Multifamily Where Do We Go From Here?

[Bill Rapp]

While the pandemic disrupted much of the commercial real estate market, it notably boosted the multifamily sector, driving demand for rental apartments, especially those with home office space. The period saw massive subsidies to families and historically low interest rates, making multifamily investments highly attractive. However, as 2024 begins, the landscape is shifting. A development rush has led to hyper supply in 63% of U.S. markets, and recent interest rate hikes have reduced cap rate risk premiums, pressuring property values. Additionally, the post-pandemic migration trend is leveling off, and rising insurance rates are straining operating budgets, indicating a year of complex adjustments for the multifamily sector. Join us as we delve deeper into this year’s multifamily market report to uncover the underlying dynamics and explore potential pathways in this evolving market.

Multifamily housing starts are hitting decades-long highs, and analysts at Yardi Matrix are forecasting 1.5 million units delivered by 2025. As is typical of nationwide statistics, the totals disguise wide differences in local markets. Yardi sees apartment completions, related to total stock, as exceeding 3.5% in seven markets: Austin (4.6%), Nashville (4.3%), Charlotte (4.1%), Orlando (4.0%), Raleigh (3.9%), Phoenix (3.8%), and Tampa (3.7%). Such supply volumes outrun sustainable demand trends. This portends upward pressure on vacancy and downward pressure on rents. For most of these markets, the rent-to-income ratio, a key affordability metric, is already above 30%. This could even impact the Sunbelt metros that have long touted their cost advantage.

Exacerbating the pressure for multifamily operators, especially in the South and West, are double-digit increases in apartment complex operating expenses. Florida, Texas, and California are particularly affected. One critical reason: soaring insurance costs in areas where climate change and related risks are eroding the bottom line. After taking into account the increasing frequency of multi­billion-dollar natural disasters — tracked for more than half-a-century by Swiss Re — some property/casualty insurers have decided to exit certain states entirely. Investors have taken heed. Data from MSCI Real Assets shows 2023 transaction volumes contracting steeply from the COVID era recovery peaks (2021-2022). This is reflected in our regional rates comparison chart which shows reported cap rates rose between 41 and 83 basis points, depending upon region and property classification. The risk premium in multifamily cap rates — which average between 5.5% and 6.2% on a national basis — is now very thin compared to 10-year Treasuries, which are at about 4.5%. Investors seem to be saying they’re not being sufficiently compensated for risk at current multifamily prices and income levels. Something has to give.

Housing tenure choice — own versus rent — comes into play as well. Here again we find massive differences among major U.S. markets. For some cities, the spread between monthly mortgage costs and average monthly apartment rent is just $300 or $400, according to a study released in May 2023 by the website SmartAsset.com. Those cities include Atlanta, Charlotte, Las Vegas, Nashville, Philadelphia, and Phoenix. These markets are unlikely to see homeowner demand being diverted to rentals for economic reasons, given the tax advantage of ownership and the potential for equity gains. On the other hand, the differential in Los Angeles, New York, Seattle, and San Francisco is well over $1,000 per month, enough to edge the own-vs.-rent choice decisively toward apartments.