Leading multifamily real estate fund manager Origin Investments predicts a moderate recession by October 2023 and negative annual rent growth of 1% to 5% with increasing levels of real estate investor or manager distress. However, because of strong real estate market fundamentals, Origin expects rent growth to return in 2024 and build-to-rent (BTR) developments to be a leading real estate investment opportunity in 2023.
“Current conditions in the multifamily market are causing some investors to retreat to the sidelines until there is greater direction and clarity for the economy and the sector,” says David Scherer, co-CEO of Origin Investments, who compiles the firm’s top predictions each year. “But when you look at the basic fundamentals—demand and the long-term prospects for increasing rents and asset values—there is no better sector today than multifamily real estate.”
For 2022, Origin predicted that inflation would impact all factors associated with multifamily investments. Based on a 15-year track record in the industry, a management and investment team with hands-on experience, and its proprietary suite of machine-learning models, Multilytics, Origin's predictions include the following:
- A recession is coming. With 100% certainty, Origin is predicting a recession by October, based on the modeling completed by Multilytics. One of the most predictive indicators of a recession is an inverted yield curve, which the U.S. has seen since the end of March. Historically, an inverted yield curve is almost always followed by a recession, Origin says. “While Multilytics can’t foresee the length or depth of a recession, we’ll likely be swimming closer to the deep end of the pool,” Scherer says. “It won’t be as deep as the Great Recession or as brief as what we saw in the pandemic-influenced recession of 2020. But it will be a serious downturn without a soft landing.”
- Rents will enter negative growth territory. According to Multilytics’ analysis, rental rate growth will range from -1% to -5% in 2023, depending on the market. Origin says negative rent growth will occur in part because current affordability ratios are not sustainable. A healthy ratio is nearly 25% of income toward rent. Today, the ratio in many markets ranges from 30% to 38%. Also, forecast deliveries of new apartment units in 2023 will put further downward pressure on rents. Although negative rent growth will be unpleasant for investors, Origin characterizes 2023 as an anomaly and rent growth will return to largely positive territory beginning in 2024 and remain positive through at least 2026. “When rent growth ranges from 10% to 20% for two years in a row, it is reasonable to believe that a flat or negative year will bring you back into balance and a level that will be healthier over time,” Scherer says.
- Inflation has peaked and will decline to around 4.5%. Inflation was 7.1%, according to November CPI figures, the smallest year-over-year gain since this time last year. Commodity pricing, supply chain pressure indices, and shipping container backlogs have moderated partially because of four consecutive 75-basis-point increases since mid-June 2022. There is still a long way to go to get to the Fed’s target rate of 2%, and it is not likely that inflation will fall as quickly as it rose. Origin expects that by the end of 2023 inflation will be at or about 4.5%.
- Wage inflation will persist. Wage inflation persists because of the significant shortage for blue-collar and service-industry jobs, Origin says. The layoffs occurring in the financial and technology sectors are overshadowed by the shortage in the service sector like hotels, restaurants, and retail. Companies are paying more and increasing costs to attract a quality workforce. The beneficial pay for employees will maintain upward pressure on and impact inflation for longer than most people think, Origin says.
- Interest rates will keep rising. The Federal Reserve has made it clear that continued short-term interest rate increases will occur in the fight against inflation. Origin would not be surprised to see short-term interest rates continue to climb, but at a slower trajectory, to a range of 5% to 5.25%, which translates to 30-year mortgage rates above 8%.
- Cap rates will go higher. In an environment where interest rates have been rising and are moving higher and rental rates are expected to lower—at least in the short term—multifamily cap rates are expected to go higher. Year over year, cap rates have increased approximately 100 bps, from 3.3% to 3.5% to 4.25% to 4.5%. Origin estimates 2023 cap rates to move closer to 5%.
- Market distress is coming. Due to acquisition, development, and/or redevelopment strategies that were inextricably linked to variable-rate debt, Origin predicts a greater level of financial distress among investors and owners in 2023. Today, there is little or no opportunity to refinance/recapitalize an asset, Origin says. Investors who overpaid for assets—double-digit percentages above replacement costs—based on a strategy to upgrade and improve an older property and be able to achieve significantly higher rents, may also be a likely cause for distress.
- Opportunities for investors will emerge in preferred equity. At least through mid-2023 and probably longer, the greatest opportunities will be in the preferred equity position of the capital stack. Lenders have retrenched and are borrowing less and/or charging more. Investment funds will deploy capital at a preferred position within the capital structure, Origin says. The returns, potentially as high as 15%, are well protected. Additional opportunities later in 2023 and 2024 will include the ability to acquire existing assets at prices below replacement costs.
- The build-for-rent segment will boom. There was a dramatic increase in the number of BTR projects being developed across the country. The slowed development trajectory, because of the current interest rate climate, will be short-lived, allowing developers and investors to move forward with projects that have tremendous appeal for renters including would-be homeowners priced out of the market and those who have grown out of apartment living.
- Multifamily housing fundamentals will gain momentum in 2024. Fundamentally, the multifamily sector is sound. Despite headwinds in 2023, it is a favorable long-term investment. Conservative estimates suggest that the U.S. faces a housing shortage of around 4 million units. The significant decline in multifamily construction starts during the second half of 2022, and projected into 2023, will only exacerbate that situation. Origin’s Multilytics is predicting rents in 2024 and 2025 to ultimately move higher. This will pave the way for a situation where development and construction activity increases and values are pushed higher, Origin predicts.
