Is Multi-Family Getting A Bit Crowded?

[Dan DiFilippo]

I'm a broker in the Fort Bragg area in North Carolina.  It's an opportune area for investing and we've seen out of state owners bringing more money in over the last few years.  Particularly, people go crazy over multi-family deals.  I can understand why these deals work well in some ways.  It's priced right for a value-add?  Go for it!  House-hacking?  No doubt!  In fact, let me preface with a quick list of pro's and cons for a multi-family as compared to a single family.

Pros:
Proportionally lower taxes/insurance
Ease of management(locationwise)
Lower roof capital expenditures
Higher rent to price ratio
Rarely fully vacant - can reno-rotate too
Low price volatility

Cons:
May pay minimum management fees due to lower unit rents
Greater potential for delinquency/damage
(Much) higher HVAC capital expenditures
Low price appreciation

Overall, it's a somewhat bizarre phenomenon to me to watch the money rushing into multis.  We're aware of bubbles.  Anyone old enough to be an investor has 2007 in living memory.  We all know that the market can turn on us.  More than that, we know that we can ruin our own markets.

I can understand a euphoric rush into single families.  That would make sense.  In economic terms, single family is a normal good, whereas multi-family is an inferior good.  What I would think we would *want* to see is this kind of a rush into single family.  That kind of a move would seem to indicate strength in the economy.  With the partial exception luxury apartments in popular cosmopolitan areas, single family homes are supposed to be the ideal living situation for the American family.  Throw in some pointy pieces of white-painted wood and you've got the American dream.  And while the American dream doesn't mean what it did half a century ago or earlier, I don't think that the apparent shift to multi-family is a function of any sort of romanticization of the lifestyle.  I think we can rule out a change in tastes as being a primary driver -frankly a driver in any capacity- of the multi-family buy-up.  Right off the bat, we should be regarding this as a bad thing from a social perspective.  This by and large, is more people living in ways that they probably don't want to.

And at first it's not a particularly difficult concept to understand "it's sad, but Americans just don't have the money, so they're living in multi-families now".  That makes perfect sense.  Until you think about it.  If your household income drops because you or your spouse loses your job, you'll just manage your budget and make some changes and not much will happen.  If a recession comes into town, maybe the local steakhouse ends up closing because everyone stops spending money there.  Fair enough.  The steakhouse produces steaks which are consumed every night and then one day it just stops because it's no longer economically viable.  Because nobody is buying.  But this isn't how houses work.  A house is built and then it produces shelter for years.  With its upkeep costs being extremely low relative to its price.  There shouldn't be a slew of vacancies in homes if those homes are desirable.  Those single-family homes are all still there.  They don't get destroyed, condemned, or somehow cancelled when people move out of them.  Who is living in them?  Why are their supposed former residents huddling up in 950sqft apartments when single-family homes are theoretically *sitting vacant*?  Theoretically the market would use the price mechanism to clear, but that doesn't appear to be happening.  What are some of the variables that could be contributing to this?

1) Divorce - divorce is a housing multiplier. But divorces, in absolute terms have been declining.  This wouldn't explain an increase in multi-family living.  On an unrelated note, declining divorce is not indicative of Americans beginning to take marriage more seriously, etc..  It's a sign of Americans not even marrying in the first place anymore.

2) Short term rentals - Where are my Vancouverians at?  We know that if the tourism market can support it, a short term rental property will do pretty well.  Some will argue that in urban areas, short term rentals all tend to be apartments.  In the more investor friendly areas, they may more commonly be single family homes.  At the end of the day, it doesn't really matter which it is.  Conversions of *any* residence into a short term rental indiscriminately depletes the housing stock, causing the rest of the demand side of the market to squeeze into a smaller supply.

3) More households - Along the same lines as the divorce argument, I suspect that following the crisis of 2007-2008 we saw more young adults (say, in their 20's) remaining home with their parents.  Either after finishing highschool and not finding work or after finishing college and not finding work in their field.  Of course, we did eventually grind our way out of that economic mud.  And although our method for calculating the unemployment rate is terribly flawed, it does perhaps mean something that it was at fifty year lows going into the COVID crisis.  And while consumer debt levels over the last five years tells a different story, perhaps the American young consumer was feeling stable enough to move out.

4) Demographics - Yes, I know that 1 and 3 would appear to be "demographics", but let's specifically look at these two components.  Population growth and net immigration.  Net immigration has been relatively stable over the last decade at about 0.35% per year.  While this may not sound like a lot, it actually is going to require a constant increase in new constructions to accommodate on any sustained basis.  Probably not a driver, but definitely a contributor.  And then there's population growth itself.  Endogenous, that is.  Births is pretty small - and also stable throughout the 21st century, while deaths have been steady and with a slight push upwards.  Not much of a culprit.

5) Replacement - There is a question of the capital stock and whether it's being replaced on a sufficient basis.  Permitting data does indicate a slowdown of new constructions.  Being houses don't, on average live as long as people, this variable, which is found wanting, will actually have a heavier weighting than the demographics variable.

Overall, I think it is difficult to tell which direction things "should" be moving.  This is only a snapshot review of the major variables.  I'm sure there are other variables and as well there are probably intricacies that I am missing to what I've already discussed.  Overall, however, I think that a bet on multi-families is inherently a bet against the American consumer.  For the multi-family investment to work, one needs there to be sustained population growth set against a degradation of the capital stock.  For it to work, we need to see new permits suppress to lows and remain at those lows as more and more of the population funnels into multi-family residences.  On the opposite side, if we see the American consumer do well and we start building the homes we want, multi-families will be left vacant.  They will essentially be forced to choose between remaining competitive and remaining viable.

And none of this is to say that its "a patriot's duty" or any such thing to invest in single family homes.  I simply want to point out that housing manias are frightening enough when they're surging manias - luxury manias.  They're darkly scary when the mania is a race to the bottom.  A different set of rules applies.  I've been trying my best to anticipate what's around the corner and would love your guys thoughts on this.