The short answer is no, the multifamily industry isn’t heading toward a bubble, but the long answer is more complicated. Cap rates dropped across the country in 2012 but remain above peak levels. Further, when one considers the interest-rate differential between now and the peak, cap rates are not close to being in bubble territory. That said, billions of dollars of capital have been raised to invest in multifamily, and yields in major markets are too low for most of this capital, so we’ll be watching nonmajor markets carefully to see if this glut of capital drives pricing into bubble territory. On a related note, most of the development activity in this cycle has been in major metros with high barriers to entry, but if development starts to ramp up in smaller markets, watch out. Lastly, any sudden movements in terms of either interest-rate policy or the GSEs’ role in the market could change the game entirely.
— Ben Thypin, director of market analysis, Real Capital Analytics
An asset bubble typically occurs when the price of an asset becomes inflated due to excess demand for the asset class, as opposed to the growing financial performance of the asset itself. The multifamily industry is not in this type of bubble now, because apartment market fundamentals remain solid, though they are moderating slightly after three very strong years (2010 to 2012) of growth. I still see a lot of “rational exuberance.” However, the Federal Reserve’s low interest-rate policy has artificially inflated the value of apartment properties by resulting in historically low interest and capitalization rates—which operators, investors, and lenders are certainly enjoying right now. This policy could increase the risk of another bust when interest and capitalization rates inevitably rise and supply eventually exceeds demand. As a result, there is the potential for significant losses for stakeholders if they have to sell or refinance a property in such an environment.
— Ron Johnsey, president and CEO, Axiometrics
National vacancies have reached their lowest level since late 2001. Most landlords have shifted from pushing down vacancies to increasing rents in the continuing search for revenue and income growth. Effective rents increased by 3.8 percent in 2012, an impressive number that is 140 basis points higher than 2011’s figure. However, with such strong fundamentals, supply growth will escalate, spiking slightly in late 2013 and through 2014. But that just brings us back to the 10-year average. Meanwhile, cap rates for apartments have flattened and moved very little over the past year and a half. Investors have become wary of paying low cap rates in primary markets. More consistently, market participants are using the word “bubble” to describe the state of the apartment transactions market. While interest rates remain low and fundamentals remain strong, it is difficult to describe the current market as a bubble, but it is undoubtedly getting frothier.
— Ryan Severino, senior economist and associate director of research, Reis
My view is that we are nowhere close to a bubble in the multifamily industry. Last year, we only had 233,000 five-plus multifamily unit starts, and that’s well below the average we did in the past 10 years, when production was very stable. It was really close to 300,000 units. We haven’t even gotten back to that level. I think if you look at the demand levels, we can justify at least 300,000 and perhaps as many as 350,000 to 400,000 multifamily units going forward, to cover pent-up demand, ongoing demand, and the loss of stock that comes in the wake of a hurricane or older buildings deteriorating. Nationally, we’re a long way from meeting the level we need. Permits are higher, so that may be an indication that we may be picking up the level of new construction. And demand is certainly higher now than it was before.
— Mark Obrinsky , vice president of research and chief economist, NMHC
Capital flows into the apartment sector, in terms of both debt and equity, are exerting upward pressure on asset prices independent of fundamentals. Investor and lender behaviors increasingly reflect a virtuous dynamic of rising cash flow and exceptionally low-cost credit that has developed its own independent momentum. Are there segments of the market where prices have diverged from rational expectations for income and the long-term cost of capital? where agency financing under conservatorship plays a reduced role in subsidizing credit? Yes. As the housing market stabilizes, the tenure bias that has weighed so strongly in favor of apartments will moderate. That coincides with new inventory that, in most submarkets, will be well absorbed. But the overall result is a slower pace of growth in apartment cash flow that will, in many cases, prove insufficient to offset the impact of higher-yielding benchmark Treasuries and rising opportunity costs.
— Sam Chandan, president and chief economist, Chandan Economics