The Boom in U.S. Multifamily Housing

The recent increase in interest rates and the likelihood of additional increases in the coming months sidelined many investors worried about a U.S. recession. So, they will miss a once-in-a-generation chance to invest in multifamily housing since experts say occupancy rates will stay above 95% for the foreseeable future and net effective rents will grow by nearly 7% next year. [i] While parts of the economy will cool due to the U.S. Federal Reserve's action, the demand for shelter continues to swell.

For decades, the United States has failed to build adequate housing (single and multifamily units). The housing industry failed to produce enough housing stock for the country's growing population. From 2010 to 2020, the number of households grew faster than the number of homes built, according to the Rosen Consulting Group. "There has never been such a severe lack of homes in the U.S.," said NPR reporter Chris Arnold.

Supply and Demand Forces

The confluence of supply and demand forces determines real estate prices. When supply is greater than demand, prices drop, and vice versa. It's important to look at both sides of the supply and demand equation to figure out where prices are likely to go in the future and how much money an investment is likely to make back.

The Supply of Housing Units is Stable

The number of housing units added to the nation's inventory since 1965 is significantly less (20 percent) of the number of new households added during the same period. The latter is 20% higher than the number of new homes built since 1965. From 2010 to 2020, household formation exceeded housing production by nearly 3.2 million units. While new house construction has increased in recent years, it would still take more than 20 years to close the 5.5-million-unit housing gap at its current pace. [ii]

The annual increase of multifamily units – a substitute for individual houses – has been insufficient to meet the increased need for shelter. According to the National Multifamily Housing Council, the country needs to add 528,000 new apartments yearly at different price points to meet expected demand. Since 1989, production has exceeded 500,000 units just three times. 

The pace of new housing, including multifamily units, is unlikely to grow significantly in the next three to five years due to

• Community resistance to new construction. The combination of regulations, municipal mandates, and zoning requirements, coupled with the emerging residential NIMBY (Not-In-My-Back-Yard) sentiment, restricts development, increases costs, and extends construction periods.
• Shattered supply lines. The Wall Street Journal reports that global supply-chain woes have stymied the flow of goods and materials critical for home building, including windows, garage doors, appliances, and paint. Prices for materials are increasing. John Paul Joy, a contractor in Philadelphia, notes, "Where we would pay $2.60 for 2-in x 4in dimensional lumber, it's now costing $6.84."
• Skilled labor shortages. The industry is struggling with significant labor shortages. Ed Brady, CEO of the Home Builders Institute (HBI), says, "From 2022 through 2024, this total [of new units needed] represents a need for an additional 2.2 million new hires for construction… The construction worker shortage has reached crisis level." Brady expects the construction labor shortage will intensify as other industries rebound from the Covid-19 pandemic and offer higher wages.
• Restrictive financing policies. As interest rates rise in response to the Federal Reserve's actions, lenders pass along the higher costs and raise underwriting standards for construction projects and sponsors. Many small lenders and banks have reduced real estate construction portfolios, with private lenders assuming their role. Consequently, projects deemed "marginal" are less likely to be financed.

Many investors turn to single-family homes for rental as an alternative to multifamily properties. In 2021, the single-family build-to-rent (SF BTR) sector accounted for $1.5 billion, a minute percentage of the $335.3 billion in multifamily sales in the same year. Adding SF BTR properties will not increase the housing supply during the decade.

The Demand for Housing is High and Continues to Grow

Demand for housing has exceeded supply for years. Recent financial and social changes have intensified the number of people looking for shelter and the prices they are willing to pay to secure a place to live. The factors that created the increased desire are likely to continue for years, including

• Changing lifestyle preferences – Millennials – the largest generation in U.S. history – are disinclined to own a home. They are "renters by choice." A 2020 Zumper survey found that almost one-third do not consider owning a house part of the "American Dream." One-quarter of the renters surveyed declared that they never plan to buy a home. Unsurprisingly, one-quarter of those owning a house consider it a burden and wish they were renting instead.
• Major demographic shifts – Older people typically downsize their living space by moving into smaller homes or multifamily communities after raising families and nearing retirement. The sale of their current homes adds to the inventory of available housing. As interest rates rise above their 20-year average, Baby Boomers tend to hold onto their homes, unsure of any savings from buying a new, smaller property. They will most likely relocate to a community-based, multi-family facility when they sell. A 2019 National Multifamily Housing Council report found that renters aged 45 and above account for almost 30% of rental households.
• High ownership expense – A 2018 study found that renting was less expensive than owning a home. The gap may widen as property taxes and maintenance costs increase.

• Increased financing costs – "In April [2022], 30-year fixed mortgage rates averaged nearly two percentage points higher than one year earlier. With the growth in home prices, the monthly principal and interest payment to buy the median-priced home was up about 50% in April compared with last April," says Dr. Frank Nothaft, Chief Economist of CoreLogic.  

A first-time buyer of a median-priced new house ($450,600) with a loan-to-value (LTV)of 80% ($360,480) with a fixed-rate 30-Yr mortgage will pay more than $420 each month for the 2% difference. Consequently, it is not surprising that a  survey of potential homebuyers in 2022 found that 26% were unlikely to buy a home with the recent interest rate increase.

Supply and Demand Gap Drive Rents and Occupancy Higher

Due to the high demand, landlords can raise rents without jeopardizing occupancy rates. Since multifamily rents are usually one year or less, property managers can quickly take advantage of strong demand. Conversely, the length of the leases dilutes the impact of sudden competition with a nearby property. Experts project that Class B and C properties, buoyed by residents fleeing the higher costs of Class A properties, will have more flexibility to raise rents over the intermediate term. Kriston Capps of Bloomberg notes, "The housing shortage is so severe that property owners likely don't need to charge max rents to make a bundle."

Driven by a lack of available multifamily units and access to higher-income renters, multifamily occupancy for the Class A, B, and C multifamily asset classes are above 97%, well above any year since the mid-1980s. While occupancy rates are likely to drop as new multifamily properties are available, remaining above historical occupancy average rates (95%-96%) for two to five years is expected.

Final Thoughts

Investors today have a rare opportunity to invest in desirable U.S. multifamily properties when the demand for housing units is much greater than the supply. By historical standards, financing for appropriately selected properties remains readily available. The potential to update or rehabilitate Class B and C properties, especially in the United States secondary markets, is largely untapped.

Multifamily real estate combines the potential for regular cash-on-cash income, consistent appreciation, and substantial tax advantage without the volatility of equity investments or the low returns of debt instruments. Owning real estate is like owning a 24-7 money machine; it never stops working to put money in your pocket.

[i] Staff. (2021) U.S. Real Estate Market Outlook 2022, Chapter 6 Multifamily. CBRE. (December 8, 2021) https://www.cbre.com/insights/books/us-real-estate-market-outlook-2022/multifamily

[ii] Rosen, K., Bank, D., Hall, M, Reed, S. and Goldman, C. (2021) Housing is Critical Infrastructure: Social and Economic Benefits of Building More Housing. Rogan consulting Group for the National Association of Realtors (NAR). (June 2021) https://cdn.nar.realtor/sites/default/files/documents/Housing-is-Critical-Infrastructure-Social-and-Economic-Benefits-of-Building-More-Housing-6-15-2021.pdf