The multifamily sector is a long-time investor favorite. Regardless of the economic climate, people prioritize housing as a basic need, giving multifamily a lot of investment durability through up and down cycles. Today, that durability has been amplified by a severe supply-demand imbalance and an inflated housing market. As a result, Ed Chazen, senior lecturer at Boston College Carroll School of Management, is very bullish on the multifamily sector, even as economic headwinds mount.
In 2012, the median housing price in the US was $241,000. Today, the median cost of a home is $467,700. That is an increase of 6.7% annually over ten years. Simultaneously, median household income has only increased from $51,371 to $70,784, a compound growth of 3.2%. The math doesn't compute—and this gap between housing costs and wages has pushed people out of the housing market.
While the trend does not bode well for the broader economy, it has been a source of demand for the rental housing market. According to Chazen, every 1% decrease in the homeownership rate creates demand for 1 million new apartment units. "We don't produce enough housing," said Chazen in an interview with Northspyre. "We have a real housing shortage. Even though there are lots of apartments being built, it barely scratches the surface."
Both apartment and single-family developers are bullish on multifamily due to this historical need for housing. Here is a deeper look at why developers should be expanding housing construction and how to overcome rising debt costs to make deals work.
Strong demand warrants voracious construction.
In 2022, the Federal Reserve did its best to suppress consumer demand and the inflationary pressure that came with it by increasing interest rates seven consecutive times. The aggressive action led to increased mortgage rates, corporate layoffs, a series of bank runs, and a heightened risk of a recession. However, somehow the multifamily market seems to have remained unscathed. The occupancy rate is only expected to increase a nominal 50 basis points this year, growing from 5.5% at the end of 2022 to a forecasted 6% at the end of 2023, only slightly above the long-term average of 5.8% vacancy.
Strong occupancy has helped to sustain rent growth. Experts expect national apartment rent growth of 4% this year. While this is well below the double-digit gain in rents over the last two years, it trends well above the long-term average of 2.5% rent growth.
Job and wage growth are also good indicators of demand in multifamily. Weak job numbers could foretell increased vacancy or lower rents, but the unemployment rate has remained steady at 3.4%, the lowest since 1969, and wages are up 6.1% in 2023. Employment is foundational to a healthy rental market.
The strong demand has already sparked tremendous multifamily construction. There are currently 750,000 units under construction, the largest pipeline of apartments since the 1980s. The construction will increase the current apartment stock by 4.2%, but CBRE estimates that the country will still need an additional 2.3 million apartment units over the next decade to meet current demand.
Pandemic migration trends have created widespread opportunity.
The incredible demand dynamics support an active new construction market with continued new starts, and investors have plenty of options when selecting sites. Migration patterns during the pandemic reallocated housing demand into new markets. Secondary and tertiary markets throughout the Sunbelt, in particular, saw an influx of new residents, and Chazen noted strong demand in the suburbs as millennials starting families are looking for more space and good school districts.
Housing developers are rife with opportunities to meet demand in new markets, and local cities are working with developers to make that happen. Chazen explains that many states and cities are changing zoning restrictions to allow for density bonuses near transit stations to accommodate more houses. That legislation has opened the door for more housing development in targeted areas, and Chazen expects that trend to continue. "I think we're going to see, thankfully, the start of a wave of development on transit station lots," he said, adding that he is very optimistic about new apartment development across the country.
The top markets for new construction are a mix of major gateway cities—New York, Washington DC, and Los Angeles are all on the list—as well as smaller emerging metros, like Miami, Austin, and Atlanta, illustrating the diversity of demand across the country and the widespread opportunities for housing developers in new markets.
Interest rates are a wild card.
Although the multifamily construction pipeline has swelled to a 40-year high, new starts are beginning to taper. According to CBRE, we are already experiencing the construction peak, although there remains an imbalance between supply and demand. Rising interest rates are the likely culprit behind the decrease in the construction activity. The Fed increased interest rates seven times in 2022 and twice in 2023, doubling mortgage rates.
In light of the higher cost of capital, both investors and developers have stepped to the sidelines. However, there are opportunities to mitigate the capital costs and secure financing to move deals forward. To start, Chazen recommends investors secure financing through the agencies which offer competitive and low-cost rates. Investors are still able to secure an attractive loan-to-value at 80%, helping to offset the risk of a new project. Chazen also says we must contextualize the high-interest rate environment. While interest rates have been low for the last decade, historically, they have been between 8% and 9%.
Developers can also leverage technologies to offset higher interest rates. By streamlining a project through automation and AI, developers can drive efficiency, minimize errors and improve project outcomes. These benefits have a tremendous monetary value, reducing overages by up to 66% and reducing budgets by as much as 6%. That is real value that can help make a project pencil even with a higher interest rate.
As market uncertainty swells, multifamily resiliency shines. Today, strong demand fundamentals have readied the sector to withstand a storm and prosper through it. Developers and investors searching for opportunities need to look no further than multifamily.
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Real Estate Development