Freddie Mac Outlook: Slow and Steady

A graph measuring employment growth, alongside the national vacancy rate and gross income growth. Chart and data courtesy of Freddy Mac and Moody’s Analytics

Data and analysis of fundamentals from Freddie Mac’s 2023 Midyear Multifamily Outlook shows a multifamily sector that is slowly beginning to revert to pre-pandemic seasonal norms, despite latent economic headwinds that are expected to persist for the rest of the year. Consequently, predictions for a recession were less severe. Data cited by the report showed a 17 percent decline in the probability of a recession.

The sector is struggling with persistently high interest rates, depressed transaction volumes and loan originations, as well as wider bid-ask spreads and lower property values. Still, the sector’s longer-term outlook is positive, with high demand for all asset classes nationwide, large construction pipelines in Sun Belt markets, steadily declining inflation and a healthy job market are all positive trends.

Findings and fundamentals

Predictions for a recession – a motivator for many lending and borrowing sentiments in the industry – were muted in the report. Freddie Mac cited data from Moody’s Analytics that forecasts a 33 percent chance of a recession for the remainder of the year, down from 50 percent. For its part, the Federal Reserve is no longer predicting a recession, but still expects its repeated rate hikes to send further waves of uncertainty throughout the economy, with two more Consumer Price Index and jobs reports expected before the organization’s meeting in September.

Headline inflation, one of the biggest hindrances to deal making and development, has been reduced significantly from June 2022’s peak of 9 percent, but still remains “comparatively high,” according to the report, while core inflation growth remains “persistently high” at 4.8 percent. For its part, the Moody’s data predicts that inflation growth will trend downwards, totaling 2.2 percent in 2024.

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The report sees a recession in 2024 as a “coin flip”, with government action that has been designed to reduce inflation having the opposite effect. Here, the report identified “missteps” by the Federal Reserve, the government once again reaching its debt limit, an abrupt resumption of student loan payments, further banking instability and geopolitical strife as the primary catalysts for a downturn.

Still, these changes would have to be both rapid and destabilizing, according to the report, in part due to a strong job market, with wage growth increasing 5.6 percent, alongside a labor force participation rate increasing by 40 basis points to 62.6 percent, as of June. “Despite the overall slowing of the economy, dour sentiment and expectations levels, the labor market is still performing comparatively well,” the report said.

If a recession does occur, Freddie Mac expects it to be mild, comparing a potential recession to those in 1991 and 2002. “If a recession does occur, we believe multifamily performance would likely be in a similar range,” the report said.

Multifamily outlook: a mixed bag

Falling rent growth, alongside declines in occupancy at the end of 2022 into this year have contributed to an “inflection point” for multifamily, one where both metrics were predicted to increase substantially. The increases were only moderate, in part due to drop-offs in demand attributable to declines in household formations. Overall, the nation’s occupancy rate was lower than both last years’ and the long-term average, with a mean decline of 217 basis points year-over-year through May, according to Freddie Mac’s internal data.

Additionally, rent growth has remained sluggish in markets such as Phoenix, Las Vegas and Sacramento that previously enjoyed nationwide highs and have since declined steeply. The current metrics are a far cry from those of last year,  Here, Class A assets saw the greatest increases, averaging out at 2.9 percent, while Classes B and C measured out at 2 and 2.4 percent respectively. According to the report, the primary culprit is an inflation rate that, while easing, is still leading to elevated expenses.

A graph depicting multifamily permits, starts and completions. Image courtesy of Freddie Mac

Development remains a strength, according to the report, with 560,000 new units permitted for construction in the first five months of the year, with starts near those of 2022. At the same time, construction completions are elevated, with 450,000 new units built nationwide, a 27 percent increase from 2022. For Freddie Mac, the increases were indicators that the labor shortage and supply chain struggles of two years past “appear to be abating.”

Putting the fundamentals together, Freddie Mac expects the market to remain “relatively stable,” given the state of the overall economy. Provided that the strong labor market does not slow, trends are expected to continue at a more moderate pace. The national vacancy rate is expected to stand at 5.1 percent, with rent growth averaging at 3.1 percent, increases over current figures.

Dealmakers adjust

As rent and demand modestly improve, deal making fundamentals have adjusted, as cap rates have increased at the same time property valuations have declined. Citing data from Real Capital Analytics, the report stated that as cap rates have increased by 5.2 percent, a 50-basis-point increase from the third quarter of 2022 into the first quarter of 2023, the spread of 150 basis points in the first quarter of 2023 compressing “some of the tightest levels since 2001,” according to the report. However, the report does not expect this narrowness to remain, particularly as interest rates put “upward pressure” on cap rates.

A chart depicting the multifamily price index, alongside cap rate spreads and treasury rates, from 2001 through 2023. Image courtesy of Freddie Mac

Additionally, 10-year Treasury rates, a marker of property valuations in deal making, ranged between 3.5 and 4 percent through the first five months. Describing these statistics as “somewhat volatile,” the report stated that the transaction market is and will continue to be slowed. Property valuations have declined by 6.3 percent quarter-over-quarter and 10.3 percent year-over-year, according to the RCA data. “Additional upward pressure on cap rates will put downward pressure on property price,” the report added.

As a result of headwinds in the investment market, the report anticipates a $370 billion fall in transaction volumes, a 17 percent decrease from 2022, due to both the decline is property prices and volatile 10-year Treasury rates. The report noted that such difficulties could be compounded if the Fed decides to raise rates again.