Sometimes by choice, and sometimes by necessity, record numbers of American families have swelled the rental ranks since the onset of the housing market collapse. This migration has fueled the robust fundamentals that undergird the sector’s post-crisis investment thesis.
Absent stronger economic foundations for space demand, no other property sector has kept pace. And, so, nearly four years after the economy’s return to expansion, apartments continue to define the recovery in commercial real estate. But this year, firming housing market conditions will coincide with the cycle’s first big increases in apartment supply. Cash flow gains will slow from their peaks in the first real test of the sector’s current resilience.
Priced Near Perfection
Investors, developers, and lenders have all responded to the momentum in apartment fundamentals trends, lifting multifamily valuations and debt levels to within range of their previous peaks.
The apartment vacancy rate was comfortably below 6 percent heading into 2013, reports Dallas-based research firm Axiometrics, supporting rent growth well in excess of renters’ current income trajectory. Cap rates on property sales and refinancing appraisals have also tested new lows over the past year, falling well below 5 percent for the most aggressively contested assets.
In the relationship between fundamentals and liquidity, the availability of historically low-cost financing has been critical to the multifamily equation. When dislocations in credit markets were most severe, Fannie Mae, Freddie Mac, and the Federal Housing Administration ensured the flow of capital.
As the turnaround has developed its own momentum, banks, life companies, and conduit lenders have all re-engaged with borrowers. The resulting lending competition raises questions about the soundness of apartment underwriting trends.
Implications of a Housing Recovery
For many advocates of the new apartment paradigm, trends won’t slow even after the nascent housing recovery takes hold. In some cases, they argue, household preferences have changed, favoring the flexibility afforded by renting. For others, mortgage qualifications represent an insurmountable barrier. Over an even longer term, demographic and lifestyle changes are delaying the exodus of young families to the suburbs, postponing the move to ownership.
It is entirely plausible that the housing crisis has left an indelible mark on our convictions about the American Dream and the importance of homeownership. But in the extreme, multifamily’s promoters dismiss the notion that cyclical forces are also at work.
The next year will test such assessments of the apartment sector’s resilience. New forces are coming to bear that will temper its momentum, an enlarged development pipeline not least among them.
Renting will be more important than at any time in recent history, but rising home values will also unleash pent-up demand for the alternative. Market forces will combine with shifts in the policy environment, including agency reform. As Fed interventions ease, the distortions they have introduced will weaken.
Not every market will see apartments adjust to a housing recovery in the same way, of course, but crisis levels of demand won’t persist as the new normal. MFE
Sam Chandan, Ph.D., is president and chief economist of Chandan Economics, a New York–based research firm, and adjunct professor of real estate at the Wharton School of the University of Pennsylvania. He is on Twitter at @samchandan.