Multifamily investors have continued to enjoy rock-solid stability and strong fundamentals in the early half of 2018. Even with oversaturation and overbuilding in urban cores, capital market demand for multifamily remains robust, with sales volume up 44% year over year, according to recent reports. Now, midway through the year, many wonder if the multifamily sales appetite will continue or if we’re facing the “end of easy” across the asset class.
To find out, here are five trends to watch for in multifamily investment for the remainder of 2018:
1. Demand Is Gradually Catching Up to Supply
With large supply deliveries in major markets, we’ll continue to witness the residual effects of softness, especially in the boom submarkets and Class A asset space. As an example, infill Nashville was once a darling of multifamily. Now, the city is on the “no-fly list” for many institutional investors due to record-level new-apartment deliveries. The influx of new supply inevitably led to rent concessions in excess of two months free. However, the city is turning the corner this year with moderate effective-rent growth from the gradual burn-down of concessions and unit absorption.
Other submarkets in major MSAs are now starting to see a concentration of supply deliver and are expected to chart a similar, if slightly less severe, path as demand catches up to supply over a multiyear period.
2. Buyer Demand Outweighs Higher Borrowing Costs
Not unlike some other property types in real estate, there are more market participants pursuing multifamily assets than assets in other sectors. At the same time, the cost of debt has increased, with the 10-year U.S. Treasury up 80 basis points since September 2017.
The result of such competing factors in asset pricing suggests that the increased level of equity capital outstrips the higher debt cost. As a result, cap rates and expected investor returns have held steady or slightly decreased in most markets. Important to note, buyer demand isn’t spread evenly across asset types and locations. The increased level of sale offerings has created appealing opportunities for some assets that don’t “check all of the boxes” for the average investor. While tighter yields are a reality, investors continue to view multifamily as an attractive asset class, especially in comparison to alternatives such as equity/bond markets or other real estate asset types.
3. Workforce Housing Fundamentals Are Still Strong
Marketwide averages for rent growth and occupancy don’t tell the whole story as specific asset types drift further from the mean. Fundamentals continue to deteriorate for Class A product in core submarkets, for example, while Class B properties continue to show gains.
In general, the supply-and-demand picture is more appealing for workforce product, which is typically synonymous with Class B properties. The lower price point for workforce housing ensures insulation from new supply, given the high rents needed to justify new construction.
On the demand side, the labor market remains strong by most measures, including job growth and household formation, two related demand drivers for multifamily. Additionally, alternatives to apartment rental for the workforce population are scarce, due to rising home prices and tighter lending standards.
Hand in hand, these macroeconomic trends show no sign of imminent change and will continue performing for the workforce housing segment of multifamily.
4. Non–Top-Tier Submarkets Are Flying Under the Radar
With some properties averaging 40-plus bids in certain MSAs, competition is fierce and the odds of securing those assets at reasonable terms are low. However, buyer demand varies widely, and many of the assets that aren’t located in top-tier submarkets or that lack a significant physical value-add upside aren’t receiving the same attention from buyers.
At Fogelman, we expect that properties outside the “bull’s-eye” will offer the best risk-adjusted return as (a) the less-sexy submarkets are outperforming most top-quartile areas, due to less pressure on fundamentals from new supply; and (b) higher going-in yields and smaller renovation scopes inherently mean lower execution risk.
Looking ahead in the near term, we expect properties located outside of the top-tier submarkets within growing MSAs, such as those in the Southeast and Texas, will outperform the average, especially Class B properties.
5. Generational Sandwich Is Keeping the Market Healthy
The average age of a first-time home buyer recently rose to 30 as millennials opt to rent longer. Furthermore, 2018 has presented a new set of challenges for first-time home buyers; namely, a new tax law whose effect has yet to be felt on homeowner taxes or property values; low inventory; tough credit; and rising mortgage rates. Coupled with baby boomers selling their homes and downsizing to multifamily apartments in exchange for flexibility and mobility, the generational sandwich of millennials and boomers continues as one of the most important macrotrends for apartments this year.
