How Quickly Will Apartment Rents Start Growing Again?
After the U.S. apartment market turned to rent cuts amid the economic recession of 2020, how long will it take for rents to recover? The answer varies based on whether you’re talking about the nation overall or specific local markets.
At the end of 2020, annual effective asking rents for the nation overall were cut by 1.1%. Moving forward, however, pricing is expected to reach the breakeven point in the last half of 2021, and then growth could return, getting higher than 3% by the end of calendar 2022.
But rent change performances were bifurcated across metros in 2020, and that trend is expected to continue in the near term, with some markets far out-performing other locations.
Some markets have already recovered back to pre-pandemic levels, so future rent growth in these areas will take pricing to all-time highs. This group includes some slow-and-steady Midwest region markets and some Sun Belt spots where building has been restrained.
Less encouraging, rents probably won’t get back to early 2020 levels until 2022 or later in a handful of markets that have seen a lot of new supply of late. This group includes most of the Texas markets, as well as Minneapolis and Nashville.
In the worst cases, RealPage models suggest there is a long way to go in some of the gateway markets, which have been hardest during the COVID-19 pandemic. This group includes the Bay Area, New York, Los Angeles, and Chicago. Pricing performances in those markets might not get back to the early 2020 results until 2025 or later.
Freddie Mac played a critical role for multifamily borrowers in 2020 during the COVID-19 pandemic and the subsequent economic downturn, financing roughly 803,000 rental units, with more than 95% of those units being affordable to households earning 120% or below the area median income. Freddie Mac Multifamily also set a record $82.5 billion in loan purchase and guarantee volume last year, surpassing the prior record of $78.4 billion in 2019.
“In a volatile year, Freddie Mac was a stabilizing force in the multifamily market,” said Debby Jenkins, executive vice president of Freddie Mac Multifamily. “The fact that we hit a record in the midst of a pandemic shows our commitment to be a consistent force of debt financing for multifamily operators in both good times and bad. Our network of Optigo lenders did not skip a beat, and the Freddie Mac team kept up with a demanding pace to ensure we fulfilled our mission. At the same time, we exceeded our mission-driven benchmarks, the vast majority of units we financed are affordable to low- and moderate-income households.”
The $82.5 billion in production last year combined with the $17.5 billion in volume for the fourth quarter of 2019 put the government-sponsored enterprise (GSE) right at the $100 billion cap mandated by the Federal Housing Finance Agency. Freddie Mac also surpassed its mission-driven requirement of 37.5%, with approximately 40% of volume meeting the definition. These mission-driven transactions benefited affordable housing, smaller multifamily properties, seniors housing, manufactured housing, and rural housing. A new $70 billion cap has been established for 2021 with a 50% mission-driven requirement with new and different criteria.
Freddie Mac served all corners of the multifamily market in 2020 through its offerings, including nearly $5.3 billion small-balance loans, a record $12 billion in Targeted Affordable Housing loans, and $3.7 billion in seniors housing loans, including senior-living apartments. The GSE also securitized a record $78 billion through its securitization offerings, such as K- and SB-Deals, transferring a majority of expected and stress credit risk to third-party investors. Freddie Mac also provided $500 million in low-income housing tax credit equity investments to support underserved communities.
“We are proud that our achievements in 2020 reflect the critical role we play in the multifamily market,” said Richard Martinez, senior vice president of production and sales at Freddie Mac Multifamily. “During a global pandemic, Freddie Mac continued to provide critical liquidity to the market and continued working to address the persistent affordability challenges facing countless renters. We quickly adapted to the environment around us, rolling out a forbearance plan for borrowers and protections for renters to help address the challenges presented by COVID-19.”
Construction materials prices edge higher as lumber rebounds
The Bureau of Labor Statistics (BLS) released its producer price index report for December 2020. It showed that the BLS price index of materials and components for construction was up 0.8 percent from November, seasonally adjusted. It was 5.2 percent higher than its year-earlier level.
Overall prices for processed goods for intermediate demand rose by 1.5 percent. This index was 1.3 percent higher than its year-ago level, reversing last month’s decline.
For reference, the changes in these indices compare with a 1.4 percent rise in the all-items consumer price index (CPI-U) for the 12 months ending in December. The CPI-U was up 0.4 percent for the month.
Yield Pro (PRO) compiled the BLS reported price changes for our standard list of construction commodities. These are commodities whose prices directly impact the cost of constructing an apartment building. The two right-hand columns of the table provide the percent change in the price of the commodity from a year earlier (12 Mo PC Change) and the percent change in price from December 2020 (1 Mo PC Change). If no price data is available for a given commodity, the change is listed as N/A.
12 Mo PC Change
1 Mo PC Change
Soft plywood products
Hot rolled steel bars, plates, and structural shapes
Copper wire and cable
Power wire and cable
Plumbing fixtures and fittings
Enameled Iron and metal sanitary ware
Furnaces and heaters
Sheet metal products
Electrical Lighting fixtures
Asphalt roofing and siding
Mineral wool insulation
Last month, we reported that softwood lumber prices, while officially down for the month, were again on the rise by late November. Prices continued to rise during the month of December and the BLS reported prices were up 12.2 percent for the month. However, in early January, softwood lumber prices backed off slightly from the highs they reached in late December. The Random Lengths Lumber futures contract, which traded as high as $934 in 2020, is priced at $655 for March 2021 deliveries and is under $600 for deliveries in May or later. The recent run-up in prices is being attributed to the weather being unseasonably favorable to building activity for this time of year, along with mills shutting down for maintenance.
The price of soft plywood products continued to decline from its recent high in December. However, its price has recently tracked that of softwood lumber, but with a delay. If it continues this pattern, price increases may be ahead for this commodity. Prices of other wood products that we track have been relatively stable, although hardwood lumber has started to move up in recent months. This is shown in the first chart, below.
The second chart, below, shows the recent price history of several other construction materials. Copper wire and cable made the biggest jump this month, rising 5 percent. The price of copper has been rising rapidly since March and is now at its highest level since 2013. The only good news here is that copper futures seem to have stabilized with contracts out to September 2021 trading in a narrow range close to today’s price. The price of aluminum, which also had been rising rapidly since May, seemed to plateau in December. This may account for the drop in the price of power wire and cable, which was down 1.5 percent for the month.
The prices of most other commodities tracked in this chart have been relatively stable despite the market disruptions caused by COVID-19.
Price changes for several of the more finished goods from our sample are illustrated in the final chart, below. The prices of these items seem to be continuing their recent trend of growing at a rate that is slightly above the general rate of inflation in the economy
Fortunately, for those who own commercial real estate, eliminating the 1031 exchange probably won’t make Biden’s near-term agenda after all.
The 1031, also known as a like-kind exchange, benefits small business owners who want to sell their properties. It allows sellers to defer capital gains tax when their proceeds are reinvested into other investment properties.
Right now, the 1031 exchange is more important than ever. During the coronavirus-caused economic downturn, it has helped relieve the tax burden on those who are selling investment real estate that may be tied to struggling sectors such as hospitality. Investors who own other types of real estate, such as rental homes, apartments, retail centers, restaurants, bars, farms, and ranch lands may also use a 1031 exchange.
Dodged A Bullet For Now
However, with COVID-19’s recent resurgence, the focus of the new administration will likely be on health and economic stabilization. At the same time, infrastructure will be a heightened focus, especially for the first two quarters of 2021. And even if a proposal to narrow or eliminate 1031 exchanges was brought forward, it seems unlikely (though anything can happen), that Congress will take on efforts to cancel or modify Section 1031 of the Tax Code for now.
This is great news for business owners, entrepreneurs, and commercial real estate investors. Indeed, it can be good for job growth and the economy overall. 1031 exchanges facilitate liquidity—particularly important for small business owners or individuals who don’t have access to the same sources of financing as larger institutions. Not only that, but these transactions can often boost local employment as suffering properties are transferred to owners who have the time and resources to invest in improving and maintaining the property.
Incentives to transform out-of-favor properties into new uses can have far-reaching, positive effects throughout local communities.
Section 1031 like-kind property exchanges have been part of the American real estate DNA since 1921. Tax-deferred exchanges give businesses — and ordinary people — much more flexibility and liquidity than they would otherwise have in reallocating their investments.
As much as 20 percent of commercial real estate transactions over the last decade relied on 1031 like-kind exchanges, according to a 2020 economic study by professors David Ling and Milena Petrova.
A stubborn misconception clings to the 1031 exchange: That it’s a loophole used primarily by ultrahigh net worth individuals and corporations to avoid paying taxes. That led to a proposal by the Obama administration to limit 1031 deferrals to an annual $1 million per person. Republicans considered eliminating it as part of the 2017 tax reform bill. Biden said he’d consider phasing the benefit out for investors with incomes over $400,000.
That would fly in the face of mounting evidence that 1031 exchanges benefit a much broader group of Americans while contributing federal, state, and local tax revenues, creating liquidity and deal flow in the real estate markets, and creating jobs.
The Ling and Petrova study —which reviewed more than 1.1 million commercial real estate transactions—found that many perceptions about 1031s are false.
For one, exchanges may lead to future taxable transactions, offsetting some fears that 1031s erase tax revenue entirely. According to the study, on average 63 percent of 1031 exchange properties are eventually sold in a taxable transaction at a later date. Of course, it’s impossible to determine what real estate transactions might have occurred — or not — without the 1031 benefit.
The study also found that like-kind exchanges result in 7% less debt compared to taxable transactions, reducing the financial vulnerability of the real-estate sector.
A separate economic study in 2015 by Ernst & Young found that that eliminating 1031s would result in less tax revenue and shrink the U.S. economy by up to $13.1 billion annually. Even if the pandemic hadn’t revealed its benefits in such sharp detail, the economic fallout from cutting the tax benefit could be devastating.
Huge Economic impact
By keeping money flowing through real estate investments, 1031s stimulate and support a plethora of jobs in the sector, ranging from title company employees to appraisers to contractors who are hired when people buy and improve properties. The Ling and Petrova study found that a repeal of section 1031 could result in lower investment activity, a fall in real estate prices, an increase in rents, an increase in holding periods for property, and a rise in the use of debt.
Even at the best of times, that would be an economic blow to businesses and communities across the country. Without it, more investors are likely to sit on their properties to avoid taking a tax hit, slowing the repurposing of property.
With 1031s in place, someone who owns a restaurant or retail store will more easily be able to sell to another investor who plans to turn the space into its highest and best use. Take away the 1031 incentive, and there’s significantly less chance of that sale occurring. The result: more underutilized properties, more depressed areas, less economic activity, and fewer jobs.
If the Biden administration’s goal is to revive the economy, create jobs, and bring back business and consumer confidence, getting rid of 1031 exchanges would be an effective way of shooting the economy in the foot.
Fannie Mae headquarters. Image courtesy of Fannie Mae
Rumors that the outgoing Trump administration would spring an 11th-hour effort to privatize Fannie Mae and Freddie Mac were set to rest last week when the government-sponsored enterprises’ overseers reached an agreement to limit their growth—but without major structural changes.
The agreement between the Federal Housing Finance Agency and the Treasury Department includes such elements as a permanent ceiling on the agencies’ multifamily lending volume; locking in requirements to focus on affordable housing; enabling them to retain much more of their profits, and an obligation to comply with rules that require them to set aside more regulatory capital.
Taken together, these provisions put Fannie and Freddie on a path toward ending conservatorship by strengthening their long-term financial position. Although it could diminish their dominance of the multifamily lending market somewhat, the new rules fall short of the all-out effort to privatize the agencies that was rumored to be in the works.
“The amendment will allow FHFA Director Mark Calabria to move the GSEs slightly closer to a conservatorship exit, (but) it doesn’t open the door to ending conservatorship without buy-in from the Biden administration or new legislation from Congress,” said David McCarthy, senior director of government and policy relations at the CRE Finance Council, a Washington, D.C.-based trade group.
Running Out the Clock
The Trump administration, particularly FHFA Director Mark Calabria, set ambitious goals to release the GSEs from conservatorship, where they have been since being bailed out by the federal government in 2008. After he was appointed to a five-year term in 2019, Calabria ended the cash sweep that sent Fannie’s and Freddie’s profits to the federal treasury, the first step toward financial stability and setting them free.
The upcoming change in the administration on Jan. 20 set off a regulatory clock for Fannie and Freddie. Not only will the new Treasury Secretary—Joe Biden plans to nominate former Federal Reserve Chair Janet Yellen—have a different perspective on the GSEs, but the new president could try to dismiss Calabria immediately. It remains unclear whether that is Biden’s intention, but the president’s power to fire an agency head without cause is the subject of a case before the Supreme Court.
That left Calabria and Treasury Secretary Steve Mnuchin to walk a tightrope between negotiating an agreement that would help achieve their goals of privatization and reducing the market footprint of the GSEs without roiling the real estate lending industry, which has been operating without much trouble in recent years. Industry housing trade groups including the Mortgage Bankers Association sent a letter to Mnuchin last month urging him to not push the agencies out of conservatorship before they had enough capital.
In the end, it was impossible to raise the capital needed to release the GSEs from conservatorship in the time before the new administration took charge. Thus the agency heads opted for incremental change that puts Fannie and Freddie on the path to privatization, but which can’t be achieved without the support of a future administration.
Weaker Competitive Position
The new agreement does put some limits on Fannie and Freddie that leaves more room for competitors. The most obvious limits are an $80 billion annual cap and the requirement that at least half of originations are on properties that meet a threshold of affordability. The FHFA has set annual caps in the past; for 2021 it is $70 billion, following an $80 billion limit in 2020.
The new cap is permanent, although it could be changed through an agreement between a future Treasury Secretary and FHFA director. That gives Calabria some control if he can stay on as FHFA director through the end of his term, a possibility which depends on the outcome of the lawsuit before the Supreme Court.
Another element of the agreement is that enables the GSEs to retain capital beyond the previously agreed-to level of $45 billion ($25 billion for Fannie and $20 billion for Freddie). To date, Fannie has accumulated about $21 billion and Freddie $14 billion, according to CREFC. Now, however, the agencies can retain earnings up to a combined $280 billion, which is what the FHFA estimated was the necessary level for privatization.
For more than a decade after conservatorship began in 2008, Fannie and Freddie were required to sweep profits into the federal coffers. The GSEs’ preferred stockholders, which own about $31 billion of preferred stock that has not received a dividend since 2008, remain embroiled in a lawsuit that contends the cash sweep agreement was illegal. The Supreme Court is expected to rule on the case during its current term, which ends in June.
Another element of the new agreement is that it binds the GSEs to the capital framework adopted by the FHFA in 2020. The rule requires the GSEs to maintain tier 1 capital of 4 percent of assets, which amounts to an increase in the amount of regulatory capital the GSEs must hold. That serves to make them safer from losses but also increases their cost of capital.
These and other parts of the new agreement, taken together, put Fannie and Freddie on the road to better financial health while slightly reducing their competitive position in the multifamily market. The GSEs’ chief advantage has been their low cost of capital, which enables them to beat competitors on loan rates. That advantage is diminished somewhat by the higher capital threshold. Meanwhile, Fannie and Freddie are also constrained by origination limits and the requirement that half of their business must encompass properties that meet the test of affordability.
Permanent reform has been discussed for years, and the commercial mortgage industry would prefer a permanent framework for the GSEs, but the agreement has been impossible. No solution has a consensus among policymakers and the lack of an imminent problem in the mortgage markets has made it less of a political priority.
As such, the new agreement is being well-received by most of the industry. Lenders such as commercial banks, insurance companies, and CMBS programs would all like a better competitive position relative to the GSEs so they can originate more loans on apartments. The utility of the agency model, however, was demonstrated in 2020 during the pandemic, when Fannie and Freddie remained active as most lenders stopped writing new business because of COVID-19.
Rob Van Raaphorst, vice president of communications at MBA, said the new agreement “preserves and extends a level playing field for lenders of all sizes and business models while avoiding near-term measures that could have threatened market stability … It is critically important that measures guide the GSEs’ market footprint carefully balance the need for them to meet their affordable housing mission for both single-family and multifamily homes.”
To some, the action was mostly about optics since most of the changes can be reversed when new appointees gain oversight powers. “The only thing going on is that earnings can continue to be retained,” said one long-time industry insider. “The rest is about optics and politics and actually is unlikely to last very long.”
The multifamily sector weathered the storm in 2020, living up to its reputation as one of the most stable commercial real estate asset classes. The forecast for apartments in the new year is also bright. And even with where things sit today with the still-raging pandemic and the terrifying scene that unfolded in the nation’s capital last week, observers point to the continued rollout of vaccines and the likelihood of new COVID-19 relief measures with the new administration and Democratic control of Congress as reasons for high hopes for the balance of 2021.
Economists expect the average apartment community to remain close to fully-occupied in 2021 with relatively stable rents and stable collections. Investors ended 2020 on a brisk buying clip fueled in part by capital providers remaining more than willing to finance the sector. Hopes that working vaccines against the coronavirus will eventually be distributed have helped offset—so far—the recent jaw-dropping spikes in new infections, hospitalizations, and deaths. Hopes that Congress might provide more support to people and businesses hurt by the pandemic—and emergency assistance passed in December 2020—should make up for the expiration of vital programs in the second half of 2020.
“Multifamily remains a very stable investment with a very stable outlook,” says John Sebree, senior vice president and national director of Marcus & Millichap’s Multi-Housing Division, working in the firm’s Chicago office.
The biggest exceptions to this stability are all the new apartments still opening in the downtowns of expensive, “gateway” cities, where rents are likely to fall again in 2021. “You have to talk about that market… a few urban, core markets like San Francisco and New York City… and then you have to talk about everything else,” says Sebree.
Despite a slow rollout, the vaccine is coming
Doctors diagnosed hundreds of thousands of new coronavirus infections every day on average in the first weeks of 2021. The panic caused by the pandemic weakened a recovery in the U.S. economy—and also weakened the demand for apartments.
“Job losses in the December figures do not bode well,” says Andrew Rybczynski, managing consultant at CoStar Group, based in Boston. “Employment correlates well with apartment demand, and so while the jobs figures remain weak, it is reasonable to remain wary… Progress slowed over the past few months.”
However, the demand for apartments has already survived a lot since the coronavirus struck in early 2020. Apartment managers continued to lease apartments even in the first months of the pandemic. Markets in the U.S. absorbed 71,493 apartments in the second quarter, according to CoStar. That’s surprisingly strong considering most of the U.S. economy was shut down to slow the spread of the virus, though it is also the weakest absorption in years for a second-quarter—usually the busiest time of year for the apartment business.
Demand for apartments strengthened through the rest of the year. Markets absorbed a net 114,000 apartments in the third quarter, one of the strongest third quarters CoStar has ever recorded in multifamily. And the fourth quarter was the strongest since 2015, based on preliminary data, says Rybczynski.
So far, relatively strong demand helped managers keep most buildings fully-occupied, despite the pandemic and competition from a flood of new apartments. The percentage of occupied apartments inched slowly downwards to 93.16 percent in the fourth quarter of 2020 from a peak of 93.84 percent in the second quarter of 2019, according to CoStar.
That’s a decline so slight, it is almost difficult to see in the data. If you round to the nearest whole percent point, the occupancy rate doesn’t change from 93 percent throughout 2020, according to CoStar.
In the last months of 2020, health officials approved two vaccines against the coronavirus. “The vaccines undoubtedly make tenants, landlords and nearly everyone more hopeful,” says Rybczynski. “There is certainly a light at the end of the tunnel… though the [slow] rollout does not suggest that the end of the pandemic is right around the corner.”
“Our economic forecasts already assumed sluggish job production in the first half of 2021 and then more robust expansion in the last half of the year,” says Greg Willett, chief economist for RealPage, Inc., headquartered in Richardson, Texas. “The introduction of vaccines has made us more confident in that outlook.”
More stimulus dollars, not a moment too soon
Housing advocates warned millions of renters could be evicted if federal programs like enhanced unemployment benefits expired at the end of August 2020. Many who lost jobs in the pandemic were still out of work, and millions had already fallen behind in their rent, especially at smaller, less-expensive apartment properties. Well, Congress let most of the supports created by the Coronavirus Aid, Relief, and Economic Security (CARES) Act expire and did not renew or replace them until December 2020.
A federal moratorium on evictions has protected the vast majority of unemployed tenants from formal eviction—but many seem to have moved out anyway, according to CoStar. Rents in less-expensive, began to fall in class-C apartment buildings as the year ended—though these rents had been stable for much 2020.
“The end of the CARES Act coincides too closely with the start of weakness in one-star and two-star [Class-C] rents to be ignored,” says Rybczynski. “It is possible that additional stimulus will buoy those households renting at the lower end of the market.”
Competition from new apartments hammers overbuilt downtowns
Developers still plan to open thousands of new, luxury apartments begun before the pandemic in some of the most overbuilt and most expensive downtown submarkets in the U.S.
“The areas scheduled to get some of the biggest increases in deliveries are the gateway metros where performances already are struggling,” says Greg Willett.
Developers are expected to open 403,644 new apartments in 2021, with much of that concentrated in downtowns already crowded with new apartments, according to RealPage. Even if thousands of those units are delayed, 2021 will be the biggest year for multifamily construction in decades. It will be up 17 percent from 2020 when developers finished 344,380 new apartments despite the pandemic—which seemed like a huge number at the time. In comparison, developers finished less than 200,000 new apartments a year in most years since 2000, according to RealPage.
“The run-up in completions are especially pronounced in New York/New Jersey, Los Angeles, the Bay Area, and Seattle,” says Willett. “Even though we think demand in those locations improves in 2021, it appears likely that rent cuts continue due to the negative influence of all the new supply.”
Collections for public housing reached 97% of 2019 rates, and affordable housing reached 83%—the highest level for the latter class since June.
By Les Shaver | January 14, 2021, at 07:09 AM
Even though money from the recent stimulus hadn’t yet reached the economy, rates of collections in affordable and public housing were high in December, according to MRI Software.
MRI says collections for public housing reached 97% of 2019 rates, and affordable housing reached 83%. That was the highest level for the latter class since June.
Collections increased as new applications increased significantly YOY in both public and affordable housing, by 56% and 14%, respectively. MRI says this represents a significant shift in direction since the start of the pandemic when new applications trailed the numbers of 2019.
The December data also showed occupancy tightening across all asset classes, as move-ins outpaced move-outs for the sixth consecutive month. Move outs were down across the board but fell 80% in affordable housing.
While occupancy tightened across the board, some of MRI’s indicators show market-rate housing struggling more than affordable.
The year started strong for conventional apartments, with pricing up 2% over 2019, but it quickly eroded over the summer, according to MRI. Apartment operators relied on concessions, and those steadily increased from September through December.
In December, lease prices fell 2% for market-rate housing. In all, aggregate concession values for market-rate housing increased by over $6 million YOY.
MRI’s data also showed an increase in new payment agreements in conventional housing, which allows residents to manage past due balances formally with their landlord.
This highlights National Multifamily Housing Council’s latest rent payment data, which found that collections for conventional apartments fell 3.4% year-over-year in December 2020.
The NMHC’s Rent Payment Tracker, which surveys 11.5 million units of professionally managed apartments across the country, found that 89.8% of apartment households made either a full or partial rent payment by December 20. That’s 393,952 fewer households than the share who paid rent by that date in 2019. NMHC data shows that 90.3% of households paid rent by November 20, 2020.
Fittingly capping off an unusual year, the U.S. apartment market saw solid leasing activity in the 4th quarter, a time when little to no demand is typical in most other years.
About 79,000 units were absorbed in the final three months of 2020, a far stronger performance than normal as demand that typically would have registered during the 2nd quarter was pushed to later in the year. Before 2020, the decade’s strongest 4th quarter demand performance was in 2014, when absorption reached a notable 37,000 units.
After apartment leasing slowed drastically in the spring and early summer of 2020, due to the COVID-19 pandemic, demand rebounded in the last half of the year. Adding in the 3rd quarter total, absorption in the final six months of 2020 came to over 234,000 units, a big portion of the total annual volume.
In fact, after an unpredictable year, with atypical highs and lows, annual apartment demand shook out to be rather average in the end. Apartment absorption in calendar 2020 came in at a little over 296,000 units, shy of 2019’s total by only 9% and essentially identical to the average annual demand posted in the previous five years.
The demand performance in calendar 2020, however, was split down market lines. Solid absorption registered throughout most of the Sun Belt, led by Dallas/Fort Worth, Atlanta, Houston, Phoenix, Denver, and Charlotte. On the other hand, New York and the Bay Area suffered sizable net move-outs, and there was minimal demand in other gateway locations.
While the nation’s late-in-the-year demand comeback was impressive, apartment absorption still didn’t quite keep pace with rising completion volumes. Like demand, completions bumped up in the last half of the year, after project timelines were delayed. In total, nearly 345,000 market-rate units wrapped up construction in 2020. This was the biggest annual block of deliveries since the mid-1980s.
Over the past decade, average annual completion volumes were elevated, but still under current levels, at 230,000 units. In the decade before that, annual deliveries were even more modest, at under 197,000 units.
Moving forward, there still are about 583,000 market-rate apartments under construction, with nearly 404,000 of those scheduled to complete in 2021. That’s roughly 50,000 more than the already elevated construction volumes from 2020. Even assuming some delivery delays will continue, completions in the coming year could well exceed those volumes. The biggest increases in new supply scheduled for delivery in 2021 are slated for the struggling coastal gateway markets.
Apartment demand should remain robust as the economic recovery continues in 2021. However, leasing activity will struggle to keep pace with such elevated delivery volumes, especially in the gateway markets. For the nation overall, any potential supply-demand imbalance in the year ahead should be modest, as Sun Belt markets continue to bolster U.S. demand totals.
When it comes to navigating multifamily real estate investments through a global pandemic, life in the suburbs has been pretty good. Of the two dozen development deals that The NRP Group had on the books in January of last year, 23 of them were closed successfully, resulting in a record production year for the Cleveland-based developer of affordable and market-rate housing.
“We started 5,000 units representing roughly $1.4 billion in real estate value, and 60% of that pipeline was in the affordable business, so we do feel blessed and very thankful again that we are a diversified company,” says NRP principal and president of development Ken Outcalt. “And we’re bullish on both sides of the business going forward. Our past experience of not getting aggressive in high-density urban deals has benefited the portfolio, and we don’t have any of those urban deals right now. We are 100% suburban.”
To be sure, 2020 was not without its challenges. The onset of the pandemic and related shelter-in-place orders in March and April resulted in a virtual freeze on apartment investment and development activity as debt providers vanished, equity players sat on cash, and contractors temporarily shuttered job sites. But despite a hard stop on buying and building in the second quarter, most multifamily firms report a rebound across the second half of the year and are buoyed by stability in underlying business fundamentals and capital markets that portend a thriving rental sector for 2021.
Like NRP, Charlotte, North Carolina-based Crescent Communities headed into the year with high expectations and the deal flow to match. “Obviously we were at the height of the real estate cycle,” says Crescent senior vice president and chief investment officer Jason LaBonte. ”Everyone was flush with cash, the fundamentals were phenomenal, and our pipeline was strong. We do roughly 10 deals a year, and we were out looking to capitalize the 10th for 2020 when the pandemic hit.”
Although six of those development deals were paused due to pandemic-related capital market pricing issues and two deals had joint-venture partners that ultimately walked, Crescent was expected to close out 2020 with all 10 deals intact.
“A lot of equity partners simply needed some insight into what the future was going to look like, and we all needed to get further into this and realize that people still needed a place to live and that Class A multifamily would be impacted less by the job losses,” LaBonte says. “The JV partners are back in the game, and we’ve replaced the ones who walked, so we’ll get all of our deals done for the year.”
Investors, developers, owners, and operators across virtually all multifamily asset classes report similar positive business fundamentals headed into 2021. At Philadelphia-based student housing company Campus Apartments, executive vice president and chief operating officer Miles Orth say occupancies and performance have remained relatively strong across a portfolio of assets serving 50-plus universities and colleges in 18 states.
“That’s not to say that there was not significant disruption,” Orth says. “Operators had to pivot quickly and address new issues and concerns while remaining laser-focused on supporting their teams. But now that we’re nine months into the pandemic, student housing occupancies and collection rates are among the highest in the real estate industry and are clearly demonstrating that this sector is strong, stable, and vibrant.”
Follow the Money
Indeed, strong multifamily asset performance during the pandemic while other real estate classes have foundered is boosting already high rates of global investment into the apartment sector, catalyzing development and possibly sparking consolidation via the acquisition and disposition of portfolios in 2021.
“There is so much capital out there that is ready to invest into multifamily, and a big reason for that is that until the pandemic is resolved, hotel is uninvestable, office is not for the faint of heart, and retail is dead,” Outcalt says. “So there is a lot of dry powder out there looking for apartment deals because most of the other international options for these investors are really risky.”
Equity already allocated to multifamily investments but forced to the sidelines in the second quarter of 2020 also has rushed back into the market, and lending commitments to the apartment sector made by Fannie Mae and Freddie Mac have admirably filled the momentary void from banks, life companies, and CMBS lenders who are now reentering the market. In November, the Federal Housing Finance Agency announced a combined $140 billion commitment to multifamily for 2021, with 50% of that allocation committed to affordable housing.
“Given the pause in activity, the agencies would have to have had just a rocking and rolling fourth quarter to meet the [2020 allocation of $200 billion],” explains PGIM Real Estate head of agency lending Mike McRoberts. “But the amount of capital still chasing the preferred equity and mezzanine parts of deals is still there, and sellers are seeing close to pre-pandemic pricing, which encourages a lot of cross pools that can tie assets together and go to the agencies to structure a credit facility. We did over $1 billion of that in 2020.”
As operators across a majority of markets report only slightly depressed—if not steady—rent fundamentals, buyer appetite in 2021, absent a force majeure event, will remain robust.
“There is a significant amount of pent-up demand for quality multifamily product in quality locations because of the slowdown from the pandemic. A lot of equity players have to get that capital into play or return it,” explains Kevin Keane, executive vice president, and chief operating officer for the Wellington, Florida-based Bainbridge Cos. “We are certainly looking at 2021 as a portfolio buyer because we have those funds in play with investors who want to make those kinds of purchases.”
With asset valuations driven by net operating incomes that are heavily weighted toward rent rolls, it’s remarkable that multifamily pricing has remained steady in the face of epic U.S. unemployment and a national eviction moratorium. While rents have remained fairly flat, operators are yet uncertain whether they’ll face exposure to delinquencies across 2021. Anecdotally, the so-called urban exit of renters who no longer need to be close to core office employers and desire lower population density due to the pandemic seems to be bolstering rather than dragging down apartment fundamentals.
“We had some properties that went into lease-up in spring where leasing velocity was down in the 20s versus 30 to 40 units per month, but we did not have to discount rents,” says Keane. “But we are conservative with our underwriting and in some cases even beat our expectations. We think we are benefiting by migration to the suburbs because we are already here. A lot of competitors are still looking for sites, and we have a healthy pipeline of seven developments slated to close in 2021.”
Healthy development pipelines are keeping builders busy, too, and veteran general contractors say the action is hottest in the suburbs, where the pandemic has accelerated millennial household formation and renters escape the dense urban environments that could increase the risk of exposure to the pandemic. “All of these factors are shifting demand for multifamily housing to the suburbs,” says Richard Lara, president, and CEO of RAAM Construction. “It’s bringing us more business, and we expect to see huge upswings in demand for affordable communities in suburban markets in the next few years.”
Outbound urban population migration could also offer insurance to student housing operators should universities and colleges struggle with lingering pandemic issues. In particular, off-campus, purpose-built student housing in smaller college towns or suburban submarkets could be repurposed to meet market-rate demand.
“We have some properties where we were able to pivot to market-rate given their location and proximity to desirable locations in addition to the university they serve,” Orth says. “Five of our properties benefited from that pivot and were able to stabilize occupancy by reaching out to market-rate renters, but that won’t work in every instance, which is why we’ve accelerated our leasing program for 2021 to encourage early decisions by students in their housing selection for the fall.”
As president of Walker & Dunlop Investment Partners, Sam Isaacson oversees a $1.2 billion commercial real estate portfolio and one of the largest multifamily lending and brokerage shops in the country. While Isaacson agrees that softness in the multifamily market has thus far been limited to the urban core, Class A assets, and could perhaps trigger a larger market shift toward suburban development, he’s unsure if multifamily assets as a whole have yet to prove themselves so bulletproof against the pandemic and its socioeconomic aftershocks.
“Multifamily will not be insulated from millions of people being unemployed and having to change careers,” Isaacson says. “We are taking a risk-off position and taking preferred equity instead of joint-venture last dollar exposure, and are avoiding going 100% on the stack given what is going on. If we are taking last dollar risk, it will be on ground-up construction because the risk-adjusted return is better, and we expect a shift there to more suburban product and even single-family build-for-rent given the migration patterns.”
The Long Haul
That’s not to say that luxury urban core is dead as an asset class. On the contrary, veteran multifamily investors and owners feel that market challenges in 2021 and beyond will help winnow an overcrowded playing field of yield chasers and me-too operators and managers, with firms that can adapt without being reactive championing over their peers.
“It’s still too early to predict if there are going to be defaults beyond San Francisco, New York City, and Chicago luxury, and whether or not there has been a true flight to the suburbs,” says LaBonte. “Yes, urban is depressed right now, but time and again those markets have proved to be resilient, and you will see capital come back to core investments. By 2023 and 2024, you will have some suppressed pipeline coming into most of the market, and as long as you are not going in with a merchant build model and build in an eight- to nine-year hold, there will be great opportunities there.”
Like Lara, Outcalt sees increased opportunity in affordable housing across NRP’s markets, particularly given the perfect storm of migration, millennial household creation, and agency allocations to projects meeting affordability thresholds. Playing into the firm’s diversified model (roughly 60% of the portfolio is affordable), NRP is also having success offering third-party construction services to developers anxious to get communities out of the ground.
“In both property management and construction there has been a real flight to quality, and we have 10 deals in our 2021 pipeline that we’ll be building for third parties,” Outcalt says, adding that NRP isn’t hesitant to take on projects in submarkets where it operates its own assets. “Those are the markets where our sub base is the strongest, and one way or another someone is going to build it, so why not us?”
Politics and the economy, too, will continue to shape multifamily real estate across 2021 and beyond. While drastic changes are not expected to agency caps and allocations, leadership at the FHFA is likely to see an overhaul with the rest of the executive branch, and housing policy, in general, is likely to become more stringent and shift further toward affordability.
“Obviously it’s not just getting at the virus with a viable vaccine and treatment. There is a relief rally in the stock market that can provide higher confidence in your top-line underwriting,” McRoberts says. “Then what is the direction of the recovery, and how quickly can we employ people? The speed of that recovery, the speed of changes to the tax plan, the rent control, and eviction moratorium will all have to settle out.”
Navigating portfolios through those challenges might not be such a bad thing, Isaacson says. “Over the last 10 years, anyone could do well in multi-family, and we expect that 2021 will see a separation of the good from the not so good. A bifurcation in performance is coming that will present new buying and business growth opportunities for top performers.”