Multifamily Market Mid-Year 2020Paul Winterowd
As we round first base in the 3rd quarter of 2020, from my perspective we’re settling into a new-normal. A normal that is full of question marks and ambiguity. Not an easy place to be as an investor, but the appetite for multifamily remains quite strong.
The first half of 2020 is essentially the tale of two economies: the pre-pandemic economy and the economy of the pandemic’s first three months. The very nature of what this crisis has caused will impact the housing market, but to what extent is still being played out.
The multifamily market started 2020 on solid ground and experienced nearly 10 years of above-average growth. But because of weakened economic drivers, multifamily fundamentals are expected to slow throughout the rest of this year and possibly into next year.
Being an Econ undergrad, I must admit I really preferred micro-economics to macro. I still remember a 300-level class where miraculously my grades throughout the semester improved as I progressively became more and more confused. Fortunately, I passed and will try not to complicate things much here…
We know the labor market was on strong ground before the pandemic hit in March. The economy had added 2.3 million jobs in the 12 months ending February 2020 and the unemployment rate continued to strengthen down to 3.5%.
During the second quarter, the unemployment rate peaked in April at 14.7% with 23 million out of work. So crazy. Who could have imagined that would happen so suddenly??
In May and June, employment started to rebound, adding 7.5 million jobs since April. First quarter gross domestic product (GDP) fell by 5% while second quarter dropped 32.9%. Ouch!
While unemployment is improving as the economy begins to recover, it is expected to remain elevated for the foreseeable future. While I don’t align politically or ethically with unemployment boosters that disincentivize people to return to the workforce, that stimulus has certainly helped multifamily owners.
Investment activity has slowed since March, but we are seeing increased activity levels. It appears there is some pent-up demand for multifamily and the numbers have stayed strong.
Many lenders remain more conservative today than how they began the year, but the capital markets are loosening ever so slightly which is what we want to see.
Cap rates remained relatively stable across the country as interest rates have dropped and cap rate spreads increased. Quarterly price appreciation was relatively flat with little movement in property prices indicate that market perception of the multifamily asset class continues to favor longer-term fundamentals.
Given the volatile few months since the pandemic, some impact to property prices is expected later this year but not as severe as the Great Recession.
Total multifamily loan origination volume is expected to slow in 2020, but the extent to which is still uncertain. We estimate volume could slow by as much as -20% to -40% this year on the Agency side of the business. The magnitude of which is dependent on the recovery trajectory and how well the virus can be contained.
Supply & Demand
Multifamily demand in the second quarter saw a meaningful slowdown given the nationwide shutdown but at the same time saw a high rate of lease renewals as tenants remained in their units during the height of the lock-down.
Slower new construction completions this year will help offset some of the reduced demand. Reis reports completions are tracking lower this year by at least 30% compared with pre-pandemic levels. With less units expected to be delivered over the year, that may provide some relief to rents and vacancies that will be impacted from a slowdown in demand.
My gut tells me that on a practical level that one’s living circumstances will become more important and we as a society become more home bound. My money is on larger units will be more en vogue and we’ll see a bucking of the diminishing unit size trend.
The pandemic-induced recession in 2020 will continue to drive changes in macro-economic and multifamily forecasts for the remainder of the year. Rent growth is expected to slow and vacancy rates increase for the rest of the year due to the higher unemployment and reduced income.
Rents are anticipated to be down -1.2% to -1.7% (negative rent growth always seems like an oxymoron to me), while vacancy rates could increase 2% – 2.5%.
Declining income growth and collections are not estimated to impact well-positioned properties, especially given the solid footing the industry was entering the recession with several years of above-average income growth and property price appreciation, but as they say, we are facing some headwinds.
In summary, I’ll say this. I’m very glad I’m in the multifamily space as a loan originator and investor. Hospitality, retail, and office assets are feeling the pain much greater than we are. Opportunity still abounds and interest rates are as good as they’ve ever been.