This has been an interesting year in the world of multifamily housing trends. The market for commercial housing properties continues to be strong, even as the current business cycle extends to a more mature phase.
The Big Picture: Multifamily Housing Trends
2017 saw an abundance of new supply, but a recent slowing of new construction permits seems to suggest that the market may find equilibrium.
Rising interest rates and investor caution seem to be tamping down over-exuberance, with property buyers showing resistance to many seller asking prices. When it comes to multifamily housing trends, middle market, suburban properties in vibrant communities are now particularly interesting.
Finding Goldilocks in a Maturing Market
Industry professionals interviewed as part of the annual “Emerging Trends in Real Estate”
report jointly produced by the Urban Land Institute and PwC generally believed that no particular clock is ticking on this real estate cycle.
The report argues that the gradual slope of economic growth since 2010 lacks the obvious characteristics of a “boom” that would trigger a compensating “bust” to correct its excesses.
This recovery has seen gross domestic product (GDP) growth averaging just 2.2 percent annually—relatively modest growth compared to earlier business growth cycles. (article continues below)
Annual Real GDP and Employment Growth, Current and Recent Five Business Cycles
In addition to this measured economic pace, some participants in the ULI/PwC report cited a reassuring lack of “late-cycle optimism” in continued upward momentum.
As one private equity executive said, “We’ve been getting and continue to get generally more conservative, more defensive” as the cycle has matured. A New York–based international fund manager remarked, “Lenders are being tougher, and that’s a good thing.”
"Lenders are being tougher, and that’s a good thing."
The Slowing Pace of Multifamily Construction
Broader investor caution seems also to have tempered new multifamily construction efforts, which in the late stages of prior expansionary periods have led to building “booms.” These have historically contributed to over-supply and follow-on “busts.”
2017 began with increased multifamily construction, which had caused some concern
: “The national apartment vacancy rate increased in the first quarter due to a combination of high Class A construction deliveries and historic fourth-quarter absorption weakness being pushed into the first quarter,” said one senior-level financial services executive.
But he also noted that “a 4.1 percent rise in the overall average rent and 242,000 units absorbed over the past year point to the underlying strong demand drivers for multifamily.”
“a 4.1 percent rise in the overall average rent and 242,000 units absorbed over the past year point to the underlying strong demand drivers for multifamily.”
Because apartment starts began to slow in 2017, the multifamily market will likely see
a slowing of new supply by late 2018 and throughout 2019. A recent Freddie Mac report
predicted that supply will increase slightly faster than demand, so that vacancy rates nationally may rise. But these rates are still below historical averages.
The report also forecasts continuing rent growth at current levels, thanks to a strong labor market and an ongoing preference for multifamily living. The below comparison of the current vs. long-term jobs-to-housing relationship suggests that oversupply is not likely to be a major concern over the next 4-5 years. (article continues below)
Housing Over/Under Supply Patterns, 1990–2023
Home Buying? Still Not a Threat
The increase in multifamily stock was generally offset by continuing demand for rental apartments, which shows signs of strengthening even further.
Millennials seem to be lining up behind renting as a housing preference, perhaps because it can be a more affordable way to form a household, allows for greater flexibility, and provides greater on-demand access to community connectivity.
Renting-by-choice also seems to be trending among other age groups, including the 55-plus households who want to downsize to a more maintenance-free, connected lifestyle, with easy access to health care, culture, entertainment, and food.
Millennials seem to be lining up behind renting as a housing preference, and renting-by-choice also seems to be trending among other age groups.
Thus, homebuying still hasn’t gained much traction. Wells Fargo’s April 2018 Housing Chartbook
notes that sales of both new and existing homes are off to a disappointing start for 2018. Homeownership remains near recent 20-year lows. (article continues below)
Affordability and Demand
Worsening home affordability across much of the country seems to be a primary driver of multifamily popularity.
The past decade has generally seen a significant move back to major metro areas, particularly among younger households; but affordability in the fastest growing of these areas has deteriorated sharply.
Even secondary markets formerly considered affordable have seen a sharp increase in the amount of income needed to qualify for a mortgage. The earlier-cited Wells Fargo report noted that, at the end of 2017, a prospective homebuyer in Dallas would have had to earn 37.7 percent more than he/she would have needed in 2013.
Even secondary markets formerly considered affordable have seen a sharp increase in the amount of income needed to qualify for a mortgage.
In Atlanta, the figure was 35.9 percent, and in Nashville it was 41.7 percent.
Taxes and Rentals
The recent Tax Cut and Jobs Act may amplify this trend toward rentals.
The changes to the mortgage interest deduction and to sales taxes will likely further cause workers in higher-cost metropolitan areas to shift from homeownership in the suburbs to renting closer to their jobs.
The general strengthening of economic growth and of labor markets may also result in renters having more disposable income available to pay higher rents, which would also favor property owners.
Opportunities in Secondary Markets
While primary markets now seem overheated, secondary markets like Seattle, Atlanta and Austin are increasingly interesting.
Why? Affordability—for both companies and their young workforces. Invigorated downtowns and urban nodes, burgeoning light rail systems and bike paths have brought millennials into formerly ho-hum real estate markets.
The ULI/PwC report
indicates that the cities with the highest recent gross absorption were generally secondary cities: Dallas, Boston, Washington D.C., Chicago, Phoenix, Atlanta, Seattle, Kansas City, Salt Lake City, and Austin.
While primary markets now seem overheated, secondary markets like Seattle, Atlanta and Austin are increasingly interesting. Why? Affordability—for both companies and their young workforces.
Absorption of suburban Class B properties was particularly high. Other secondary markets with a significant technology industry, such as Salt Lake City, Portland, Minneapolis, Raleigh, and Nashville, topped the current “buy” rankings of many observers.
Overall market statistics indicate that the best development opportunities may be in the middle market sector of suburban areas. (article continues below)
Rent Growth by Market Size and Submarket Type (2-yr average)
Steady as She Goes
With interest rates on the rise, it seems likely that the climate for financing new development will remain relatively conservative, and debt costs somewhat expensive.
While all markets present both opportunities and risks, the industry seems increasingly focused on areas with a strong live-work-play environment: submarkets outside of the urban core with characteristics similar to downtowns, such as concentrated employment and retail / entertainment amenities.