Wednesday, November 29, 2023

There’s No Place Like Home For the Holidays: A Look At The Multifamily Market

Photo by August de Richelieu via
Thanksgiving has passed and the holiday season has officially begun, so it is only natural that TRET finishes its real estate asset class series with a look at home—multifamily properties. Also, for those who consider the holidays a time to get away, we’ll also take a look at the state of hospitality properties, as well.

Multifamilies: The Context

Multifamily properties have been one of the most consistent commercial real estate asset classes in the past three years. Although industrial property have been the champion since 2020, both multifamily and hospitality properties have offered real estate owners the ability to earn income and appreciation over the past three years, without the clear market disruptions that have resulted from the market’s new orientation to office and retail properties. According to Avison Young, multifamily property in particular peaked in demand in 2021 and has since performed strongly, despite a slightly declining ever since. Hospitality properties, on the other hand, declined dramatically in value and demand (some estimates have the value as high as 50%) until after the pandemic, but made strong recovery in 2022 to be one of the best hedges for the current inflationary conditions.

Although multifamily properties continue to be a great investment, national rent growth is nearly flat, at 0.5% and new construction has dramatically declined by nearly 60%. To understand the current condition of multifamily properties in particular, one must understand the incentives that home-seekers are facing. According to Newmark, it is on average $994 more expensive every month to own a home instead of renting. The significant size of the comparative cost of ownership, coupled with the relatively high interest rates and the currently increasing costs of homeownership, incentivize many people to rent over purchasing a home. Despite this pressure away from buying, occupancy has only fallen slightly, from 97% to 95%, signaling a return to normalcy from previously inflated vacancy rates. Although technically a decline, 95% vacancy continues to be a higher than normal vacancy rate that would be attractive to most investors.

The strong showing in the tenant market described above, however, has not done very much to attract many new investors into the market. The fact of the matter is that cap rates have moved slowly in the market despite rising interest rates, causing compression. To state this in another way, rising interest rates have made borrowing and value of cash more expensive, but prices of multifamily properties have not reduced to provide either an adjusted or increased return on investment for these real estate assets. This current compression makes multifamilies more expensive than desirable and is a clear sign that acquisition in most cases is not the best option. In some markets, especially in the South, this compression has be exacerbated by an oversupply of housing, a remnant of once over-heated housing demand. All of these factors, coupled with increasing costs of multifamily ownership have caused a noticeable slowdown not only in multifamily transactions, which are down 62% since last year, but also in new construction starts, which are noticeably down. Despite this reduction, there are still 1 million units under construction across various markets that will exert more downward pressure on multifamily pricing, once they are completed.

The Market Leaves Much To Be Desired

The multifamily market is very much on a downward trajectory, but it is following a path of correction instead of rapid devaluation. Despite all being on the declining side of the market curve, Sunbelt markets, like Miami and Houston, and large metro areas, like New York and San Francisco, continue to perform above average, mitigating, but not fully avoiding the current decline. As always, there are opportunities to find value, even in a correcting market, such as this one, but the conventional wisdom would be to adopt a "wait-and-see" orientation to the current market. Some of the current state of these properties can be attributed to the seasonal slowdown in the residential market that usually takes place during the holiday season at the end of the year. Only time will tell, however, which of market trends will continue to have a lasting effect. 

Hospitality to the Rescue

Hospitality property, on the other hand, has continued to serge, boasting a close to 6% increase in prices over last year. Given that hospitality value and income depends on cost per room, these properties tend to outperform multifamilies in inflationary environments. Demand for these properties continues to increase as travel demand continues to feed off of pent-up post-pandemic wanderlust. Currently, the hottest hospitality markets are New York City, Fort Lauderdale and Tucson, AZ, according to Colliers. Whereas multifamilies may be seemingly less desirable at present, hospitality may be a great way to acquire exposure to an asset class that continues to perform in current market conditions.

And thusly we end our extended look on the state of the various property types that make up the real estate market. Across all of these articles on commercial real estate there has been a consistent theme--the new normal. In some instances, as with office and retail, this new normal is a indication of a new reality in the face of a changing world. For others, like multifamily and industrial properties, this new normal is return to pre-pandemic performance, after a period of strong or outstanding growth. All markets continue to deal with the effects of the present high interest rate market, cooling demand and the resultant changes in consumer and investor behavior. As we enter into the final month of year, the question on the mind of every investor is the following: "What is the best way to take advantage of the newly established norms?"

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