Apartment rents are still on the rise. Rental communities across the country are still fully occupied on average, despite years of new construction. But just a few months ago, the financial markets flashed warning signs of a possible recession in 2020.
How long can the good times last? What challenges and opportunities will apartment investors find in 2020? Multifamily Executive asked Steve Guggenmos, vice president of research and modeling for Freddie Mac Multifamily, to share his outlook for the coming year.
MFE: What will multifamily stakeholders need to know heading into 2020?
Guggenmos: There are mixed signals in the overall economy. … I think it leads to a year where there is positive growth in the broader economy. In terms of the housing market, apartment rents should grow and grow faster than inflation. Expenses should largely be in line with what they are now, and net operating income should grow.
It all points back to the labor market. … We continue to extend the run of positive trends with the unemployment rate being extremely low, job growth continuing, and claims for unemployment insurance very low.
On the single-family side with limited supply and low rates, that is going to lead to increasing prices. As households are beginning to consider moving into the homeownership market, there are hurdles to finding the houses they want.
That flows through to multifamily. There is still a bit of a shortage of supply. That is evidenced by vacancy rates being very tight. Supply on the multifamily side is continuing at levels that are consistent with the last year or two: above average. That puts us in a place where we may see vacancy rates increase some. But that doesn’t flow through to slow rents meaningfully.
MFE: What is the biggest difference compared with 12 months ago?
Guggenmos: The key difference is the interest rates. … If we look back a year ago, long-term interest rates [the yield on 10-year Treasury bonds] were north of 3%. Now we are in the sub-2% range. The expectation a year ago was maybe that they would move up a little bit.
[However] there’s the amount of sovereign debt that is out there that has got negative yields. We talk about rent inflation, but if you look anywhere else in the economy, you don’t see a whole lot of inflation. Those are things that lead to the expectation that rates stay relatively low.
The baseline forecast is that rates move a little bit up from here, maybe north of 2%, but not a whole lot. Lower for longer might be a little bit more real.
MFE: What does that do to multifamily?
Guggenmos: There is a potential that there is a little bit more upside in property price appreciation. When interest rates were a little bit higher, cap rate spreads were tighter then. Cap rate spreads are very wide right now.
MFE: Is there a mental barrier to people bidding cap rates lower again? Or are you already beginning to see it?
Guggenmos: Cap rates have been really sticking in the mid-5% range. There will have to be a wider acceptance that interest rates truly are going to stay lower for people want to build low interest rates into the valuations.
[However,] when you consider alternative investments, there are not a lot that produce the cash flows that apartments are producing right now, certainly if you look across other commercial real estate types … even as you look out into the broader financial markets. Investors have to really decide whether they are willing to make that move, but when they look at the fundamentals there is a potential that they do get comfortable with a little bit of a tighter spread.
MFE: How do you factor the risk of a potential recession into your overall forecast? Are you one of those people on recession watch?
Guggenmos: The discussion of a potential recession was especially prominent when there was an inverted yield curve. Now that we have moved away from that, there is a little less. Things like the labor markets point to continued growth. Our expectation, which is consistent with the consensus forecast, is that there will continue to be growth in the economy.
That said, at Freddie Mac, we are careful about looking at all different kinds of economic scenarios. We certainly do look at what happens in the case of a downturn. One thing that comes through is that when vacancy rates are as low as they are, the starting place for where you would enter a recession is a tight market where properties are performing very well so that they have a buffer… Our expectation is that multifamily mortgages continue to perform very well, especially given the underwriting that we have.
Thinking of different segments of the multifamily market, when you are looking at properties … the Class A is the newest and might be sensitive and have competition from all the supply and might be harder to afford in a recession. I think there is quite a bit of demand in the Class B and Class C space.
MFE: What factors could change in the economy—and change your forecast?
Guggenmos: If there were idiosyncratic effects that could bump interest rates off the course that they are on right now, that would be worth watching … policy decisions, reactions to different trade agreements, those sorts of things. It is an election year. A lot of things can happen policy-wise that are very hard to predict.
MFE: How do the limits on Freddie Mac’s lending to multifamily affect your business, and your policy goals?
Guggenmos: We do forecasts of the overall market size as does the Mortgage Bankers Association. Our expectation is that the market for multifamily mortgages continues to grow. I think the effect of the cap is that we largely stay about the same … Freddie Mac and Fannie Mae combined will be about the same size that they have been in the last two to three years.
And if the market is a little bit bigger, that means our proportion of the market is a little bit less, and then it is all about how that business gets picked up. I think that to the extent that there are markets with a lot of competitors, somebody will come in and get some of that business. We are somewhat more selective, I suppose, if the cap is constraining.
We are in every market every day, and we are seeking to serve the affordable segments of those markets all the time. If the folks who are the other capital providers in the debt market are less interested in those markets, then that is where the shortage of capital would come in. When less capital flows into a market, then that could lead to less incentive to invest there and would lead to potentially less development of new units or maintenance of old units. That’s where the impact would be felt.
