By Zain Jaffer. Originally published at ValueWalk.
Headwinds in the multifamily real estate space have been strong and coming in from almost all directions. While the complications of the COVID-19 pandemic and its effect on the economy threatened to displace tenants and pose real revenue holes for landlords—and at times, it did just that—the space has also been faithfully supported by concurrent counter factors. Namely, the soaring housing market and the cost of materials for new builds have brought more and more families back to the multifamily rental space. In effect, the outlook for the sector as a whole is extremely positive in terms of supply and demand; all signs point to continued strength in the months ahead.
But it’s not a market strength that will play out without complications. The largest hurdle for tenants, landlords, and investors as it stands is the current conversation around more widespread rent control measures, which are being entertained as a way to bottle neck the quickly rebounding and raising rental rates. While families who are still recovering from the economic hardship of the pandemic risk being displaced by rents that are increasing by a high percentage of their previous rates—and while this is certainly to the entire sector’s detriment—there are likewise risks associated for landlords and investors who risk being unable to earn sufficient, risk-adjusted returns. In such cases, buildings fail to be properly cared for, and tenants suffer in the long run; a double dead end.
Following will be a look at the multifamily niche in the larger conversation or commercial real estate; its historic performance and how it’s fared to date. The focus will then turn to the current barriers and opportunities following on the heels of the pandemic, with concrete advice for investors to be a part of the sector’s continued strength.
A Long-Time Market Winner
In areas with notable and sustained job creation, particularly within the Southeastern and Southwestern markets, the multifamily sector has seen a three-fold increase in demand, in tenants, and in capital flows. And while this success is particularly notable in those markets, it’s the rule rather than the exception—Moody’s Commercial Property Price Index model shows that in almost all market niches, multifamily has been the highest performing asset class since 2000.
The natural effects of demographics as they stand will support further growth and market strength. According to data from the US Census, relayed in a recent UBS report, there are currently 129.8 million Americans in their 20s. The bulk of tenants renting in multifamily properties are between the ages of 20 to 50, and the increasingly complicated financial equation of owning a home is keeping many renters in the multifamily space.
Naturally, capacity plays an important part in the supply-demand equation, and according to UBS, it also relays that the number of new starts in the multifamily niche is above the long-term average (roughly 315,000). But in the last decade or so—during which that long-term average was established—the sector was notably under-built, following the challenges of the financial crisis. And most of those new starts are coming up in markets with job growth, population influx, and increased demand from other channels—all of which warrants the increase in supply.
Challenges: Current and Soon To Be
Against the aforementioned strength of the multifamily sector as a whole, it’s worth zeroing in on this moment in history and confronting the short-term challenges that lay a few steps ahead of where the sector now stands on the path to recovery. With forewarning and nuanced thought regarding the nature of those challenges, investors can put the necessary strategies and solutions in place to protect and expand their multifamily portfolio.
On the heels of a few very hard quarters, rents are beginning to rebound. But the rebound is happening fast enough to raise alarm, and some rent prices are soaring past the financial capacity of their current tenants. Frustration and headlines are often the by-products, causing some widespread confusion in the space.
Concurrently, the rate of occupancy in most multifamily market niches is increasing considering a return to a post-pandemic normal, whether or not that means, for the tenant, a new city, job, or home office set up. And some of that occupancy is coming from professionals and families who are further along in their careers so as to be ready for homeownership, but dissuaded by the ludicrous boom that’s been the hallmark of post-COVID housing; those professionals and families might be more able to support the hike in rent, which is helping occupancy remains more or less level even as prices climb.
In light of the appreciation, and in the continual post-pandemic government management, many states are considering a pre-emptive turn toward rent control measures. The National Multifamily Housing Council has stated that as many as 25 states are considering an implementation of rent control at the state level. Currently, only Oregon has a fully state-controlled rent cap protocol, and California has statewide rent control caps with laws that correspond to specific cities.
While there’s an image in the multifamily sector that all buildings and units are owned by large institutional players, more than 70% of 2 to 4 unit properties are owned by individuals, often hands-on investors. And for those individual investors, COVID-19 has been as much a financial hurdle as it has been to their valued tenants. Rent control has a dystopian tone to landlords and investors, large and small, who have to earn a sufficient risk-adjusted return in order to justify their upkeep, time, and largely illiquid capital investment. Without that return, interest wanes and the sector as a whole slowly suffers; in time, the long-term negligence of buildings and upkeep can be as detrimental to the tenancy experience as overpriced units in the short-term outlook.
Naturally, the best possible outcome for the sector as a whole would be one in which demand continues to slightly outpace supply, achieving optimal occupancy rates at monthly averages that return to investors that sector-winning, risk adjusted revenue without climbing to unmanageable rates for loyal, hardworking tenants. On the path to that goal, which should be shared by both sides, will be some trial and error that will no doubt create struggle for both sides. In their comprehensive overview, the experts at UBS return investors to the basics, recommending a focus on free cash flow, risk adjusted returns, and realistic assumptions during the underwriting stages. With an understanding that some political interference might be involved in their next venture, and with the long term hope of a multifamily sector that caters both to outsized returns and to financially viable tenancies, investors will be well-positioned to take this next market chapter in stride.
Sign up for ValueWalk’s free newsletter here.