If you were to focus solely on the slowing pace of rent gains, burgeoning supply and the rise in interest rates, you might assume that the real estate market isn't in a strong place right now. But despite all of the above, the multifamily market is in a healthy position. Demand is being driven by encouraging demographic shifts and a strong economy. Despite moderating elements, because the economy is healthy, the apartment market is similarly healthy, even if the boom from earlier in this economic cycle has tapered off.
GDP growth came in at 2.3% for the year in 2017, and a whopping 4.2% in Q2 2018. Consumers are buying confidently provided that tax cuts will improve yearly income even despite stagnant wage growth. Our multifamily clients are anticipating that U.S. rent growth should maintain its current pace, largely thanks to cities in the South and West, where supply hasn't outpaced demand.
According to the Spring 2018 Yardi Matrix U. S. Multifamily Outlook report, given the state of supply and demand in most metro areas and the steady economy, rents are projected to increase by 2.9% nationwide this year, with heavy concentration in late-stage southern and western U.S. markets. However, concerns about affordability are keeping prices from rising at an exceptionally fast rate, and new supply is also helping to keep those costs level. As for the supply, completions are expected to maintain the same steady pace they have over the past few years. Absorption rates are anticipated to remain strong for the remainder of the year, and 290,000 additional units are expected to finish construction by 2018, resulting in a 2.2% increase of stock. Another big factor that's supporting the real estate market is the steady flow of capital pouring into the industry.
Given all this, the outlook for multifamily units remains bright and stable, barring unforeseen risks, in most locales. Real estate investment requires assessing local markets, so analyzing the data from individual property markets is always wise.
Opportunities And Risks For Multifamily Developers
The economy appears to be in a healthy state. Reduced taxes from the recent Tax Cuts and Jobs Act and the booming equity markets combined to increase consumer confidence in the early part of the year. Last year's 2.3% increase in the GDP was driven largely by business investment and exports, according to the Yardi report. However, the market is also volatile right now, given the shake-up in international trade stemming from tariffs and strong-arm trade maneuvers with some of the U.S.'s trade partners. Still, short of an actual recession that hasn’t shown up in any predictions for this year, the multifamily sector will withstand any market volatility.
However, the biggest outside factor that is likely to impact commercial real estate markets is the threat of rising interest rates. The Treasury seems to be considering 3%, which would make it higher than it has been for the past few years. Given the federal deficit and anticipated economic growth, rates are much more likely to increase than decrease, which could have a major impact on the cost of debt.
The oldest millennials, now in their mid-30s, may be impacted by the rate increase as they consider homeownership versus renting. Most millennials are still in their 20s, however, meaning that there shouldn’t be a major shift in demand for multifamily rentals in the short term. Moreover, this doesn’t change the predictions of steady and continued job growth, which will continue to decrease unemployment, increase wages and balance out interest rate hikes.
Supply And Demand Trends
Development has been slowing down for the past two years, with over 300,000 completions nationwide, compared to this year’s forecast of only 290,000 completions according to the Yardi report. This is likely because projects have been taking longer to complete, an issue that stems both from rising material costs and shortages of labor. That means that the current rate of development should stay steady instead of rising to meet demand. This won’t affect the multifamily market in the next year, but it’s something to watch in the future.
Demand, however, should continue to be strong, especially considering that developers are going to be more cautious about projects given the problems listed above and the increasing cost of land, Yardi reports. Some metro areas, like New York, have a glut of luxury developments that are more difficult to fill. Other cities that have historically had high demand are seeing a loss of interest. Washington, D.C., and Austin are good examples of this trend, and rent growth in those markets should be low going into 2019 due to competition. However, on a national scale, development should roughly pace with demand.
Are developers bringing the right product to market? Yardi reports that most new developments have focused on the luxury portion of the market, while demand has been increasing for middle-income renters at a much faster rate than for those that can afford luxury units. As a result, a larger number of luxury housing has been left unoccupied.
The smart money right now is investing in developments that cater to mid market multifamily living. Markets on the edge of urban cores, including outer boroughs of New York City as well as suburban markets within short commuting distances of metro areas, are prime locations to invest and meet the growing demand of middle-income renters seeking value and affordability.
Outlook
Despite a few negative trends, the multifamily market will remain stable and strong through the remainder of the year. The market is most active in southern and western regions, especially near up-and-coming tech hubs, and the economic conditions are still solid enough to support a healthy real estate market moving into next year. Those looking to invest in developments would benefit most from non-luxury projects aimed toward the outskirts of metro centers, since the demand for more affordable housing is rising and most new projects are adding to an already crowded luxury market.
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