Favored as one of the most stable real estate investments, and quickly becoming America’s abode of choice, apartments are inching toward center stage in the residential real estate realm.
Skyrocketing home prices, hefty interest rates and demographic trends are creating a perfect storm for multifamily to step into the spotlight.
There are 111,054,354 renters in the U.S., according to the U.S. Census Bureau. This represents 35% of the U.S. population, and that number is increasing as people continue to move from rural or low-growth areas to national job nodes.
DEMOGRAPHIC TRENDS
This story really begins with the changing demographics in the U.S. population. There are two major cohorts driving the massive absorption numbers in the multifamily market: Millennials and, wait for it, Baby Boomers.
Typically, the headlines focus on Millennial hordes renting in droves as they enter the adult world en masse, but the Baby Boomers have been quietly selling off their homes in a hot housing market and downsizing to nice apartments closer to their kids or desirable areas of town.
“It’s kind of funny; you have bookends now. You’ve got the younger people getting out of school who want that [flexibility, walkability, etc.]…and now you have the seniors getting back into that [lifestyle],” Monument Capital Management Principal Stuart Zook told HousingWire.
That means the two biggest living generations are both opting to rent. This is the backbone of the multifamily market, and most experts feel it isn’t going to change anytime soon.
According to Zook, people are already experimenting with transforming existing multifamily properties into senior housing developments to age with their Baby Boomer residents. As the Baby Boomers age into assisted living and memory care, multifamily developers will have the potential to capitalize on a large and lucrative demand pool.
On the other hand, Millennials are waiting to start families and purchase their first homes. The average age of the first-time homebuyer just broke 30 earlier this year, and as lifestyle preferences seem to be departing from the traditional family structure, the multifamily industry can anticipate strong, steady, long-term demand for the foreseeable future.
FINANCIAL TRENDS
By and large, investors are looking for the sure bet when it comes to real estate investment, and right now, thanks to the demographic trends, multifamily product of every level, Classes A, B and C, are proving to be solid investments.
Right now, the action is centered on buying and selling value-add properties (typically Class B, upgraded to B+ or A) in first-ring suburban markets. These are the Holy Grail of multifamily investment properties, and competition for these properties is fierce.
What makes them so desirable is that (at first) they could be purchased for cheaper than average, and high-growth suburbs are typically reluctant to issue permits for new builds, meaning there is little to no competition in the area. Once properly upgraded, these first-ring suburban units can start yielding very attractive returns on investment.
“It’s very, very difficult in these suburban locations to get a permit to build new multifamily in these first-ring suburban locations, because their roads are jam-packed with traffic, their schools are full, all of their municipal services are kind of at max capacity, and the last thing that they want is 300 units and 300 new families on a relatively small plot of land,” LEM Capital Co-founder and Partner Jay Eisner told HousingWire.
And though rent growth has been slowing in general, investors surmise that these suburban locations will exhibit better than average rent growth.
“We believe that the demand is actually higher than what is being projected by the various services and that in the right locations with the right business plan, that rent growth is going to be higher than the average that is being projected,” Eisner said.
“I think we’ll consistently see 3% to 5% rent growth in our portfolio,” he added.
The second investment trend is that investment interest has trickled down from big and medium-sized firms to small-time private investors, typically business owners who want to try their hand in the multifamily market with small properties under $1 million in value. This is largely due to a healthy economy lining everyone’s pockets with a little extra padding.
The rapid growth of this demand has spawned a spate of companies cropping up to satisfy the appetite for these small loans that banks typically shy away from for risk reasons.
“People are curious [about investing]. We have this product; we put it out into the market; and we’ve seen ramp up. Whether it’s because we’re getting better at targeting and marketing to these people or there are more of them, you know we’re still kind of trying to figure out what that balance is, but we’ve gone from zero production to actively closing loans within the last two quarters,” Commercial Direct Managing Director Leslie Smith told HousingWire.
Investors of all sizes are hungry for multifamily product, and that is part of what is propping up the affordability crisis in the U.S.
AFFORDABLE HOUSING TRENDS
Though some people contest the severity of the situation, most people agree that there is a crisis of affordability in the American housing market, both in the single-family and multifamily spaces. Experts say the root of this problem is primarily a lack of supply. Though production levels for the multifamily market have been elevated for the last few years, they have not been enough to meet the seemingly insatiable demand for apartments nationwide.
What this has caused is large rise in the amount of people who are considered rent burdened (paying 30% or more of their income for rent and utilities). According to the National Multifamily Housing Council, the number of rent burdened people has risen from 42% to 55% since 1985, and now, more than one in four (29%) of residents spend at least half of their income on housing.
In an attempt to stop the bleeding for low- to moderate-income renters, some municipalities are enacting inclusionary zoning policies that require a certain amount of any new developments built to include an affordable portion. As one might imagine, this is not developers’ favorite policy.
Earlier this year in Louisiana, there was some fierce legal jockeying from the Louisiana Home Builders Association to get rid of inclusionary zoning. The LHBA claimed that inclusionary zoning so crushed its members margins that it wasn’t worth building anymore. Their pleas fell on deaf ears, and they lost that battle when Louisiana Gov. John Bel Edwards struck down their bill banning the practice.
It is easy to make the LHBA the bad guy here, but the organization was not crying crocodile tears. Rising construction prices are putting a real hurt on developers, necessitating rent growth and making developers, like the members of the LHBA, reluctant to build new product.
CONSTRUCTION/ECONOMIC TRENDS
According to industry experts, there are five major things driving construction costs up:
- The focus on high-rise, urban-core product
- Natural and artificial growth in commodity prices
- Labor costs
- Inexperienced builders
- Regulatory costs
Most of the product built in this cycle has been luxury, high-rise product in the urban cores. These are inherently more expensive to build because they use more and more expensive materials than low- and mid-rise product. Land prices are also typically higher in the urban core than in the suburbs, another hit to the bottom line.
Material costs are baked into every project and lately they’ve been climbing. The Canada lumber tariffs have hit mid-rise and low-rise product hard. The tariffs ($602 U.S. dollars per 110,000 board feet of Canadian softwood lumber) are approaching their record high back in 1993 of $741 per 110,000 board feet.
This bodes poorly for both new single-family construction and new multifamily construction.
Prices on the steel used for high-rise product have been on their way up for natural reasons, but with this administration’s stance on trade relations, it looks like the rising steel prices will see an artificial acceleration as the U.S. levies tariffs on Chinese and European steel.
Rising interest rates are also making it difficult to finance these projects, especially as this decade-long cycle appears to be approaching a gentle end.
Labor shortages also play a role in the rising cost of construction. After the crash in 2008, many workers left the construction industry, which means skilled labor is in high demand and comes at a premium.
Because the multifamily market is so hot and the demographics are so favorable, many newcomers to the market have sought to throw their hats in the ring with the experienced developers. But without the wealth of knowledge built up over years of building, these newbies often don’t employ the best practices in construction. Inefficient techniques mean a longer job time and wasted material, both of which tack extra dollars onto an already fat bill.
Lastly, according to a study by the National Association of Home Builders and the NHMC, regulatory costs make up a crippling 32% or more of the budget of 90% of the projects built today. These regulatory fees can come from every level of government local to federal, and at the worst can make up 42.6% of a development’s price tag.
LOOKING FORWARD
People are moving in droves to booming metros, meaning the multifamily market has steady demand lined up for a long time to come. As this continues to happen, density issues and affordability issues will be a constant thorn for residents and cities.
The end of a long upcycle is on its way, and many investors see multifamily as a great investment for weathering the eventual downturn. People will always need places to live, and as long as home prices stay like they are and people continue to move into densely populated cities, there will be gobs of renters by necessity to absorb units.
The question the multifamily industry must answer is how to make building affordable housing more affordable. Right now, there is a large pool of pent up demand for affordable housing that no one can seem to get to because building is too expensive. Government subsidies and policies help some, but the industry is far from figuring out its affordability problem.
But, by all indications, whether the industry solves the affordability issue or not, the multifamily industry will only get stronger and take up more of the housing market share with time. Home prices are sky high, wage growth is sluggish, and it seems more and more people prefer to rent anyways. The thought of one day owning a house and starting a family is not necessarily what drives Americans anymore. The American Dream is evolving with the people, and the multifamily industry appears to be part of that evolution.
