Time to Invest in Multi-Family Real Estate Stocks? Not So Fast

Is it time to invest in multi-family real estate stocks? There's plenty to consider before investors rush in.

It's no secret the housing market is getting hit hard as the Federal Reserve's aggressive tightening campaign lifts mortgage rates and cools demand. Just one example of this is the September housing starts report, which showed new home construction slid 8.1% – led by a 13% drop in multi-family real estate. 

Plus, the CalculatedRisk newsletter recently highlighted comments from former Fannie Mae economist Tom Lawler that suggest residential rent increases will continue to slow over the remainder of this year and could decline in 2023.

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Lawlor argues that housing construction starts continue unabated while the demand for rental units is falling, creating excess supply when shortages have been the norm in recent years.

The economist points out that U.S. households grew by nearly 2 million between March 2021 and 2022. Of the growth in households, more than 50% was from people aged 15-24 and 25-34. Many of these folks cannot afford higher rents in these inflationary times.

He suggests that household growth between March 2022 and March 2023 could fall by half to 975,000, while housing production could be much higher.

"At the same time, it would appear as if housing production – completions plus manufactured housing shipments – will be somewhere in the range of 1.5 to 1.6 million, suggesting that housing production will significantly outpace household growth over that period," Lawlor wrote. "Next year should see an especially large increase in the supply of new rental units, given the sharp increase in multi-family housing starts and the long lags between start and completion."

With this in mind – and given data from online rental database company Zumper – investors might want to think twice before buying shares in multi-family real estate stocks.

Specifically, an Oct. 25 Zumper blog post indicates that rental prices across the U.S. are dropping. The post reveals the national average price for one- and two-bedroom rental units was down 0.8% and 0.7% month-over-month, respectively – marking the first time both have declined simultaneously in two years.

"In many metro areas, declining prices are actually a correction to prices that'd become overly inflated," says Anthemos Georgiades, CEO of Zumper. "We saw historic levels of migration throughout the pandemic, as people switched to working from home and re-imagined their living situations. Now – with a turbulent, unpredictable economy causing fear of recession – migrations are slowing, occupancy rates are falling and rent prices are following suit."

Another reason to be cautious on investing in multi-family real estate stocks in the near term: Zumper adds that it expects a "significant amount of new supply" of rental units to come on the market in the next six months. This could put pressure on property owners "to compete for residents" and potentially drive prices even lower.

Still, for investors keeping an eye on this section of the real estate investment trust (REIT) sector, analysts are still upbeat toward a handful of multi-family real estate stocks. 

One is Essex Property Trust (ESS), which markets itself as "the only public multi-family REIT dedicated to the West Coast." Approximately 82% of the REIT's net operating income is generated from nine California markets, with another 18% from the Seattle area. The consensus recommendation of the 25 analysts covering the stock tracked by S&P Global Market Intelligence is Buy. 

AvalonBay Communities (AVB) and UDR (UDR) are two other multi-family REITs boasting consensus Buy ratings.

Before deciding to invest in multi-family real estate stocks, investors will want to look at the top 25 cities in Zumper's October rent report. There, they will see that of the 15 declines in rent for one-bedroom apartments from September to October, one-third were California markets, which averaged a decline of 3.3%. Other notable drops in rent prices included Atlanta (-4.5%), Austin (-3.5%) and Seattle (-3.9%).

So, it follows that multi-family REITs with significant holdings in California and the three cities outside the Golden State would be a good place to avoid for the foreseeable future.