Multifamily Roundtable: Fewer Deals But Little Distress
- Sep 18, 2020
Multifamily has traditionally been a safe harbor for commercial real estate investors. When all else fails, the American consumer needs a roof over their head. For many, by choice or necessity, that will be an apartment. Meanwhile leases are short, promising steady rent growth.
But not even this formidable asset class could withstand a pandemic and massive job losses without impact. Multi-Housing News checked in with three industry leaders—one portfolio manager specializing in housing and two multifamily research experts—to find out what the multifamily pain points have been, and, since we are not out of the woods yet, what they could be in the coming months.
Participants in our roundtable discussion were James Martha, head of housing sector in the Americas for Nuveen; Jeanette Rice, head of multifamily research in the Americas for CBRE; and John Chang, national director of research services for Marcus & Millichap.
Our panelists seemed to be in agreement: The pandemic halted record high multifamily investment initially, but trading and development have restarted, and capital is available thanks to Fannie Mae and Freddie Mac. Fundamentals, though struggling and changing in some markets and asset classes, are relatively sound.
“Those looking for distress are pretty disappointed so far,” Rice noted.
How has investment activity recovered since the freefall earlier this spring?
Martha: The pipeline of transaction activity is opening back up. There’s a significant amount of capital. Some of it is still on the sidelines, but a lot of it is back in the market, and it’s very competitive. In some markets, values are at pre-COVID-19 values. In some markets, we’re seeing a slight reduction, but those reductions are generally in that sort of 2 percent to 4 percent range.
Rice: From a market fundamentals perspective, multifamily certainly has been impacted by COVID-19 and the recession. No surprise. If anything, the surprise has been that it hasn’t been hurt as much as many people anticipated. We’re not through this yet either. Investment continues and pricing has actually held up quite well. We have debt capital markets in large part to thank for this, but also there is just a really healthy appetite for multifamily from before COVID-19. Many buyers still see opportunity.
Chang: Fortunately, the government stepped in with a strong stimulus package at the outset of pandemic, including expanded federal unemployment benefits. I think that was a key factor supporting people’s ability to pay their rents. Rent collections, over the course of the pandemic, have so far been quite good—in the 95 percent range.”
Which regions and which markets are struggling the most due to COVID-19?
Martha: The hardest-hit markets have been where unemployment was greatest, and that tended to be service, tourism, hotel, gaming and other entertainment markets. At the top of the list is Las Vegas. People aren’t traveling. They are not staying in hotels. They are not going to casinos. Orlando, Fla. is another market that has outperformed operationally, but its exposure to entertainment and tourism makes it sort of suspect going forward. Miami is another hard hit one.
On the strong side, you have Nashville, Tenn. It’s a health-care center and a tech center. Austin, Texas, is another tech market.
Rice: Regionally, the Midwest is outperforming the country as a whole. There is a lot of variation within the other regions. For example, on the West Coast, we find Seattle is doing better than California. In Texas, Dallas is doing better than San Antonio and Houston—although Houston is not doing as bad as a lot of people thought. The Southeast is a little mixed. The Southeast is a region of the country that has been dependent on steady migration, and, with the recession, that of course has slowed. But then the dynamics of the market have mitigated some of the losses from migration. There has not been much investment in Las Vegas or Orlando but that is because of market performance.
Does the newfound love for the suburbs bear out in data or is it the media’s flavor of the month?
Martha: Nashville, Tenn. and Austin, Texas, as examples, are not in your top 8 or 10 metro markets. Those are not your mass-transit-type communities. Those are car commutes. They’re not they’re not high-rise cities, generally speaking. They’re not high-cost markets. We have seen, at least in the short run, a sort of deurbanization, a sort of pullback from those large metro markets, like New York.
And I think there are some things that support the move to the suburbs and less expensive cities for the Millennial population, particularly for the older Millennials who are starting their families and are looking for more space. They’re looking to cut their housing costs. There is a demographic component of that suburbanization that may hold.
Chang: So much of the focus over the last several years has been on density and urban lifestyle because of all the amenity-rich options that cities provided. But because of the pandemic a lot of the amenities of downtown have been closed and the cost of living down there is higher. We saw for the first time on record, in the second quarter, the vacancy rate in suburban apartments actually fall below the vacancy rate for urban apartments. That’s something we have not seen—at least in modern history.
Is this a lasting change or a temporary condition?
Chang: This really is an important short-term trend and, then ultimately, two years down the road, we could see a lot of these people starting to come back or the next generation starting to backfill that space in the urban cores as they progress in their careers and want to be proximate to the major financial and tech firms in those major cities.
Martha: I think the jury is still out on whether the Millennials—particularly the older Millennials in their early to mid-30s—whether their outmigration to second-tier, less expensive cities and suburban locations will reverse post-COVID-19 and post-vaccination, or whether that migration will hold.
And how about renting vs. homeownership? Has that dynamic shifted?
Martha: We have been on a decline in homeownership since 2006. I think last year there was a slight rebound. On the positive side for homeownership, interest rates are so low. On the downside, today the for-sale housing stock is down. The latest I’ve seen was by 25 percent. So, there is that uncertainty. “Do I sell my house, and then where do I go? How secure am I with my job?” That’s the consumer confidence part of things. But there’s also been a declining percentage of wealth for 35-and-under households that’s been going on for 15 years.
How has COVID-19 impacted the various asset classes?
Rice: In terms of market fundamentals, Class A is doing worse than Class B and Class C. Although it may not seem intuitive, Class C is the best right now in terms of keeping a low vacancy. Vacancy in Class C hasn’t moved since the beginning of COVID-19, and rents have actually moved up. That might not seem to make sense because we know there are some rent collection issues, and we know folks who live in more affordable housing don’t have a very deep cushion if they lose their income. But we also understand that, with the low vacancy rates for Class B and Class C going into COVID-19, there’s not a lot of housing choice. The affordable housing problem is still around, so we are seeing people stay in their apartments longer.
There is a new policy by the CDC that came out last night that suggested that no one should be evicted from their housing units through the end of the year due to income impacts due to COVID-19. Because of the pandemic, we don’t want to add to the homeless problem or exacerbate the health and safety of all Americans, especially the most fragile—the homeless. The challenge is owners of properties are still expected to pay the mortgage regardless of whether the rents are coming in. That creates a huge problem, and without rent relief programs, this moratorium creates quite a bind for the industry.
Chang: Most of the construction that came on the market in the first half of the year is Class A, so that influences that vacancy rate and those upper-tier new development properties have had a very difficult time getting leased-up during the pandemic. It is a slower process to fill all of those new units as they come online, so we are seeing that Class A vacancy rate rise because of the new construction but also because people are being much more cautious with how they are allocating their budget.
Martha: We have 55,000 units across the U.S. on the equity side of our portfolio, and, going into COVID-19, we decided to track occupancy across the portfolio and collections daily, so we could be proactive on the trends that we were seeing.
What we’ve seen is a decline in occupancy on the class A product. We’ve seen an increase in occupancy in class B, and we have very little exposure to the class C side. But occupancy has held on that side as well. What we’ve seen on the collection side is Class A collections have been strong, Class B collections have been quite strong as well, and Class C collections have been very weak.
The other thing that we’ve seen on a very high end is that a portion of those renters are renters by choice and in many cases, they have two residences. They have something outside the city, and they have something inside the city. Sometimes it’s for convenience and sometimes it’s for schools. But once you take having to go to the office off the table, there is a drop in demand on that side.
I think that Class B will become the winner. The Class B or A-minus that caters towards the middle-income household and the Millennial will gain on the demand side. I think class C will tend to suffer unless there is continued government support because I think that demographic was hardest-hit by COVID-19, and it’s going to be a while before all those service jobs are back.
What is the development outlook for the near future?
Chang: For the year, we expect to see somewhere around 250,000 new units completed. To put that in perspective, historically in the U.S., over the last several years, we have been hovering around 300,000 new units. It’s down a little bit, but not as much as one would think.
Martha: I think we’re in a period where development will continue over the next 12-18 months, and that’s the delivery of supply that’s currently in process. Then, we’re going to have a dearth of supply because lenders are supplying very attractive financing for very safe investment—fully occupied, stable multifamily units in stable metros. You’re not going to see a lot of financing for development.
I do think there will be opportunity for development. I think, in the short term, there’s going to be challenge on lease-up. That is both because of the oversupply and the job situation. There’ll be a contraction of household formations. Following the next 12-18 months, I think there’s an opportunity to be able to deliver on development and new supply into that gap.
Rice: If you are a developer or maybe a construction finance lender and you are looking at the market conditions right now, you’re thinking, “If I start this community in fall 2020, it will open in fall 2022. Market conditions will be back to pre-COVID-19 levels then. There will still be a need for housing in America.” And if it is a great site that the developer worked on for five years to put together, I think the position is one of optimism and confidence that the development that starts today will be in a pretty good position when it opens.
The big thing that has to be resolved, which developers and lenders are very attuned to, is: “What kind of rents do you need and can you get those rents?” My scenario is that, by third quarter 2022, rents will be pre-COVID-19 levels. But is it that enough to make the job work?
What more can be done to help the housing-insecure? And how can the real estate industry be further incentivized to build affordable housing?
Chang: The cost structure of the land and construction really forces builders to construct at the upper end of the spectrum. In order to drive profitability, they are having to complete Class A apartments and that’s pretty much been true historically. The difference with this cycle is that we do have a housing shortage in the country, and a lot of investors were purchasing class B apartment properties and upgrading them to A-minus properties or B-plus properties. Essentially, all of the new product was coming in at Class A, and a lot of the properties that would have traditionally fallen down the value chain from Class A to B to C were actually being remodeled and pushed back up the chain. It reduced the total number of apartments that were out there for Class B and Class C.
There is not a lot that can be done to enable builders to build Class B and Class C aside from government incentives. If they can reduce the amount of bureaucracy in the development cycle—and that varies from city to city and state to state—and if they were to put (more) subsidies or tax incentives in place to support the construction of less expensive housing, that’s about the only way that this can be done.
Martha: We’re very active in a tax-exempt bond financed affordable housing program that requires a minimum of 20 percent of your units set aside at a certain percentage of median income for a particular area. We have literally billions of dollars invested in that type of housing. It is very successful, and I think there should be an expansion of those types of relationships. It enhances everything. It enhances the city or the town. It enhances job prospects. It enhances the immediate market. Everyone wins in that process.
Rice: The private sector would love to build more affordable housing. Builders of all kinds are very attuned to where demand is, and they know there is enormous demand for affordable housing. But it’s been really difficult to find solutions to that. Folks have been over the last couple of years building more of what the industry has begun to call “attainable.” It is not the most affordable. It’s not a $1,000 rent, but maybe it’s $1,600. That has been a great pattern, and I think that will continue going forward.