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Multifamily Outlook in 2023: The Sky Isn't Falling
Multifamily rent growth may be slowing, but there are many reasons to be optimistic — albeit cautious — about the year ahead.
When you ask someone in the multifamily sector how they expect this year to go, you generally get one of two answers: Things are either about to fall apart — the sky is falling — or they’re moving ahead, slowly but surely.
I’m part of the latter category.
I’ll outline my thoughts below on how multifamily will perform this year .
First, let’s look at the latest news. There’s a lot, and most of it isn’t great. That said, don’t take everything as part of a longer-term trend, and you’ll be fine.
There are a couple of major borrowers who have found themselves in a bit of trouble: Chetrit Group and Veritas.
Chetrit was reported facing a default on a floating-rate CMBS loan of $481 million late last year. Basically, the company had financed 43 different properties with the loan in 2019, and then disaster struck: a combination of rising interest rates and severe vacancy issues across the portfolio.
Veritas had a similar, albeit more severe, situation. The investor defaulted on a $450 million loan that had financed about 1,700 affordable housing units in San Francisco. In case you were wondering, yes: It was another CMBS loan, also with a floating rate.
With rates rising, distressed assets are unavoidable — especially for investors who unwisely locked themselves into floating-rate loans without the ability to refinance. But don’t take these two situations as a prophecy for the rest of the sector.
And even for investors that keep ahead of their debt service, the landscape is changing. Just look at TheRealDeal’s report from early February on Tides Equities. The large-scale value-add investor has taken some hits to its bottom line, thanks to a combination of rent growth deceleration and, once again, rising interest rates on its variable-rate financing packages.
There’s a common denominator here: rising rates. For borrowers who have fixed-rate financing, there’s little to worry about, as long as they don’t face huge drops in occupancy.
But with that in mind, let’s move on to what most of us are expecting for the rest of the year.
Let’s go back to those drops in occupancy I mentioned earlier.
Yes: Occupancy is expected to fall this year a bit. Much of this is related to the massive amount of apartments slated to deliver this year. RealPage pegs that figure at about 590,000 new units in 2023. Yardi Matrix projects the number at closer to 440,000 apartments.
Regardless of who’s closest, it’s hard to deny there are a whole lot of multifamily developments scheduled to wrap up this year. When those units come online, they’ll lead to increasing vacancy. Let’s face it: It’s unlikely that all of these new units will be swiftly absorbed — and if they are, that just leaves other units vacant.
If this is your main concern, there are several meaningful steps to boost occupancy you can take right now. Take those steps. Focus on resident retention: You don’t want to see an exodus of renters heading off from your building to a newly completed Class A property down the block.
At the national level, though, occupancy won’t fall by a catastrophic amount: Another RealPage report anticipates a drop of about 30 basis points. Some metros will face a steeper decline, and some property types within those markets will drop even further. As long as you’re prepared (and you’ve got a property in relatively good condition), you will likely not face any major challenges.
Interest Rate Hikes
Now let’s move on to interest rate increases. The Federal Reserve just announced its eighth consecutive rate hike at the start of February, and we’re not out of the woods yet. I may be wrong, but I’d expect to see another couple of 25-basis-point jumps before the Fed slows its cadence.
This is bad news for many reasons, especially if you’re a large-scale, floating-rate operator like Chetrit, Veritas, or Tides. Even if you’re not, though, let’s look at the facts: There’s about $162 billion in commercial real estate debt scheduled to mature this year — in securitized loans alone. That’s a whole lot more than last year. A lot of people are going to need to go for new financing this year at higher rates — or be pressured to sell off some assets.
Of course, something we often forget is that a higher federal funds rate doesn’t always translate into higher mortgage rates.
Look at Freddie Mac right now. The agency put out a 40-basis-point discount for any February deals, and that comes after other reductions earlier in the year.
Of course, the nature of discounts is that they don’t last forever — so those investors who wait until the very last minute may miss out. Rates may climb higher to levels seen in 2006 and 2007, so if you do have a loan maturing, it’s best not to wait.
You already know that occupancy is going to creep down this year as huge numbers of apartments come online. Demand, however, could also be on its way down if household formation remains relatively low.
In 2022, household formation slowed significantly. RealPage’s fourth-quarter report pointed to falling demand at the end of the year, highlighting the peculiarity of it during a time of strong job growth and wage increases.
Still, there are now signs that household formation is picking up, which will, in turn, drive further renter demand. Even so, it’s unlikely to pick up enough to cover the new apartment buildings opening their doors throughout the year.
Multifamily Rent Trends
I’ll come right out and say it: The outlook for 2023 is good, but your definition of “good” may be different from mine if you’ve only gotten involved in the sector after 2020.
That’s around the sector’s historical averages, even if it’s far slower than the past couple of years. Of course, later in January, Yardi Matrix did revise its forecast down to 2.6%. That’s on the low side of normal, but it is still relatively normal.
What Can I Do as an Investor?
With this in mind, you must take great care deciding which multifamily properties you buy, and reevaluate your investment strategies throughout the year. Nearly everything we’ve talked about is a type of projection — it may not hold true. It may be revised.
More than anything, be ready to adapt to a changing market.
Buying and renovating a dated community will not likely get you the same return as it would have a couple years ago. Ask yourself how much you can realistically increase rents while asking rates elsewhere in the metro hold steady — or even fall.
All of this goes especially true for markets at the highest risk of oversupply. Phoenix and Las Vegas immediately spring to mind. These two desert markets have been the focus of many value-add investors and developers during the past few years, but they’re quickly becoming overbuilt.
Regardless of where you own, though, it’s a great time to take a step back and reevaluate each investment.
Dedicate time and energy to boosting retention.
Now may not be the best time to renovate, but make sure you’re keeping your property in good repair.
Evaluate your marketing efforts. Cut what isn’t working. Double down on what is.
Don’t be afraid to hold your property longer than planned.
See if you can get a better deal on financing — and don’t stick with a floater any longer than you have to.
This year will bring some challenges you may not have faced in a while. Be calm, be flexible, and spin them into opportunities.
What are the current trends in multifamily financing?
According to Freddie Mac®’s predictions, multifamily origination volume is estimated to expand to $317 billion in 2019, a nearly 4% increase from the approximate $305 billion of multifamily financing originated in 2018. Factors that can be attributed to this trend include consistent investor demand for apartment properties, as well as other market forces, including a strong economy, reasonable job growth, and low interest rates.
It's unsurprising that the majority of respondents — more than 60% — pointed to rising interest rates. After all, the current federal funds rate of 4.25% to 4.5% is in stark contrast to the same time last year, when rates ranged between 0.0% and 0.25%.
What are the benefits of investing in multifamily real estate?
Investing in multifamily real estate can provide a number of benefits, including potential for high investment returns, the ability to take advantage of compounding returns, and the ability to diversify your investment portfolio. Additionally, multifamily properties provide reliable monthly cash flow from renters due to reduced risk of vacancies.
For more information, please see the following sources:
What are the risks associated with multifamily financing?
The risks associated with multifamily financing include prepayment penalties and required reserves. Prepayment penalties can be significant and some types of apartment loans require the borrower to keep a certain amount of cash reserved for necessary property repairs. This can limit an investor’s flexibility. Note that all HUD loans require reserves. Source 1 and Source 2.
What are the best strategies for securing multifamily financing?
The best strategies for securing multifamily financing depend on the type of loan you are looking for and the qualifications you have. Generally, it is important to be well informed and make the best decision for your investment and financial situation. It is also important to consider all options and speak with a multifamily financing expert to determine which type of loan is best suited for your specific needs.
Some of the most common types of multifamily financing include Fannie Mae and Freddie Mac loans, FHA loans, bridge loans, and CMBS loans. Fannie Mae and Freddie Mac loans are typically the most popular option for multifamily financing, as they offer competitive rates and terms. FHA loans are also popular, as they are backed by the government and offer more flexible terms. Bridge loans are short-term loans that can be used to finance a multifamily property while waiting for a more permanent loan to be approved. CMBS loans are commercial mortgage-backed securities that are backed by a pool of mortgages and offer competitive rates and terms.
When applying for multifamily financing, it is important to have a good credit score, a solid business plan, and a clear understanding of the loan terms. Additionally, it is important to have a good understanding of the market and the property you are looking to finance. Having a good relationship with a lender can also be beneficial, as they may be more willing to work with you and provide more favorable terms.
What are the most important factors to consider when investing in multifamily real estate?
When investing in multifamily real estate, the most important factors to consider are:
- Your investment objectives
- The type of property you want to purchase
- How you will handle the everyday operations of the property
- Market conditions
- Available capital
- Operational plans
- Utilization of property management companies
- Expected operating expenditures
For more information, please see Early Considerations for First-Time Multifamily Investors and Operational Expenditures.
What are the long-term implications of the current multifamily market outlook?
The long-term implications of the current multifamily market outlook are largely positive. Despite the higher cost of debt capital and tighter underwriting, the multifamily and industrial sectors are expected to be less severely impacted by the rate hike. Investors and lenders will likely flock toward multifamily assets during this uncertain period in search of stability, as other asset classes, such as office, retail or hotels are still highly unpredictable in terms of demand. Investors with floating-rate debt will continue to face pressure, but the average investor will come out of this year stronger, not just unscathed. Multi-Housing News and Multifamily.loans have more information on the current multifamily market outlook.