Despite decelerating rent gains, high supply, and rising interest rates in the late market cycle, the multifamily market remains healthy, according to Yardi Matrix's report U.S. Multifamily Outlook for Spring 2018.
Much of the industry's strength stems from the nation’s economic gains, with positive demographic drivers, high job growth, and low unemployment fueling demand and pushing back against market headwinds.
Yardi does expect the country’s rent growth to remain moderate in the near future. Up-and-coming Southern and Western metro markets are expected to lead the nation in rent growth, especially in metros where supply growth has not yet outstripped demand.
Economy Continues to Grow
GDP grew 2.3% in the first quarter of 2018, down 60 basis points (bps) from the fourth quarter of 2017 but also the highest first-quarter growth rate in several years. While it's too soon to determine the impact of the tax cuts on economic growth for this year, overall growth is expected to be 40 bps to 60 bps higher in 2018 than it was in 2017.
Over 800,000 new jobs have been added across the country so far in 2018, with 164,000 new jobs in April alone, and the nation’s unemployment rate has declined to 3.9%. Wage growth has moderated over the past few years and remained below 3% as of January.
Increased home prices, recent tax cuts, and the hot equity market in the beginning of the year have boosted consumer confidence, according to Yardi. The Consumer Confidence Index reached an 18-year high in February, but it has since retreated, and consumer spending has only risen by 1.1% year over year (YOY).
While 2017’s 2.3% GDP growth was driven by business investment and exports, the recent tariffs and trade restriction may threaten both economic drivers. Market volatility has also increased as a result of the tariffs, as well as the possibility of a trade war between the United States and China.
Yardi notes that many of the U.S.’s major trade partners have been exempt from the tariffs. Oil prices are also starting to rise, which could reduce consumer capital and raise inflation above the Federal Reserve’s 2% target.
The 10-year Treasury rate had grown close to 3% at the start of May, marking its highest rate in several years. With a rising federal deficit, Yardi predicts those rates are likely to continue to climb. This could, according to Yardi, raise debt costs and hamper REIT prices. However, job growth is expected to continue into the foreseeable future, which in turn is expected to drive down unemployment and raise overall wages but drive inflation upward.
Rent Growth to Pick Up This Summer
The national rent-growth rate has settled at around 2.5% YOY per month. Yardi expects rents to appreciate 2.9% across all of 2018, slightly above initial predictions, with rent growth picking up over the summer.
Orlando and Tampa, Fla.; Las Vegas; and Phoenix lead the nation in regional rent gains. Western tech markets, including San Francisco, Denver, and Seattle, have also started to see some rent growth, following a period of deceleration between 2015 and 2017.
The Northeast and Midwest metros are continuing to experience slower growth, as are markets with a glut of new apartment supply, including Nashville, Tenn.; Austin, Texas; and Raleigh, N.C. Overall high supply rates have contributed to a roughly 80 bps drop in the occupancy rate over the past year, and the metros with the biggest occupancy declines have also experienced severe rent-growth moderation. The occupancy rate does remain above historical averages, however, and many markets need more housing stock.
Affordability is another constraint on rents in high-priced markets, including New York, San Francisco, and Washington, D.C. Many of the markets with leading regional growth rates are benefiting from spillover from expensive markets, including Tacoma, Wash., at 7.1%; Sacramento, Calif., at 6.8%; and Colorado Springs, Colo., at 5.0%.
Sacramento, once the top market for rent growth for 21 months straight, has since been bested by Orlando, where rents had risen 7.2% YOY as of April. Houston’s post-Harvey recovery has boosted its multifamily market over the past year. Meanwhile, New York City is the only major metro where rents are expected to depreciate this year, with a 1.0% drop across the city.
Supply Leveling Off Somewhat
Yardi expects roughly 290,000 new units this year, or a 2.2% increase in the apartment stock. While these numbers are strong, activity likely won't reach the 300,000-plus unit deliveries recorded over the past few years.
More than 625,000 new units are under construction across the country, but many are taking longer than expected to complete due to rising costs and construction labor shortages. As a result, many projects are likely to be pushed back to 2019, and new deliveries are likely to remain consistent between 2018 and 2019 instead of peaking in 2018.
Demand for new apartments remains strong, though land, labor, and material costs are forming some headwinds against new development, as is an oversupply of new luxury units in some markets. Luxury development constitutes about 88% of new deliveries, though demand is higher for market-rate or working-class units.
Occupancy is expected to continue to regress toward the mean at the national level; as of March, the national occupancy rate was 94.8%, or 80 points lower than one year ago. There remains a 90 bps divide between occupancy rates for market-rate apartments (95.2%) and luxury units (94.3%).
Dallas and Denver have the highest-forecast completions for this year, at 16,619 and 16,107 units, respectively. Both markets are noted to have high employment growth and below-average unemployment rates.
Washington, D.C.’s, forecast deliveries fell to 10,000 from a cycle peak of 16,000 in 2016; Austin’s fell to 8,400 from 12,000 in 2016; and Houston’s dropped to 6,500 from over 18,000 in both 2016 and 2017. Yardi anticipates below-average rent growth in these markets, given the impact of high delivery volume.
Capital Markets Remain Strong
Capital flow into commercial real estate remains very strong, despite rising supply, rising interest rates, weak income growth, and publicized pullback by some capital sources, including Chinese sources.
Prices remain firm due in part to a record $266 billion in undeployed capital, or “dry powder,” across the globe. Yardi attributes this high supply of unspent funds to a fear of overpaying, low acquisition yields, or specific strategies that can't be met in current market conditions. Yardi anticipates that this undeployed capital will keep cap rates low and that much of it will be deployed in niche areas and secondary and tertiary markets.
REITs are down about 10% since late last year, due mostly to the increase in interest rates, which has affected their ability to add new acquisitions. Yardi anticipates that REITs with development capacity will build rather than buy in this market. Some REITs may even convert into C-corporations, since the corporate tax rate has been lowered to 21%.
Another contributing factor to firm prices is compressing debt spreads. The average cost of debt originated by the GSEs has increased by only 25 bps, a small step behind the 10-year Treasury rate increase. This stems from competition for debt investment, especially for multifamily loans, as a means of diversifying risk. Many funds have chosen to issue debt and assume second-lien risk rather than execute a strategy that would result in first-lien risk.
"The result for borrowers,” Yardi's report says, “is that interest-rate increases haven't been quite as drastic as the headlines imply, although even the small increase in debt costs has made some deals harder to pencil, particularly those with low debt service coverage ratios.”
