a rising interest rate and inflationary environment, and even if rents don’t continue their double-digit year-over-year increases that we’ve seen in most markets the last couple of years, they’ll revert to a more typical 2%-5% increase (and perhaps more in the most desirable markets and submarkets). Ultimately, acquiring and owning multifamily as an investment is a low-risk and highly stable hedge against inflation. It will continue to offer steady value appreciation, just perhaps not the 30% to 50% appreciation since the pandemic.
On the acquisitions front, let’s make a distinction between stabilized assets offering a predictable yield, and those requiring a value-add approach and delivering potentially higher returns.
The market for the former doesn’t show as much turmoil. There are plenty of stable assets out there with owners looking to move on, for a variety of personal and professional reasons. The Offerd database tracks over 100,000 multifamily properties around the country, most of them off-market, and our algorithms—blending a potent mix of 10,000 data points encompassing rents, valuations, occupancy rates, demographic shifts, and much more—find those that represent a very sound investment. With a pre-determined cash flow, these offer yield without drama.
Of course, many investment groups also target properties that require value-add strategies, because they offer the highest ROI. These investments require time and effort, and lack a stable cash flow in the early years while the turnaround is undergoing. In these cases short-term bridge debt is necessary before long-term agency debt can be placed.
It’s important to understand the domino effect here, because each particular factor is tied to others. For example, the big challenge in this strategy is the bridge debt, which is dependent on a floating interest rate, which in turn is tied to either a 10-year bond yield or SOFR (for Secured Overnight Financing Rate, used by parties in commercial contracts outside their direct control).
The problem with bridge loans today—which are quite common in normal circumstances—is that they require the borrower to make projections not only on the asset itself, and the rent bumps and rent growth assumptions involved, but also on where rates will be on the curve at any particular time in the future. This can get very complicated very quickly. Buying rate-lock insurance is always an option, but those costs have risen dramatically in this environment.
We also have to appreciate that this is a highly dynamic environment: The rates are not what they were in the December-January period, and they won’t be what they are now in the months ahead. This has set up a mismatch between buyers’ pricing models and the sellers’ expectations.
If there’s a takeaway here, the this is it. Both the Federal Reserve and Congress have pumped enormous amounts of capital into the economy, and we are arguably at full employment. Even with a possible recession, consumers have a better foundation now than in the past. We’re still dramatically under-supplied with housing, and the current supply chain disruptions and staffing shortages will ensure this shortage will continue for a while, keeping rent growth above historical trends. For all these reasons and others, the multifamily market still has the wind at its back.
Prices may indeed fall in the year ahead. But it’s more likely they’ll stabilize and return to a typical—and no doubt slower than the last two years— historical growth curve. That makes this a good time for sellers who plan to offload properties in the next couple of years to be more rational in their pricing expectations.
We’re coming off great times and heading into some challenges. It may be a while before the pricing party returns, but the market is still resilient.