December 2021 Edition - 2021 Has Been a Record Setting Year and 2022 is Going to be Even Better
As I collected articles to summarize the 2021 multifamily market performance and to contemplate what to expect in 2022, I was overwhelmed by just how great a year 2021 has been. In our day-to-day efforts we sometimes don’t take the time to look at the overall picture and see what our individual efforts are producing. 2021 has gone better for multifamily real estate than virtually anyone predicted when the coronavirus pandemic began. Across the earnings reports, financial analyses accompanying the reports and the calls between the companies’ executives, common themes emerged with an overall sunny outlook: Average occupancy over 96%, cap rates below 4% and an impetus to build new apartment buildings at a greater rate than was expected at the start of the year.
The multifamily sector has enjoyed a meteoric rise over the course of the pandemic. Multifamily total returns rose to 12.3% through the first three quarters of the year and 13.4% on an annualized basis. Investors had largely targeted suburban multifamily markets prior to the pandemic but investor preference for assets located in non-major markets are continuing to grow, totaling 80.4% of investment through the first three quarters of 2021. (Newmark 3Q21 US Multifamily Capital Markets Report) The Southeast and Sunbelt have been disproportionate beneficiaries of these trends as well as the investment flows.
The Southeast is benefiting from inward migration and corporate relocations. “Population gains and job creation in key growth secondary markets dramatically outpaces most gateway cities.” (Roberta Casas, senior managing director at JLL) The substantial population, employment and income growth in the Southeast is forecast to outpace the US average by 2x over the next five years, making it a prime location for apartment investors. These markets offer lower taxes and a cost of living below the national average.
The multifamily sector entered the pandemic on solid footing, and despite challenges brought on by the pandemic, it has the potential to continue to outperform in the years ahead, according to Investcorp’s November 2021 White-Paper on Resiliency and Growth of US Multifamily Real Estate. “Apartments are a hot commodity throughout the US. As Q4 performance data comes in, we see that this asset class is nearly pandemic proof.” (Nate Hanks, CEO, RealSource). “We believe it will take years for new supply to find an equilibrium for housing in most major metros. Our in-house research is showing that the pace of rent growth will continue to accelerate and outperform most experts’ forecasts through 2023.”
Eddy O’Brien, managing partner and co-founder of Blaze Capital Partners says, “As we head into the final stretch of the year, the multifamily sector has never been hotter. While the pandemic presented a number of obstacles to other asset classes, multifamily has continued to fare exceptionally well, due to its resilient nature. The industry is underpinned by strong fundamentals, and it has shown resilience during these disruptive times. As such, despite the uncertain long-term implications of the pandemic, it should not affect the dynamics of supply and demand. Demand for multifamily property is expected to remain strong and will continue to outpace supply.” (Eddy O’Brien)
Optimism abounds for apartment executives entering 2022. The outlook for the multifamily asset class is buttressed by a growing economy, nationwide housing shortage, and supply chain issues, which are making it impossible for supply to keep up with demand. While there aren’t loud calls being made about bubbles nor anticipated multifamily performance problems, the commercial real estate industry’s fortunes are being increasingly tied to multifamily.
A look at lending dynamics and availability of funds are instructive to demonstrate where multifamily is heading in 2022:
- Transaction volume has accelerated considerably. Real Capital Analytics reports, “Commercial property deal volume surpassed $450 billion for the first three quarters of the year, a level never before reached.” In the third quarter of 2021, the apartment and industrial sectors constituted some 60 percent of the total activity.
- Lending volume has accelerated considerably, commercial and multifamily mortgage bankers are expected to close $578 billion of loans backed by income-producing properties in 2021, a 31% increase from 2020’s volume of $442 billion, according to a forecast released by the Mortgage Bankers Association (MBA).
- Total multifamily lending alone is estimated at $409 billion in 2021 – a new record and a 13% increase from last year’s total of $360 billion. MBA anticipates additional increases in lending volumes in 2022, with activity rising to $597 billion in commercial/multifamily mortgage bankers originations and $421 billion allocated strictly for multifamily lending.
One of the common selling points for commercial real estate investment is that the asset class provides a good hedge against inflation because it generates cash flow. Owners also have the ability to raise rents along with rising inflation. Higher revenues also correlate to higher property values. “Commercial real estate doesn’t give you instantaneous protection against all unexpected blips in inflation: however, if you look at a longer period of five, seven or ten years, generally speaking the values of real estate will go up with inflation.” Real estate does keep pace with rising inflation reasonably well with the higher prices that flow through to rents in the multifamily market.” (Barkham)
According to Bureau of Labor Statistics estimates, the consumer price index rose 5.4% in September 2021, the fifth straight month in which the inflation rate was five percent or greater. Views remain mixed on whether higher inflation could be transitory – caused by a combination of reopening economy and a choked supply chain – or whether more long-term inflationary pressures are at play. Richard Barkham, PhD, Global Chief Economist, Head of Global Research and Head of Americas Research at CBRE, believes the current inflationary trend is “transitory.” Barkham expects inflation to drop back once some of the supply side issues contributing to price increase improve as more people return to work.
“The economic recovery continues in earnest, but this is raising questions about how transitory the current high rates of inflation are.” (Michael O’Brien, Head of Real Estate Post Acquisition Activities, Investcorp). “Core inflation will likely stay elevated, which should force the Fed to push up rates. And while rising Treasury yields are projected to squeeze the yield gap enjoyed by apartments, given the strong prospects for NOI growth in the apartments sector, the effect on apartment yields are projected to stay low. Spreads between bond and property yields are also currently generous enough to absorb higher long-term interest rates in the short term.” (O’Brien). O’Brien said the rental growth for apartments is also projected to continue to outpace inflation, making it a good hedge against the pressure of rising prices.
Berkadia recently introduced a new white paper that assesses inflation and risk in real estate. In particular, the research compared performance of private commercial real estate, equity REITs and the stock market. One of the key findings of the research for the post- Great Financial Crisis period studied is that higher inflation tends to help private commercial real estate returns, while hurting REITs and stock returns. In addition, when comparing individual property types, privately held apartments followed by industrial delivered the strongest risk-adjusted performance. Noah Stone, an economic analysist at Berkadia, surmises that the suspected reason for the outperformance is the difference in liquidity. “The illiquidity of privately held real estate is likely to protect values more during time of inflation.” (Stone) The Berkadia research also showed that apartments have the strongest risk-adjusted performance during both times of moderate (2-5 percent) and high inflation (5+percent).
For your convenience, summarized below are some of the highlights of the 2021 market and the expectations for 2022:
Sales volume in 3Q21 totaled $78.7 billion, signifying the largest quarterly sales volume figure on record as investor appetite for multifamily continues to surge. (Newmark 3Q21 US (Newmark 3Q21 US Multifamily Capital Markets Report)
Dry powder rose to a record high, totaling $237 billion (Newmark 3Q21 US Multifamily Capital Markets Report)
Allocations to multifamily rose to 38.6% year-to-date, an all-time record, as well as accounting for 40.8% of total US commercial real estate investment sales volume in 3Q21. Increased allocation to multifamily is a result of a robust transaction market, reflecting pent up investor demand from traditional multifamily investors, foreign capital and groups that are seeking to diversify their core holdings away from more vulnerable property types. (Newmark 3Q21 US Multifamily Capital Markets Report)
Unparalleled demand for multifamily product has caused cap rates for both the broad multifamily market and the non-major markets to compress further in 3Q21. Since 2018, cap rates have compressed 62 basis points overall, 36 basis points for major markets and 71 basis points for non-major markets. (Newmark 3Q21 US Multifamily Capital Markets Report). Despite a treasury yield increase, apartment cap rates are projected to stay low in the next couple of years, supporting the increase in capital values. While the 10-year treasury rose slightly to 1.52% in 3Q21, multifamily cap rates continued to compress, falling 21 basis points year-over-year to an average of 4.67% nationally. The spread between the 10-year treasury note and multifamily cap rates compressed 315 basis points remaining above the long-term average of 284 basis points. (Newmark 3Q21 US Multifamily Capital Markets Report) The average price per unit for the national multifamily market rose to an all-time high of $221,081 per unit on average. Pricing in non-major markets has risen significantly to keep pace with increasing investor demand. Since 2018, pricing increased 23.0% for the national multifamily market. Major market pricing has increased 14.1%, albeit lagging non-major market pricing growth of 30.6%. (Newmark 3Q21 US Multifamily Capital Markets Report)
As demand for rental units returned largely across the US, effective rent growth for 3Q21 rose 5.9% the largest quarterly increase on record. On an annualized basis, effective rent growth grew 3.1%, recovering from pandemic lows. Increased demand for apartments is projected to support strong levels of rent growth through the end of 2022. (Newmark 3Q21 US Multifamily Capital Markets Report). The growth is driven by an ongoing surge in demand that started in the spring and has yet to subside. The average US occupancy rate of stabilized properties reached a record-high 96.1% in September, up 1.4% year-over-year. Asking rents were up 13.4% year-over-year through October, and rent growth was above-trend across the country. The market continues to post extraordinary gains in every region of the US, with the average gain in October representing an acceleration in rent growth after a stretch of strong growth. The southeast leads in accelerating monthly growth. “We believe it will take years for new supply to find an equilibrium for housing in most major metros. Our in-house research is showing that the pace of rent growth will continue to accelerate and outperform most experts’ forecasts through 2023. (Nate Hanks, CEO, RealSource)
New lease trade-outs surged to 17.5% nationally in 3Q21, the highest rate on record after averaging 2.2% from 2009-2019. Mobility has returned to the rental market and new lease trade-outs remain a significant catalyst for landlords’ ability to increase rents at a rapid pace. (Newmark 3Q21 US Multifamily Capital Markets Report). “An analysis from BTIG Research predicts that staggering pace of new leases, which have posted 15% to 25% growth this year, will likely moderate in 2022, particularly in the Sunbelt region. Lease spreads appear to be near their peak in several markets,” says BTIG’s James Sullivan and Ami Probandt. Affordability “could become an issue” in the next year.
Recent signs that multifamily rent growth might slow down have proved to be premature, as the asking rent increased by $23 in October to a record high $1,572. Asking rents were up 13.7% year-over-year, also a record high recorded by Matrix. The national median rent in November was $1,312. $117 greater than where Apartment List economists predict it would have been had pre-pandemic trends continued.
Equity Residential President and CEO Mark Parrell says, “We continue to aggressively sell our older and less desirable properties at these low cap rates and at prices that exceed our pre-pandemic value estates, as well as acquiring much newer assets in our expansion markets. We have funded these buys with approximately an equal amount of dispositions of older and less desirable assets.”
US apartment-building sales soar to record, with the Sunbelt driving deals. US apartment building sales have jumped to record levels, outpacing all other forms of commercial real estate. Deals totaled $241.9 billion in the last 12 months. (RealPage Inc.)
Competition, a shortage of quality buying opportunities and even a pandemic have not deterred apartment investors. The latest Wealth Management Real Estate (WMRE) multifamily research report shows that investor appetite to hold or expand portfolios has changed very little in the past three years, despite massive disruption in the broader markets.
WMRE survey results show a strong, sustained buyer appetite for apartments that has held up for the past several years. The success of multifamily over the last 18 months or so has really highlighted the industry as, not necessarily recession proof, but an extremely attractive sector that has good risk mitigants. In the WMRE survey, respondents continue to view multifamily as the most attractive type of investment property. On a scale of 1 to 10, multifamily rated a mean score of 7.7, followed by industrial at 7.4, single-family rentals at 7.2 and data centers at 6.9.
A common complaint from investors is the challenge in finding good buying opportunities in a highly competitive market. “Competition is as fierce as I’ve ever seen it, and the lack of quality deals out there is frustrating.” (Lebenhart, Ashcroft Capital)
The majority, 88%, of the WMRE survey respondents expect to see rents increase in the next 12 months with an average increase of 4.4%. As a result, there has been a fundamental shift in the market where investors are being much more aggressive in their underwriting on rent growth, notes Brian McAuliffe, president of capital markets and lead of the multifamily investment sales business at CBRE.
“Landing a bargain in quality multifamily these days is nearly impossible but this hasn’t dampened investor enthusiasm for apartments – especially in the Sunbelt states.” (Karlin Conklin) Conklin notes that IMG has traded nearly half a billion in this region in 2021 and is targeting even more in 2022. Having a solid understanding of submarket fundamentals – jobs, population growth, incomes -plus long-term connections with brokers and other principals is key to growing a portfolio when competition for assets is fierce. (Conklin)
“On the supply side, while the pace of new construction has picked up compared to the lows seen a decade ago, the increase is projected to not be enough to make up for the current shortfalls. It is estimated that 2.3 million homes are needed each year over the next 10 years to balance the supply/demand imbalance.” (Paul Bergeron, L5 Investments)
“Lower vacancy rates and accelerating rental growth will support apartment income. A substantial recovery in net operating income will mean that yields see little change over the next year, despite strong investor demand.” (O’Brien)
“Until construction ramps up, housing shortages will persist, increasing demand for the rental market. The multifamily sector is projected to continue to perform well as it has over the past two decades.” (O’Brien)
“Just-In-Case You Missed It” is a monthly letter prepared for multifamily owners and prospective owners. It is a compilation of multiple articles from multiple sources or a reprint of an article from a specific source (source credit given). Its purpose is to present both facts and opinions that may influence our multifamily business in the Southeastern U.S. If you have any questions and/or would like to discuss any of the comments above, my conclusions or your multifamily business, please contact me at your convenience. I can be a valuable resource to you without adding expense to your budget. I look forward to speaking with you and having an opportunity to meet with you. I am always at your disposal to assist you with your multifamily business. If you would like to review previous editions of my monthly “Just-In-Case You Missed It” letter they are posted on my website, www.rickbakermultifamily.com.
Respectfully,
Rick
G.F. Rick Baker, CCIM
Multifamily Specialist/Investment Advisor
www.RickBakerMultifamily.com
2504 Tinderbox Ln.
Greensboro, NC 27455
Cell: 336.549.6083
Email: rickbakermultifamily@gmail.com
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