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MULTIFAMILY OUTLOOK Don’t Be Surprised if it Continues to OutperformSHARE
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MULTIFAMILY OUTLOOK Don’t Be Surprised if it Continues to Outperform

Last year, most prognosticators for the multifamily sector predicted a record number of new units would cause rents to moderate and vacancies to increase. Sales of multifamily properties would dip below the record high levels of 2015, and price growth would slow down.

But that’s not what happened. Sales volume for 2016 is on pace for another record year and per unit sale prices were once again rocketing up in the fourth quarter after holding fairly steady most of the year.

So one can understand if market experts are a bit hesitant to hazard a prediction this year. But here is what is generally expected to happen in 2017: sales volume will dip below the record high levels of 2016 and price growth will slow down. From a predictive standpoint, it just makes sense, after all moderation has to set in sooner or later, right?

“Nonetheless, the forces that have produced the best multifamily market in recent memory remain largely in place,” said John Affleck, apartment research strategist for CoStar Group. In other words, the recent remarkable run in apartment demand and property values could just as well keep rolling.

The multifamily market continues to outperform other property sectors and has the lowest vacancy rate of all the major property types at 5.2% (as of the end of third quarter 2016.) In addition, also as of the third quarter, average rental rates experienced a 3.9% increase from 2015.

Aggressive pricing aside, the sector’s record of steady rent growth and high occupancy with low volatility continue to make apartment properties an ideal defensive asset as the economic cycle extends into a seventh year, Affleck said.

MULTIFAMILY OUTLOOK Don’t Be Surprised if it Continues to Outperform

He concedes that some cracks are beginning to appear, however.

“The unprecedented propensity to rent, even among the most affluent, represents the chief risk to the cycle. Historically low-interest rates and homeownership costs that have risen more slowly than rents have already coaxed some renters toward owning.”

Affleck said the trend is expected to intensify, especially among higher-income renters who can qualify for mortgages, those who would otherwise rent the priciest apartments.

“The [latest 2016] data points to a maturing cycle for multifamily, particularly for the priciest markets and properties,” Affleck added.

Although the national vacancy rate for multifamily property is projected to increase to 5.6% in 2017 and to 5.7% in 2018, even at the expected peak that is still below the 15-year average vacancy rate of 6.1%, according to CoStar Group. Meanwhile rental rate growth is expected to moderate over the next two years to 2.3% in 2017 and 2.2% in 2018, but still above the 15-year average growth rate of 1.9%.

Freddie Mac is among those who are confident that the multifamily market is being driven by solid economic fundamentals rather than leverage and speculation.

“We believe the fundamentals the market tracks, including values and rents, appear likely to continue growing, albeit at a more moderate pace,” said David Brickman, executive vice president and head of multifamily business at Freddie Mac.

Several economic and demographic factors are driving demand, according to Freddie Mac. Renter households are poised to grow in every generational cohort due to a range of economic and demographic factors. Positive job growth and a stable economy should help more Millennials form households and enter the market.

In addition, the combination of sluggish income growth, rising home prices and higher mortgage rates will likely delay home buying by many Gen Xers and prolong their tenure as renters. Finally, a significant fraction of the nation’s 67 million aging Baby Boomers are poised to downsize into more easily managed rental units.

On the supply side, absorption rates and occupancy levels exceed their historic averages. Tightening conditions for construction lending, plus significantly rising construction costs are likely to slow the pace of new deliveries. This will help mitigate the risk of overbuilding and keep inventory levels tight in all but a few markets.

Take all the above in consideration, and apartment rents are likely to rise in most markets, Brickman said. The exception, he noted, are in a select few coastal markets where the “friction” between elevated rents and modest income growth and a relatively strong supply of new units, is expected to slow or flatten rent growth for the next year or two.

“Properties are being priced fairly in most markets,” Brickman said. “When we take these factors together with today’s generally strong economy, we project annual new multifamily originations to keep expanding, albeit at a more moderate pace.”

Fannie Mae also joined the consensus of those forecasting a bit of a slowdown in the pace of rent increases and a slow rise in vacancy levels over the next 12 to 24 months.

“Considering the remarkable strength that the nation’s multifamily markets have demonstrated over an extended period, this easing off should come as no surprise,” said Kim Betancourt, Fannie Mae’s director of economics.

But then she added, don’t expect the moderation to be long-term. Easing multifamily fundamentals lasting several quarters, or even a year or two, are to be expected in any typical business cycle.

In the short term, expect concessions to rise before apartment property owners decide to lower rents.

“Considering that rent concessions have declined steadily for nearly seven straight years, and that their current level is now below 1%, it is probably only a question of ‘when’ and not ‘if’ concessions begin to rise again,” Fannie’s Betancourt added.

The industry considers concession levels of 2% as reflecting aligned and in balance apartment supply and demand, Betancourt added.

 

Source: CoStar Mark Heschmeyer January 4, 2017

Q4 2015 Apartment TrendsSHARE
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Q4 2015 Apartment Trends

Q4 2015 Apartment Trends

National Apartment Market

The national vacancy rate rose by 10 basis points in the fourth quarter – to 4.4 percent. This is the second consecutive quarter that national vacancies have risen, but these patterns do not necessarily suggest a massive weakening in apartment fundamentals. If anything, this was right in line with our forecasts at the beginning of 2015 that vacancies would finally begin to rise, after being stuck in the low 4s for a couple of years. Demographics and demand remain strong, but developers brought close to 200,000 units online in Reis’s 79 largest markets, pushing vacancies up in even places like Denver or Seattle, where the question of whether robust job creation and a vibrant economic environment could outweigh the thousands of apartments coming online. No, it couldn’t, and it didn’t. The vacancy rate in Denver rose from 4.3 to 5.1 percent in 2015, and in Seattle it rose from 4.7 to 5.3 percent. Denver and Seattle added what was in effect anywhere from three and a half to four percent of new inventory in 2015, and that exerted upward pressure on vacancies.

With that said, the apartment sector also had a banner year in terms of asking and effective rent growth – the other major driver of top line revenues, aside from occupancy rates. Asking rents grew by 4.6 percent at the national level, and effective rents grew by 4.7 percent. Those figures are stronger than the peak years in 2006 and 2007, and one would have to look back to the period from 1999 to 2000 to find rent growth figures that were comparably strong – and back then vacancies were in the low three’s.

So where is multifamily heading?

q4-2015-apartment-market-graph.jpg

Supply and Demand Trends

Our expectations for multifamily have not changed. We expect vacancies to rise through the end of our five year forecast period, but if this comes to pass and national vacancies end 2020 in the low 5’s, that just doesn’t spell doom and gloom for multifamily properties. Supply growth for 2016 will likely be stronger than the past year’s, adding to the upward pressure on vacancies, but this is not news either. If anything, there is anecdotal evidence of finance sources throttling back on apartment developments, waiting and seeing whether new properties that opened their doors lease up at an acceptable rate before they green light new investments.

What we are projecting for the multifamily sector is very much a soft landing, with ample runway for rent increases despite worries of median household income and wages not catching up. Now, that doesn’t mean rent growth won’t be cramped by rising vacancies – already, concessions are making their way back to places hardest hit by new supply. It just means that overall, while market players may need to backpedal on the most optimistic of double digit growth rate projections, demand and supply conditions for multifamily remain healthy. The riskiest play, as always, will be those submarkets and neighborhoods enduring large amounts of new supply – they face the larger risks of income loss and occupancy deterioration if we are struck by a recession over the next five years.

Source: REIS Victor Calanog on Feb 23, 2016