Multifamily real estate posted another exceptional year in 2018. Whether judged by gains in property appreciation or income growth, multifamily fundamentals delivered. Mapping the year ahead, investors are positioning themselves now as the market signals that dynamic changes are underway.
Three primary impacts will move the multifamily market in 2019, including pressure from volatile financial markets, a growing housing supply and emerging development risks.
Rising Interest Rates (The 800-Pound Gorilla)
Debt pricing looms as the largest multifamily market mover in the coming year. In the first half of October alone, an equities sell-off dropped the Dow Jones almost 7% and pushed the 10-year Treasury yield to a high-water mark of +75 basis points for the year. That rate, if left unchanged, would rank as the third-largest increase since 2000. On the public side, the Fed is widely expected to continue bumping up the federal funds rate through 2019 at least.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Private market behavior and federal monetary policy both point to rising interest rates. And more so than any other investment, real estate class and multifamily asset pricing is tied to debt pricing.
Inexpensive debt capital and plenty of equity seeking placement in the multifamily market have supported rising property values in recent years. But when the cost of borrowing goes up, cap rates must move correspondingly as investments don’t make financial sense until sale prices come down. It’s a pricing fundamental that has always existed, but one that sellers never want to concede. In fact, the seller’s market has run so long that owners now faced with downward pricing adjustments don’t want to budge.
The bottom line, with that inherent price pressure in mind, 2019 is looking more like a buyer’s market. Attractive multifamily acquisitions will be captured by buyers who secure assets that are “right priced” to account for rising interest rates.
Supply Balance or Supply Glut?
Multifamily operating dynamics remained strong this year. Rising rents paired with high occupancies produced income growth that generally outpaced operating expense increases. Those robust operations and attractive financing delivered cash flows. But new supply in many markets has now caught up with or surpassed demand.
Occupancy rates and rent growth prove this out in markets such as Seattle and Boston, where red-hot rent growth over the last five years made them real estate darlings and lured developers to benefit from a supply imbalance. Now those markets, and even secondary markets like Nashville and Milwaukee, are working through multifamily deliveries that put the brakes on rent growth to levels between 0% and 1.5% on a year-over-year Q3-2018 basis, according to Zillow. That compares with annualized rent increases from 2015 to 2017 near 7% in Seattle and 5% in Boston and Nashville.
The potential multifamily supply and demand imbalance is still playing out across the country. “We’re seeing a lot of rental markets peaking and coming down,” says Neil Schimmel, President and CEO of Investors Management Group.
Despite favorable rental housing demand tailwinds, a growing number of industry insiders question whether demand will keep pace to support the lease-up of new apartments scheduled for delivery in the near term. According to Schimmel, “Some of the primary markets are dealing with rising vacancies and softer rents. But we still have a lot of confidence in the supply/demand balance and cost-of-living value in cities like Charlotte and Atlanta.”
Rent growth across markets is becoming increasingly spotty, as this construction cycle slows, and housing demand still fuels impressive rent growth in some metros.
The bottom line, multifamily buyers are wise to evaluate how apartment deliveries and pending development pipelines in their area could impact asset values and operations for them locally and in markets across the country.
Known Unknowns — Development Risks
Outside of the usual macroeconomic impacts affecting multifamily dynamics, variables such as trade tariffs, construction labor shortages and local government regulations will shape how multifamily is developed and operated in the coming year.
- At a national level, federal tariffs on imported materials such as steel, lumber and electrical components have bumped the cost of some construction line items more than 10% year-over-year.
- The tight labor market shows itself especially in the construction trades, where labor costs have gone up and labor availability is scarce. The National Association of Home Builders reported in a recent survey that 69% of its members were experiencing delays in completing projects on time due to a shortage of qualified workers, while other jobs were lost altogether. New construction suddenly doesn’t pencil like it did a year ago, and moderate multifamily renovations have likewise become pricier.
- Post-recession rent growth has put housing affordability in the spotlight, and local governments in some markets are responding with affordable set-aside mandates and rent control proposals.
Apartment buyers evaluating acquisitions for the coming year are taking a more cautious approach toward income projections and capital improvement budgeting. Buyers are recognizing they can’t count on property appreciation to compensate for miscalculating the upside of a project’s “value-add” component or the cost of construction. Additionally, new legislative actions and development requirements introduced by municipalities to accomplish housing policies may force developers to factor a larger risk premium into their budgets.
The bottom line, apartment construction and renovation opportunities are still there for savvy investors and syndicators, but the margin for error will certainly be thinner in 2019.
2020 Vision & Beyond
Multifamily investors hold a consensus view that we’re likely somewhere in the late stage of the investment cycle. Buyers of core assets in top-tier cities may have already hit price ceilings based on return spreads built into cap rates relative to the 10-year Treasury.
Apartment oversupply in some markets has driven rent growth to flat or even slightly declining in the past 12 months — certainly a wake-up call during one of the nation’s strongest rent growth periods in decades. Construction costs are up due to tariffs, supply constraints and more expensive labor.
These triple impacts are setting the stage for changes in the coming years’ multifamily market. Fortunately, apartments as an asset class continue to draw capital-seeking, attractive, risk-adjusted returns, even in this period of recalibration … and especially in periods like these. Multifamily assets have consistently provided safe harbor to investment capital, and the fundamental demand for housing, combined with population growth across the country, will continue to support it through up and down markets.
The security of multifamily draws investors the same way bonds do when the stock market becomes uncertain. And the tax advantages of real estate provide benefits that can’t be matched with other investments. So, success in 2019’s multifamily market will go to the owners and operators who begin now, to manage the evolving dynamics that shaped 2018.
-
Is Your Social Security Earnings Record Wrong? Here's How to Fix ItYour Social Security benefits are based on your Social Security earnings record. It's important to review your records to avoid having your benefits reduced.
-
Stock Market Today: Markets Discount Another U.S. DowngradeAfter Friday's closing bell, Moody's followed Standard & Poor's and Fitch and cut its rating on U.S. government debt.
-
Stock Market Today: Markets Discount Another U.S. Downgrade
After Friday's closing bell, Moody's followed Standard & Poor's and Fitch and cut its rating on U.S. government debt.
-
Donating Complex Assets Doesn't Have to Be ComplicatedIf you're looking to donate less-conventional assets but don't know where to start, this charity executive has answers, such as considering a donor-advised fund (DAF) for its tax benefits and ease of use.
-
Think a Repeal of the Estate Tax Wouldn't Affect You? WrongThe wording of any law that repeals or otherwise changes the federal estate tax could have an impact on all of us. Here's what you need to know, courtesy of an estate planning and tax attorney.
-
In Your 50s? We Need to Talk About Long-Term CareMany people don't like thinking about long-term care, but most people will need it. This financial professional recommends planning for these costs as early as possible to avoid stress later.
-
Social Security Pop Quiz: Are You Among the 89% of Americans Who'd Fail?Shockingly few people have any clue what their Social Security benefits could be. This financial adviser notes it's essential to understand that info and when it might be best to access your benefits.
-
Stock Market Today: Investors Look on the Bright SideA generally good week closes on another positive note, as investors, traders and speculators look for fresh catalysts.
-
Such Attractive Yields in High-Grade Munis Are Rare and May Not Last LongAccording to this munis expert, the last time munis were this cheap was a brief period in 2023. If you kicked yourself for missing out then, you have a second chance now.
-
Financial Analyst Sees a Bright Present for Municipal Bond InvestorsHigh-tax-bracket investors have an excellent opportunity to secure low-volatility, high-quality returns at yield levels rarely seen in over a decade.
