The construction of multifamily properties experienced a boon over the last 10 years. The timing of their construction, coupled with the shortage of urban housing and younger generations’ flight to urban areas, led to high occupancy rates, quickly rising rental rates, and stability for multifamily owners and developers. With historically low interest rates over the last decade, investors who backed multifamily properties found themselves in a strong position relative to office or retail investors.
However, conditions affecting this real estate sector have changed, says David Leb, Vice President at Cushman & Wakefield | CRESCO Real Estate. As the pipeline of new multifamily projects narrows and interest rates rise to 15-year highs, investors need to be much more targeted to leverage the opportunities that still exist.
Smart Business spoke with Leb about trends in multifamily properties and how they’re likely to affect investment returns into the near future.
What trends have you seen in multifamily real estate?
Through the past 10 years, a great deal of new multifamily properties — those with four or more units per building — were developed across the country. With many cities benefiting from an influx of younger people who want to live in urban environments, multifamily units located in downtown areas quickly filled up and drove rental rates to historic highs. Growth in the sector was further encouraged by low interest rates and a capital markets environment that was eager to lend on this product type.
Even when the pandemic hit and people started working more from home, apartments that could accommodate that use did well while properties such as office and retail suffered. That got the attention of banks and of investors looking for investment safety. It became a popular investment vehicle for large institutions and smaller family offices as there was a massive shortage of single-family homes, or an inability by many to afford them. Occupancy in market rate apartments (as opposed to subsidized housing) grew in excess of 95 percent, even in tertiary markets such as Northeast Ohio.
Now, with interest rates and the expense of construction challenges, there are not nearly as many multifamily construction starts as there were just two years ago. Most of the properties that were delivered have filled up, and the pipeline for properties coming in the next couple years has thinned out. And in Cleveland, the 15-year, 100 percent tax abatement for new apartment buildings in downtown has been rolled back, which has taken away some incentive for developers and further dampened prospects.
How has multifamily compared to other real estate sectors?
Multifamily was a safer vehicle during the pandemic compared with office or retail, which both experienced massive changes during those years. Industrial is still a market that’s on fire but now is experiencing a shortage of property for distribution and warehousing.
The struggles of a lot of the downtown office buildings, in Cleveland and across the country, has led to antiquated office spaces being primed for conversion to multifamily; Cleveland has been a leader in that trend. And although retail has had a tough couple of years, the multifamily growth has helped bolster retail in many downtown markets.
What should investors know about this sector?
Those currently invested in existing multifamily are likely feeling pretty good. There’s not going to be a lot of new development coming, so the expectation is that existing properties are going to continue to do well. However, loans for those investments that had five- or seven-year balloon payments are beginning to see unexpectedly high rates, which could affect expected returns and could lead to properties not cash flowing well enough to survive. A fair number of properties, including some newer construction apartment buildings, might struggle to ‘pencil’ with an interest rate two to three times their initial loan.
There is still opportunity to invest in existing multifamily properties that exist and potentially need re-investment, otherwise known as ‘value-add’ buildings. The supply is unlikely to change significantly over the short term and interest rates may climb, so for those interested in getting involved in the sector, there is no time like the present. ●
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