Yardi Matrix Research: Safe Bet
- Jan 18, 2017
The multifamily market has seen phenomenal growth in rents and property values for several years. Can the good times continue to roll in 2017?
We think they can, though the rate of rent increases is going to slow down, transaction yields have likely bottomed and oversupply is going to negatively impact some markets. However, we expect that the multifamily market will continue to enjoy positive fundamentals.
The biggest factor is that demand for multifamily is poised to remain robust for years, maybe as much as a decade. The number of Millennials between the prime renter ages of 20 and 34 is projected to increase by two million before it peaks at almost 70 million in 2024. That coincides with a bump in the number of white, college-educated renters relocating to urban areas for the “18-hour” city lifestyle that includes entertainment and access to public transportation.
As the young worker pool grows, unemployment rates have dipped below 5 percent and wage growth has intensified, hitting 2.8 percent year-over-year as of October 2016. The result is a boom in household formations, which have steadily risen since slumping badly in the wake of the last recession.
A further reason for optimism is that new supply has not kept up with the surge in multifamily households. The number of renter households increased by 9.3 million in the 10 years between 2005 and 2015, according to the Census Bureau, while the number of owner-occupied households dropped by 2.1 million.
The result is that occupancies of stabilized properties are near all-time highs, at 95.8 percent nationally as of October, according to Yardi Matrix. Even though supply has rebounded from the recessionary lows—Yardi Matrix forecasts about 350,000 units to come online in the U.S. in 2017—that is barely enough to match the amount of projected demand from renters.
Investors still bullish
Multifamily property values are 50 percent above pre-crisis peaks, and acquisition yields were at 5.6 percent nationally as of the third quarter of 2016, lower than they were at the height of the financial crisis, according to Real Capital Analytics Inc. Gains have been driven by demand from investors seeking assets with stable cash flows.
The 60-basis-point increase in the 10-year Treasury rate in the weeks following the election could prompt an increase in acquisition yields. But unless rates climb much further, property yields should remain fairly constant because apartment cash flows are stable and the sector remains attractive relative to other investments. And over the next couple of years, investors should brace themselves for moderate returns that are limited mostly to increases in net cash flow while appreciation gains pause.
The outlook seems promising, but there are potential headwinds. The most important is the economy. The election of Donald Trump as U.S. president will introduce a great deal of change in economic and regulatory matters. The major parts of Trump’s agenda—as much as $1 trillion in infrastructure spending, lower taxes and reduced regulations—have been hailed by the business community, which sees the potential to spur growth. However, the economy could be disrupted by major changes to health care (Obamacare and Medicare, in particular), higher interest rates, new tariffs or shifts in immigration policy. What’s more, slow growth in emerging markets in Asia and Europe is still an impediment to growth in the U.S.
Another major concern is affordability, as rents have consistently grown more than household income since the start of the recovery. New supply is largely targeted for the luxury sector, while demand in most markets is stronger for units at the middle or lower end of the pricing scale.
Rents began decelerating nationally in the second half of 2016, and we expect that trend to continue into 2017. One reason is the mismatch between supply and demand already evident in the slowdown in growth in high-rent markets such as San Francisco, Denver and Austin. Each of those metros has a strong economy and an attractive lifestyle that continues to drive in-migration. But all saw severe deceleration in rents in the second half of 2016 as a result of rents growing to levels that are ahead of what many renters can afford.
The constraint posed by affordability on rent growth isn’t limited to a handful of metros. Growth in many high-rent markets across the country—such as New York, Boston, Philadelphia and Los Angeles—is limited by expensive rents.
Increasing amounts of new supply are another factor that will weigh on rent increases. Metros with above-trend increases in supply as a percentage of stock include Dallas, Houston, Seattle, Denver, San Antonio, Orlando, Austin, Charlotte and Washington, D.C. Many of these metros have strong job engines that are attracting young workers, but even so, rent growth may slow down to become closer to historical norms until the new units are absorbed.
One outlier on the high end of the spectrum is Sacramento, which has maintained double-digit rent gains as a low-cost alternative to the Bay Area with very little new development. Houston is an outlier at the low end, as job growth has slowed while construction has continued unabated.
When all is said and done, we expect rent growth to moderate to 3.9 percent in 2017, down 50 basis points from 2016 but still above the long-term average of 2.3 percent. Although growth will revert to more sustainable levels, multifamily remains a safe bet for most investors over the next few years.
Originally appearing in the CPE-MHN Guide to 2017.