2019 Multifamily Housing Trends
Commercial Real Estate
Over 40% of real estate investors say they will be net buyers of apartments in 2019, despite the difficulty of locating a multifamily property to invest in that offers the yields they would like to earn.¹ The buyer percentage is down from last year’s 47% but is still well above the 14% of investors who plan to be net sellers this year.
With a buyer-to-seller ratio of nearly 3:1, investors considering buying apartments might ask if this demand will continue, or is the market becoming overheated? And if it does continue, what might be some of the factors impacting the continued investor demand for rental housing?
In this article, we’ll begin by reviewing the performance of the multifamily housing market in 2018, and then explore five multifamily housing trends that may influence the demand for rental investments in 2019.
In its Multifamily 2019 Outlook report², Freddie Mac expects to see the healthy performance of the multifamily housing market of 2018 continue into this year, although with growth becoming more modest when compared to previous years. The company cites three performance metrics for forecasting strong growth of the multifamily housing sector in 2019:
Rent growth: Rent growth remained healthy throughout 2018 and into 2019 with only slight vacancy rate increases as new supply of rental housing units came to market. While some markets and submarkets show weakness, Freddie believes the multifamily market overall is healthy.
New supply and absorption: Building permits already in the system combined with existing starts of new apartment construction indicate new supply of multifamily housing may continue through 2019 and into 2020. However, Freddie Mac sees supply and demand remaining in equilibrium due to demographic and lifestyle preferences to rent vs. own, and the rising cost of homeownership.
Cap rates: Multifamily property prices continue to grow even though interest rates have risen slightly. According to Freddie, this has caused cap rates to remain low and even decrease – or compress - slightly over the past few quarters of 2018.
One reason cap rates compress is due to supply and demand. When there is more investment capital available than there is property to purchase, everything else being equal, cap rates compress as investors pay higher prices.³ For example:
Alex paid $10 million for an apartment building generating an annual NOI (net operating income) of $600,000. When he bought the property the cap rate was 6% = $600,000/$10,000,000. Alex’s NOI has remained unchanged, and today he receives an offer from an investor willing to pay $11 million for the property. This means the buyer is willing to accept a lower cap rate of about 5.45% for the same NOI of $600,000 ($600,000 / $11,000,000 = 5.454%).
Of course, the opposite effect can also occur. If property prices reach the point where they yield less than alternative investments, demand will decrease as capital flows elsewhere.
According to CBRE’s 2019 Multifamily Outlook Report, the multifamily sector will continue to attract high levels of investment capital, with workforce housing, in particular, being an attractive investment strategy due to the favorable amount of demand vs. supply.⁴ CBRE expects absorption of multifamily units to be “robust” in 2019 as both cyclical short-term and long-term trends remain favorable for multifamily housing demand.
The 2019 Multifamily Investment Forecast by Marcus & Millichap notes that job creation during 2018 drove the unemployment rate of adults between the ages of 20 and 34 down to a 48-year low of 4.5%. About two-thirds of this age group live in rental housing, and due to the strong job market, they have contributed to apartment demand.⁵
In all age groups combined, 2.6 million new jobs were created in 2018, compared to 2.2 million in 2017 and 2.3 million in 2016.⁶ About 2.3 million new households were formed last year⁷, and overall wage growth in 2018 was 2.8%, up from 2.6% in 2017. Through Q1 2019 wage growth has increased 3.8% and employment has risen 1.9%.⁸ National Real Estate Investor expects these growth trends to continue through 2019, with new job creation averaging 125,000 per month and personal income rising 4% by year-end.⁹
Freddie Mac observes that while rents have grown by an annual average of 4.4% since 2012, a rate which is consistently greater than the historical average, the cost to own a home has increased even more. Over the last three years, the cumulative cost to rent has increased by just 14.1% compared to the cumulative 3-year cost to own of 23.8%. Another recent study by Freddie cites high housing costs as a main factor keeping young adults from purchasing a home, making renting a relatively more affordable option despite increasing rents.¹⁰
While rising home prices are helping to drive the demand for rental housing from young adults entering the job market, Americans earning $150,000 or more per year are the fastest growing renter segment.¹¹ Multifamily Executive notes that between 2007 and 2017 over 1.35 million high-income households became renters, an increase of 175% over this 10 year period. Based on data from RENTCafé, MFE concludes that the reason people having the means to buy a home choose to rent is due to a lifestyle choice and because in some metro areas buying a home is still unaffordable even for top wage earners.
According to Yardi Matrix, multifamily rent growth remains at 3.6% year-over-year (YOY) and shows “no signs of slowing”.¹² The property technology and research company goes on to report that YOY rent growth in February 2019 was the highest in the U.S. since late 2016 and that growth has increased steadily since the fall of 2017. Yardi cites rising rents as a sign of strong fundamentals in the apartment market as demand remains strong, wage growth rises, and unemployment remains steady.
The National Apartment Association (NAA) echoes Yardi’s rent growth reporting.¹³ Citing reports by Reis and Real Page, the NAA notes that no markets tracked by Reis experienced declines in rent during Q1 2019 while 14 markets saw rents grow by more than 5%. Increases were highest in secondary and tertiary markets where lower rent rates allowed a greater threshold for rate increases while still remaining reasonably priced to renters. Using combined data from CoStar, RealPage, and Yardi, the National Apartment Association sees forecasted rent growth for 2019 averaging 2.7% and apartment rent growth in 2020 of between 2% and 2.5%.¹⁴
In the same report, the NAA observes that net absorption in Q1 2019 was 37,159 units, more than 11% above total completions for the quarter of 33,276 units. Through the end of 2019, the Association projects that a total of 336,400 new apartment homes may be brought to market. According to Freddie Mac’s Outlook report, while rents are forecasted to continue rising and more units are added to the market in 2019, new absorption may keep the average vacancy rate in the U.S. top 70 metro areas at 5.1%.
Freddie also shows that since Q2 2016, annual multifamily absorptions have continued to increase. The company notes that vacancy rates have consistently performed better than forecast, putting the multifamily market in a good position to absorb higher levels of new supply. Based on information from REIS and Moody’s Analytics, Freddie expects 2019 vacancy rates in most metropolitan areas to remain below their historical averages despite new supply entering the market.
Projections show the economy may continue to grow, multifamily rents may continue to rise, and vacancies may remain steady. Does that mean cap rates may continue to compress as prices for multifamily properties rise due to continued investor activity?
Freddie Mac attempts to answer that question by noting there is a correlation between cap rates and Treasury rates. As Treasury rates rise, higher interest rates affect the cost of financing, which in turn affects property operating costs and property values.
Using data compiled from Moody’s Analytics and the Federal Reserve Board, Freddie notes that cap rate spreads (the difference between the cap rate and the Treasury rate) remain below their long-run average going back to 1990. Freddie expects multifamily cap rates to slowly begin increasing when interest rates begin rising, although cap rates may take a longer time to react because they are “stickier” than interest rates.
In the meantime, the company sees multifamily properties continuing to experience strong price appreciation, with apartment prices having increased 10.7% annually through Q3 2018. Freddie notes that despite moderating fundamentals, multifamily investments continue to provide stable returns to investors compared to other investment alternatives.
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