It’s Not All Doom and Gloom in Commercial Real Estate. Multifamily Fundamentals Remain Sound.
The media is quick to shine a spotlight on trouble in commercial real estate. While it’s true the office sector is struggling and will likely continue to face an uphill battle for the next few years, investors would be mistaken to paint the entire commercial real estate universe with a single broad brush. The vast and diversified US real estate market encompasses more than 10 sectors—and several are on solid footing, including multifamily. A few key charts can help us see the healthy long-term fundamentals in multifamily along with signs of resilience during the current period of normalization.
Rents post moderate growth as demand holds up
For the US economy at large, recent data is sending mixed signals. As it pertains to multifamily demand, however, the signals are clearer: We’re seeing ongoing resilience in employment and strong apartment demand.
US employers added more than 1.5 million jobs year to date as hiring maintained broad-based momentum. Unemployment increased slightly to 3.7% in May yet remained near historic lows. Headlines are drawing attention to payroll cuts at big-name companies, but overall layoffs have remained low and job openings have ticked up.
A challenging for-sale market is also boosting demand for multifamily as renters stay in apartments. Affordability remains a key challenge with would-be buyers facing high home prices and rising interest rates. According to the Joint Center for Housing Studies of Harvard University, payments on the median-priced home rose from $2,500 to $3,000 between March 2022 and March 2023 as the annual interest rate on 30-year fixed-rate mortgages climbed from 4.2% to 6.5%. The result was a 22% annual decline in the number of mortgages originated to first-time homebuyers in 2022. The Center estimates more than 2.4 million potential homebuyers were priced out of homeownership.[2]
Furthermore, homeowners with low in-place mortgage rates aren’t keen on selling, tamping down inventory levels and pushing up prices.
Underpinned by these demand drivers, multifamily rents are in positive territory after pulling back from exceptionally strong growth rates in mid-2021 to mid-2022. In year-over-year terms, we’re expecting moderate rent growth for 2023, landing in line with historical growth rates. In our view, this normalized rate is still quite attractive and offers room to underwrite profitable deals.
US apartment occupancy is 94.7% as of May 2023, identical to April’s figure and in line with long-term norms. Importantly, occupancy rates have held steady this year, a sign of normalization after occupancy dropped 2.6 percentage points last year after hitting a multi-decade high of 97.6% in February 2022. Renter renewal rates also appear to be stabilizing following sharp declines from record levels.[3]
Short-lived supply effects
Deliveries of new multifamily units are expected to be elevated through the end of 2024. A big chunk of the supply coming online is in fast-growing Sun Belt locations, where we often invest on the back of compelling demographic and job growth trends. We’re closely attuned to supply dynamics, but we’re not losing sleep over this current influx of completions. Many of the new buildings will cater to the highest-end renters—this means they won’t be direct competition for our properties, which we renovate with the intention of being the best Class B assets in a given submarket. Plus, we expect any impacts to be short-lived as today’s tight financing conditions and rising construction costs have made it harder to pencil new construction projects; developers are pulling back. Once the current wave of projects is completed, the supply pipeline will likely shrink. Lastly, we believe the depth of demand in our submarkets can readily absorb the short-term uptick in supply.
Conclusion
We continue to experience sound multifamily fundamentals as the market recalibrates toward historical norms. This fundamental strength should enable multifamily to withstand market conditions better than many other types of commercial real estate. That said, we continue to keep our eyes on the horizon and carefully optimize all components of the total return equation, including operating costs and capital markets activities. By identifying the right assets in the right locations, using leverage responsibly, and adhering to a prudent investment approach, Trion Properties is well-positioned to ride out the ups and downs of the real estate cycle. We are confident our track record of success in a variety of environments will serve our investors well.
[1] https://www.wsj.com/articles/may-jobs-report-unemployment-rate-economy-growth-2023-65ae1e96
[3] https://www.realpage.com/analytics/apartment-leasing-increases-rent-increases-fade/