December Multifamily Market Update

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Nationally, for the first time in 20 months, the pace of year-over-year rent change did not further decelerate between October and November. Rents did still fall by 0.52% month-over-month in November 2023, but that’s slightly less than the 0.57% decrease from November 2022. Consequently, the closely watched year-over-year rent change metric inched up from 0.08% to 0.16%. It’s still slow, probably not a major inflection point. Yet, for apartment owners and operators, it’s positive that rent change didn’t further decelerate.

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The overarching pattern persists: there is robust demand for apartments in 2023. The deceleration in rents doesn’t stem from a lack of demand; rather, it’s a supply-related issue, as completions have surpassed the 400k mark for the first time since the 1980s. While demand is abundant, the surge in supply is even more pronounced. Rents are falling where big new supply is going, and rents are growing where supply is limited (primarily the Midwest and Northeast).

Here are a few other silver linings for apartment operators and investors from the November rent data:

  1. The most significant reductions in rent are still observed in Austin, Boise, Atlanta, Orlando, and Phoenix – prominent markets with high supply and demand. However, the pace of rent decreases has slightly moderated in four of these markets (excluding Orlando) from October to November. Simply put, the situation is no longer deteriorating.
  2. For the twelfth consecutive month, wage increases are expected to surpass rent hikes, contributing to a further widening of the demand funnel.
  3. It’s important to note that not all areas are experiencing rent declines. Among the top 150 metros in the nation, 41 have recorded rent growth exceeding 3%. The majority of these markets are situated in the Midwest and Northeast, where the supply remains considerably more constrained.

Interest Rates:

Positive signs are starting to emerge in the fixed income, credit, and interest rate markets. Pictured below in red, the Federal Reserve seems to have found the upper limit of its rate hikes, settling in a hair over 5% and keeping rates there for several months.

Even more encouraging for apartment owners and operators is the decline in the yield on the 10-year Treasury, coming off its 10-year high and settling around 4.25% as of December 8th.

Easing rates of interest have a ripple effect through our industry. As borrowing becomes less expensive, building and renovating become more economical, purchasing becomes easier, and successful exits from properties become likely.

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December has also brought a top in the credit crunch that’s been impacting our industry for the entire year. Pictured below is the percentage of domestic banks tightening their loan requirements for construction and land development loans. The percentage of banks tightening their lending requirements topped at 75% in the third quarter before easing into the end of the year.

Capital, specifically debt, returning to the space is integral to the success of real estate development.

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Risks That Lay Ahead

There’s more than $350 billion in multifamily loans maturing in the next three years (pictured below). Owners/operators’ ability to refinance these loans will have an enormous impact on the sector. If owners can’t refinance their loans they’ll be forced to take one of two actions. Either action will start a chain of events resulting in much lower multifamily prices in 2024.

The first option owners have if they can’t refinance their loans will be selling the property. Buyers, understanding the pressure sellers will be under, will make offers below market value in an attempt to acquire the asset at an advantageous cost basis. These ‘fire’ sales will reset the market for other apartments in the submarket, making it more difficult for remaining owners to successfully exit their properties.

The second option owners have will be to simply hand the keys back to the lender, defaulting on the loan and wiping out any investor equity in the deal. The lender will then auction off the property in an attempt to recoup their initial investment. If a large enough percentage of the $350B in real estate loans head to foreclosure, a very ugly chain reaction will begin that will impact most aspects of the global financial market.

I’m by no means the smartest guy in the room, but even I know the Federal Reserve doesn’t want another global financial crisis on its hands. The Fed understands all of these risks in much more detail than you and me.

If the Fed keeps interest rates at their current restrictive level and fails to pump liquidity into regional banks, it will set off a wave of foreclosures on multifamily and office properties. The loans backed by the properties that foreclose will default. The CLOs those individual loans are packaged into will default, and institutional investors like pension funds and governments around the world who have been avid buyers of US commercial real estate-backed CLOs will lose tremendous amounts of money, impacting their ability to fund state and local government services, pension benefits, etc.

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The Prediction
Facing a wall of maturities that could spark a global recession, the Fed will be forced to act… quickly. I predict that in March/April of 2023, J. Powell and crew will make their first rate cut. Following rate cuts will occur swiftly until the Federal Funds Rate settles at 3% by the end of 2024.

Additionally, and perhaps more importantly, the Fed will begin adding liquidity to regional commercial banks in the form of asset purchases. In an attempt to gain yield on their investment portfolios, regional banks loaded up their balance sheets with long-term Treasury bonds between 2020 and 2022. This very thing brought down Silicon Valley Bank and caused two other regional banks to be taken over by the Federal Reserve.

The Fed will inject cash into the regional banks by purchasing the long-dated bonds sitting on regional bank balance sheets (currently at huge losses) at par.

Regional banks, flush with cash, will refinance the wall of loans maturing, and the commercial real estate sector will finish 2024 with elevated asset prices and in a much healthier position than where we sit today.
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