The Multifamily Market Cycle

By Philip Shea, Associate Editor

Long-term fluctuations in the economy are something most income earners, business operators and investors are accustomed to seeing. Periods of expansion and contraction, recession and recovery are well-registered dynamics in both the market and society overall.

Yet what is less universally apparent is how these large-scale cycles translate into individual market cycles, and it’s safe to say that multifamily holds many unique responses to what occurs in the overall economy.

David Mortenson, senior associate at Colliers International’s Seattle office, states that since the development timeframe typically runs from two to three years, there is often a rift between at-large economic trends and construction in the apartment industry.

“Often, the pipeline is fullest just as the rental market starts to decline,” says Mortenson.  “In Seattle, for example, there were more deliveries in 2009—the first full year of the recession—than there had been in the previous 10 years.  That is because those projects were announced when the market was peaking in 2007.  So while announcements for new development projects stopped immediately when the market turned, delivery of new product did not actually stop until 2011.”

Dave Schumacher, senior vice president at Colliers International’s Seattle office, elaborates on why construction pipelines tend to fill up before recessions and how the ensuing recovery is negating what had been an oversaturation of supply.

“Developers, in general, keep developing until they can’t develop, and usually they can’t develop because lenders won’t give them money, markets become overbuilt and the equity and financing dries up,” says Schumacher. “So the Great Recession, on a national basis, pretty much stopped all multifamily development, and now it’s a brisk market again.”

Steve Bram, principal and managing director at George Smith Partners, remarks on the paradoxically positive effect the Great Recession had on the apartment industry, setting it apart from what recessions typically do.

“During the recession, demand for apartments decreased because people doubled up on housing, but then as the recession continued, people were finding it hard to afford their homes,” says Bram. “As people were evicted from their homes as a result of the Great Recession, [they] became renters again, and demand began to increase for apartments.”

Subsequently, after a slowdown in development over the last couple of years—the result of excess inventory at the onset of the recession, Bram notes that construction is beginning to pick up again in major markets, signaling an expansion of the overall market.

“New development is already increasing right now at a very brisk pace, and that’s because for the last year to six months, there’s been an anticipation of an increase in rents, and that increase in rents has begun to occur in a big way,” says Bram. “Of course, the capital is available because the lenders understand that the net yield is increasing as a result of reduced occupancy and increased rents, so the capital is going to the safest place, which is apartments right now.”

Schumacher agrees that increasing rents and higher occupancy is what’s driving renewed development, signaling that the multifamily market is in a period of considerable recovery while also noting a new dynamic in post-recession growth for the industry.

“The rapid rise in rents with low vacancy rates is certainly the driving force of all this new development taking place,” says Schumacher. “What’s strange about the marketplace here in Seattle is that most of the new construction is really in Seattle, whereas in times before most of the development took place in the outlying areas.”

Mortenson emphasizes that the multifamily market, like the overall economy, is in a period of recovery and expansion and refers to a vacancy equilibrium of 5 percent (as seen on graph) as a prime indicator of such.

“I would say certainly here and probably all over we’re very close to a full recovery; we’re probably right at that this summer,” says Mortenson. “I would say most primary markets are at 5 percent vacancy or below, and we’re probably right at equilibrium right now and just edging pass it.”

Aside from rent and vacancy rates, another factor that often figures into determining multifamily market conditions are cap rates. Generally, the recovery phase of the multifamily market cycle is marked by cap rates coming off their recessionary peaks.

However, due to a perpetuation of incredibly low interest rates, many observers believe cap rates have already hit a low, which makes the current recovery phase unique.

“Cap rates have likely bottomed out,” says Mortenson. “In 2009 and 2010, cap rates were at their highest—at least 100 basis points higher than today and sometimes more. What is unusual in this market is interest rates, which are being maintained exceptionally low by Fed intervention—resulting in cap rate compression. The fact that interest rates can’t go any lower is why cap rates won’t go any lower even though we’re a long way from the peak of this market cycle.”

Schumacher at Colliers International agrees with his colleague and points out what the current figures are and where things are likely to go from here.

“Cap rates have pretty much stabilized for really good core properties—anywhere from a 3.8 to a 4.2,” says Schumacher. “There’s no downward pressure on cap rates, and any movement at all, it will be a while, but it will be cap rates going up.”