What To Expect In Multifamily In The Coming Years
Written By Ashley Wilson
With all of the talks of a recession it is inevitable that people start talking about the ripple effects the recession will have on different industries. Within the multifamily industry, there is a lot of discussion on how properties will fair during this looming recession. While I am not here to tell you when I think the next recession is coming, nor do I have a crystal ball, here are my thoughts on the next few years as it pertains to multifamily.
Before I begin, let me start with a disclosure; the reason I was first drawn to multifamily (as compared to other real estate asset classes) was due to the fact that multifamily is a great inflation hedge investment. In other words, historically rents have trended with inflation. As we find ourselves in a highly inflationary environment it is my belief that the majority of markets’ rents will continue to trend upwards. I have also witnessed a lag time between inflation and rent growth. For example during COVID there was a tremendous amount of stimulus distributed, especially for rental assistance. The effects of these two factors were not witnessed in properties’ rent growth for approximately 3 months after the distribution. Thus, thwarting those programs won’t most likely have an impact on rental growth for approximately another 3 months.
So what will happen when the Fed raises the interest rates (again) to try to curtail inflation? Great question! The very fundamentals of how rents are established are the same principles that guide economics- supply and demand. Over the past two years a couple very interesting things happened with supply. First, new supply came to a halt at the onset of COVID, due to a government mandate shutting down most businesses for several months. Next, when construction resumed there were several chain supply issues, which we are still seeing today, that created rising costs and massive delays for product delivery. Compounding this issue further is the recent challenge with the labor supply. As the labor supply has been drying up, development prices are soaring causing even further delays. ABC (American Builders & Contractors Association) recently reported that on top of the normal hiring trends the industry needs 650,000 more laborers for 2022, and 590,000 more laborers for 2023 to meet the industry’s demand (and that assumes that 2023 slows down its growth compared to 2022). When you factor the labor issues, rising material costs and the uncertainty of interest rates, a lot of developers are sitting on the sidelines. Reuters reported in May 2022 a five month low in homebuilding, citing Single Family permits dropped by 4.6%, and Multifamily dropped by 1%. But what does this all mean?
As we continue to enter into our next recession, if all factors remain the same, I believe the majority of major MSAs with diverse economies will see a stable, or a minor dip in the A class rental space and a stable or growth in the B & C class rental space. During most recessions we actually see compression in the A space, and stable or minor growth in B & C, so why do I feel that there might be a slight change this time around? First, with a .25 basis interest rate hike from a basis of 3.5%, 1.1m Americans can no longer afford buying a median-priced home (NAHB.org). Second, millennials and baby boomers are choosing to rent over owning a home. These factors coupled with supply present a scenario that looks different than previous recessions.
It won’t all be rainbows and butterflies. While I believe rents will fair well, the expenses might take a hit due to the same factors I brought up regarding construction. Construction labor, wage growth, and the overall cost of doing business is still on the rise. Personally, I have seen this already start to cool off, but I do not believe we will see price adjustments to pre-Covid pricing.
Lastly, the biggest prediction I have is when it comes to innovation within this asset class. Over the next few years, I think we will see a tremendous surge in innovations, specifically integration with technology. I believe we will see this starting with alternative construction methods (more 3D printing, alternative building materials and building methods), the use of AI technology for general operations as it comes to leasing and day-to-day management, and finally software development supporting the management and oversight of the business. All of these needs are long overdue. While recessions are looked at negatively, it often breeds incredible innovation. I think this recession is poised to be one of the best opportunities for innovation we have ever witnessed in the industry.
What are your thoughts?