This was supposed to be a year marked by a healthy amount of new multifamily supply, as some 300,000 units were on pace to open by the end of 2020. But federal, state and local stay-at-home orders and other responses to the coronavirus pandemic will likely reduce that to around 250,000 units, according to projections by commercial real estate brokerage Marcus & Millichap and REIS, the property research arm of Moody’s Analytics.
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A recent National Multifamily Housing Council survey of 135 apartment developers with projects underway found that more than half had slowed their pace of construction due to permitting delays, moratoriums on construction and, to a lesser degree, a lack of materials. Social distancing measures—allowing only one or two trade groups to work on a project at a time versus four—is also slowing construction, reported John Sebree, senior vice president & national director of the National Multi Housing Group for Marcus & Millichap.
What happens beyond the end of 2020 remains a question mark and will depend on the extent to which the economy reopens successfully and remains open. For now, construction lenders have largely reined in financing for at least 90 days so that they can get a clearer picture of rent collections, unemployment, the decline in GDP and other economic conditions, experts say.
“We think multifamily completions larger than 50 units will be around 250,000 units per year for 2020 and 2021, based on a bottoms-up analysis of each project and expected longer city-by-city duration times as well as some increased abandoned projects. Properties currently under construction and those with previously committed capital will get built, but new debt financing will be harder to come by until expected demand returns to pre-COVID levels,” said Yardi Matrix Vice President Jeff Adler.
Yet the observers are quick to point out that multifamily properties should weather the downturn better than any other property type with the exception of industrial assets.
“Once we get through this, the underlying thesis for multifamily development remains sound—the demographics are favorable and there is a good base of stable demand,” said Ryan Severino, chief economist for commercial real estate brokerage JLL. “The real question is whether this is a phenomenon that lasts a couple of quarters or is prolonged.”
Indeed, the impact on multifamily development could be relatively negligible if a rapid recovery ensues, said Victor Calanog, head of commercial real estate economics with Moody’s Analytics REIS. As it stands now, he predicts that the market will experience continuing supply reductions in 2021 and 2022 because developers are starting fewer projects today.
But muted development could extend into the next couple of years, depending on fundamentals. In its worst-case “protracted slump” scenario, REIS is projecting that the vacancy rate could end 2020 at 7.3 percent, or 260 basis points higher than the first quarter reading, and then climb to 7.7 percent at the end of 2021. Similarly, asking and effective rents could decline by 5.5 percent in 2020 and by 6.3 percent in 2021.
“If the downturn is as bad as some people expect—if the reopening doesn’t go as smoothly as we’d hoped and if the unemployment rate stays at a relatively high level longer than we’d hoped—then you’ll start to see people moving out and maybe hunkering down in mom and dad’s basement,” Calanog said. “I think at least 12 months need to roll by before people really start to commit to longer term investments.”
Developers completed around 70,000 units in the first quarter, Sebree said. And even with tempered supply expectations, the number of completions this year won’t represent a dramatic plunge from the average of some 290,000 units added annually since 2016, he added. All else considered, multifamily professionals argue that the asset class is entering this downturn in much better shape compared with other slumps. In the Great Recession, Calanog noted, the vacancy rate spiked to 8.1 percent. Consequently, Sebree and others don’t anticipate a substantial drop in development going forward.
“Historically what happens in mature multifamily development cycles is that the underwriting becomes more aggressive and the equity required by banks diminishes,” Sebree said. “That didn’t happen this time—we did not overbuild, and we didn’t have a spike in deliveries. If anything, the banks were underwriting more conservatively.”
For now, impacts on development vary by product type and location. With a vacancy rate of around 2.4 percent, affordable housing development should continue relatively unscathed, particularly because construction in that segment has remained essential across the country, Calanog said. Market rate projects are another matter.
Real estate investment trust Avalon Bay Communities has 19 apartment projects in development valued at $2.3 billion, for example, and halted construction at six in the first quarter because of state or local regulations. It was in the process of restarting work at four as of early May, according to the company’s first quarter earnings report, but construction has slowed at other sites due to safety precautions, labor availability and inspections constraints.
Developers are even pausing in markets where construction is allowed. Recently, one such developer in the Los Angeles area had completed some initial site work and was ready to tap his construction loan to begin building vertically, said Gary Tenzer, principal & co-founder of mortgage banker George Smith Partners. But given the chance that development could be shut down, he chose to delay the project’s start.
“Maybe the lender’s not so happy that he did that, but he paid the loan fees, and the money is there to draw when he needs it,” Tenzer said. “There were a lot of question marks, and he was at a good stopping point.”