Whether by choice or necessity, record numbers of American families have swelled the rental ranks since the onset of the housing market collapse. This has fueled the robust property fundamentals that undergird the sector’s post-crisis investment thesis.
But multifamily’s outperformance can’t persist indefinitely. In 2013, firming housing market conditions will coincide with the cycle’s first measurable increases in supply, moderating property income trends and reinforcing the need for risk management in new lending.
Priced Near Perfection
Investors, developers, and lenders have responded to the momentum in apartment fundamentals trends, lifting valuations and raising debt encumbrance to within range of their previous peaks. Dallas-based research firm Axiometrics reports the apartment vacancy rate was comfortably below 6 percent heading into 2013, supporting rent growth well in excess of renters’ current income trajectory. Cap rates have also tested new lows in the past year, falling well below 5 percent for the most aggressively contested assets.
In divining the relationship between fundamentals and liquidity, the availability of historically low-cost financing has been critical. When dislocations in credit markets were most severe, Fannie Mae, Freddie Mac, and the Federal Housing Administration ensured the flow of capital. Since the sector’s inflection, banks, life companies, and conduit lenders have all re-engaged with borrowers, fomenting a degree of competition that raises questions about the soundness of apartment underwriting trends.
The Wake of the Housing Crisis
For many advocates of the new apartment paradigm, flush credit conditions reflect a secular shift in demand that will persist even after the nascent housing recovery takes hold. The observational logic is sound. In some cases, household preferences have changed, favoring the mobility afforded by renting. For others, access to mortgage financing is constrained by tighter standards and larger required downpayments.
The next year will test overly sanguine assessments of the apartment sector’s resilience. While the investment thesis will remain intact, new forces coming to bear will temper its momentum, including an enlarged development pipeline that will roughly double completions in 2013, as well as the profound rethinking of homeownership’s role in our nation, with rising home values and modest easing in single-family credit also encouraging greater balance in tenure choice.
Not every market will see apartment demand adjust to a housing recovery in the same way. But we will repeat costly investment and lending errors if we assume that crisis levels of demand are the new normal.
Market forces will combine over the next year with shifts in the policy environment, as well. As the merits of experimental monetary policy diminish, the distortions it has introduced to asset markets will become more identifiable. In particular, a status quo where Fannie and Freddie have been able to arbitrage the creditworthiness of the Treasury has resulted in substantially lower costs of capital to borrowers.
Policymakers have been loath to address housing finance reform in a serious way. But a world without the agencies, at least as we’ve known them, will receive its hearing as housing rises further from its nadir.
Sam Chandan, Ph.D., is president and chief economist of Chandan Economics, a New York–based research firm.