Earlier this month, our team attended the National Multifamily Housing Council’s annual apartment strategies conference in Las Vegas. Here are the six key takeaways from their meetings and sessions:
- Q4 2022: The market cooled, due in large part to massive rent growth of 14% YOY for those deciding to relocate (renewals were less).
- January 2023: Apartment market is off to a strong start in 2023, thanks to pent-up demand to move and a ridiculously high premium to purchase a home.
- Oversupply warning: More than 1.1 million apartments units are in the pipeline, which is far more than needed and will likely produce a supply surplus later in the year and next year.
- Demand warning: Most apartment owners are planning on a recession later this year, which is never good for apartment owners.
- Plunging values ahead: Cap rates have risen—but experts say not enough. Expect cap rates to rise and values to decline.
- Controlling expenses: Most apartment developers are focused on improving efficiencies to combat increases in expenses.
Rent and Occupancy remain high in most markets compared to history, the homeownership premium is over $1,000 per month in most major markets, and lead traffic is starting to improve. While all real-estate sectors are going through a reset, we think multifamily will outperform, but there are some things to watch out for too.
People are ready to move again.
Renters stayed in place last year and were less likely to form new households due to egregious rent hikes. As a result, over 57% of renters renewed their lease in 2022, breaking the record for renewals. This contributed to a sharp drop in net absorption (measure of demand) in 2022, after smashing records in 2021.
Asking rent growth peaked in March 2022 (+14% YOY according to the Burns Apartment Rent Index™) but has been decelerating since. As rent growth continues to cool and concessions return to the market people will move around again looking for deals. In fact, several operators indicated apartment traffic picked up in January, though caveated that more applications per unit are needed now to see an actual signed lease.
Starts slow amid fear of oversupply.
The current construction pipeline for apartments is over 1 million units and multifamily permits in 2022 were almost double the pre-pandemic norm. While this is a substantial amount of new supply being planned, actual groundbreakings slowed in December.
One multifamily developer noted they would delay development wherever they could. Resources are constrained for developers due to a shortage of labor and delays coming from sub-contractors. Financing new deals has also become increasingly difficult as interest rates have risen, and cap rates remain near all-time lows. Developers are seeking more efficient designs to help alleviate the delays. Reducing the different types of floor plans and keeping design as uniform as possible could reduce delays related to labor and construction.
Despite the current delays, the number of completions will be greatly elevated through 2024. The massive apartment pipeline has led many to speculate about oversupply risk, however, new supply will be largely concentrated in markets with stellar job growth and overpriced for-sale housing. This reduces the risk of oversupply but does not bring it zero. The supply is heavily concentrated in the markets with some of the highest recent rent growth due to the demand/supply imbalance. Austin, Charlotte, and Nashville are all expected to experience a whopping +14% increase in apartment supply by the end of 2024.
A recession is coming.
Most multifamily businesses are baking a mild recession into their forecasts. So far, the labor market remains tight and wage growth increased +4% from last year. New business formations are almost double the pre-pandemic norm. This points to a very difficult job for the FED. To get inflation to 2% or under and keep it there, the FED will likely need to slow the economy until unemployment reaches 4.5%–5% (around 2 million job losses). Because the labor market has proven so resilient thus far, the FED is likely to continue hiking rates into the middle of this year. Expect rates to peak around 5.25% and settle closer to 3.25%
Cap rates need to increase.
Sellers, far outnumbered by active buyers, have not yet fully adjusted to a decelerating market. As sellers adjust, the scarcity premium currently on deals will dissipate. Purchasing activity will increase as cap rates rise. Investors are far more bullish on apartments than any other real-estate assets.
Cut costs, not corners.
Despite astounding rent growth seen over the past few years, operators faced significant inflation of their non-controllable costs: insurance, taxes, utilities and in recent months, turnover. As we move through a period of higher risk, operators are focused on reducing the middle of their P&L by connecting and enhancing the digital technologies deployed during COVID, centralizing core operations, and improving an asset’s physical resilience. Developers are also focused on expenses due to prolonged construction timelines and increasing financing, labor, and materials costs. Many are hopeful the days of increasing costs are behind them and are realigning their projects accordingly. The current challenge is how to successfully build and execute a strong strategy around the changing environment. To remain competitive, developers and operators will need to be hyper focused on where they are going and the game plan to get them there.
