Could Hot Multifamily Be Headed for a Cooldown?

Brandon Polakoff

In the third Quarter of 2021, we observed a dramatic increase in demand for rental apartments, leading to a surge in lease signings with monthly rates returning to pre-pandemic levels. This spike has sustained itself through what is typically a challenging winter leasing cycle. More specifically, according to the February 2022 MNS Market Report, rents have risen 16 percent since July alone.

Beginning in the fourth quarter, we witnessed a corresponding rise in sales velocity, with contracts being signed at a rapid clip. Buyers who had sat on the sidelines with dry powder since the start of COVID-19 were finally ready to jump back into the fold and underwrite with confidence. They recognized a tangible correction was on the horizon and did not want to miss out on more opportunities.

Simultaneously, sellers who had been waiting to exit New York City due to lifestyle changes, political headwinds, cash flow challenges among other factors, finally jumped on bids they felt reflected their property’s longer-term value. It was the perfect storm for the narrowest buyer-seller pricing gap we have seen in six years. In turn, the Manhattan fourth quarter multi-family and mixed-use market recorded 46 transactions for just over $1.47 billion in total dollar volume, a 98 percent and 190 percent increase off the trailing four-quarter average, respectively. The average price per square foot increased by 4 percent to $738 and the average cap rate decreased by 24 basis point to 4.69 percent in comparison to the trailing four-quarter average. Our team felt every bit of this surge, signing more contracts (14) and closing more sales (20) in Q4 2021 than the previous seven quarters combined. Additionally, in Q1 2022, we have already closed on 16 sales and put another nine properties under contract.

Shifting Assumptions

As we move forward in 2022, we expect buyers to continue underwriting substantial rent growth as the apartment supply cannot match demand. There are two major drivers behind this. The first concerns the 2019 HSTPA, which effectively removed the ability to deregulate uninhabitable rent stabilized apartments through extensive renovations (very short-sighted policy). Additionally, most land that sold in Manhattan over the last five to seven years was developed into luxury condominiums. There is very limited new construction rental product coming to the market, and the 421a program (the only way a rental project pencils) expires in June with no replacement in place.

We are also keeping a close eye on interest rates, which are rapidly expanding. As interest rates rise, there is a corresponding increase in cap rates required to generate the same cash-on-cash returns.

These two factors can lead to the buyer-seller gap widening, which will lead to a decline in sales velocity. Sellers, in real time, are seeing rents soar, which is leading to higher pricing expectations. Buyers are underwriting this growth but are also receiving debt quotes that lead to lower valuations. If pricing expectations don’t level off, we may see the market cool down until the next correction.

Brandon Polakoff is principal & executive director of tri-state investment sales at Avison Young.