By the Numbers
Still the Darling of CRE?
The multifamily sector has seen continued low vacancy and solid rent growth, but the continued difficulties of the COVID-19 pandemic is putting this strong run in jeopardy. Unemployment that has settled in approximately two percentage points above the natural rate, an uptick in suburban migration to single-family homes, and a slowing of household formation have combined to create uncertainty and concern for a multifamily sector that weathered the Great Recession and has been increasingly thought to be recession-proof.
Is the Concern Warranted?
Yes, at least on the surface. Rents are down about 2 percent, vacancies have hit 5 percent for the first time in eight years, and transaction volume is 50 percent of its recent yearly average. We all should be at least somewhat concerned. But as with any CRE analysis, context and nuance are necessary.
Effective rents in 3Q2020 fell 1.9 percent - the largest quarterly decline on record since REIS began publishing quarterly data in 1999. This is certainly cause for concern, but is it a death sentence? Absolutely not. First off, much of the rent declines came from just three MSAs: San Francisco, New York, and Washington, D.C. Eliminating these dense, expensive cities from the list dramatically decreases the magnitude of the nationwide rent decline. Most areas recorded declines closer to 0.5 percent with some even boasting growth. Secondly, we do expect household formation to pick up and lead to absorption gains as the weather warms up in the spring and vaccines become more widely available. While we still expect vacancy to inch up toward 6.5 percent by the end of 2021, much of this will be due to an overwhelming amount of supply finally coming online after delays caused 2020 to record far fewer completions than initially expected. Supply increases are as much, or maybe more, to blame than declining demand.
What about the capital markets? To blame the decline in activity wholly on the economy would be imprudent. Mandatory office closures, understaffed appraisers and courts, and limited site visits certainly combined to slow the rate of activity and indefinitely pushed off many otherwise solid deals. Given the uptick in 3Q2020 activity versus 2Q2020, we expect activity to dramatically pick up in 2021 as long as health concerns are mostly behind us. As for multifamily values, expect muted growth and some declines due to the overall level of uncertainty. As the economy and migration patterns sort themselves out, dips in value from 5 percent to 10 percent of those in 2019 may not be uncommon through 2021 and into 2022.
Urban vs. Suburban Markets
To parallel the decline in dense urban markets described above, data show approximately twice the rent declines in central business district submarkets versus their suburban counterparts. Details tend to show that both A and B/C segments are struggling a bit in and around CBDs, but for different reasons. For A properties, some upper-income residents have used the pandemic as an excuse to finally make that move to the suburbs. Many residents of B/C properties do not have the income or the down payment funds to make the same jump. While a few have picked up and moved to less expensive Sun Belt cities, others have moved back into their parents’ homes or remained with roommates past the time they expected. We also must account for the disproportionate effect this pandemic has had for low-wage workers. Eviction moratoriums and loan workouts have muddied the data a bit, but unless Congress passes a major relief package or we once again reach full employment (doubtful anytime in the next year or so), we will see further stress on B/C properties.
We expect activity to dramatically pick up in 2021 as long as health concerns are mostly behind us. As for multifamily values, expect muted growth and some declines due to the overall level of uncertainty.
The Darling of CRE?
Even with some of the concerns listed above, multifamily is holding up well, and consensus forecasts continue to point towards stability. Given this, the sector will continue to get its fair share of investment dollars, and maybe even more given the issues facing retail, hospitality, and office. Only industrial, with its e-commerce-inspired boom, can be put into the same category; but even there, greater uncertainty exists. Any significant pullback in the economy or slowdown in recovery will quickly halt consumer spending and cause problems for warehouse and distribution. The same situation for multifamily will also be problematic, but likely less so. Households still need shelter, and a move to a single-family home in the suburbs becomes more troublesome during a poor economic climate. Maybe multifamily is, after all, recession- and pandemic-proof.