Is the Fed Worried About Multifamily Overbuilding?

KC Conway

ATLANTA—The Federal Reserve’s latest Beige Book release indicates that economic activity has expanded in nine of the districts since the last report. Residential and commercial real estate activity improved with stronger activity cited for multifamily construction. We caught up with KC Conway , SunTrust Commercial Real Estate ‘s credit risk manager and head of valuation, to comment on the Federal Reserve’s latest Beige Book release. He told us while Beige Book findings are anecdotal, they provide color that is useful when paired with the statistical realities in a market. In the case of the most recent Beige Book release, he says the information is generally in line with trends we are seeing in many SunTrust regions. “The Federal Reserve and other bank regulatory agencies have been signaling since mid-2015 that they had concerns about the rising levels of commercial construction activity,” Conway says. “Therefore, the comments in the latest Beige Book indicating that construction activity remains robust is not surprising.” As Conway sees it, the comments suggest concerns are focused around multifamily construction and are largely due to the “rate of increase” in activity since the trough of the 2009 housing-led recession and financial crisis. SunTrust acknowledges that there has been a material increase in the amount of overall commercial real estate activity—more so in multifamily and hotels than other property types—but a dissection of this “rate of increase” across markets suggests there has largely been good fundamental support for multifamily construction. “The fundamental demand driver for multifamily development has been job creation, and SunTrust studies the jobs-to-permits ratio to look for overbuilding risk,” Conway says. “Ratios of seven-to-one to eight-to-one in terms of jobs-to-completed multifamily units—and five-to-one for jobs-to-new multifamily permitting and planning activity—are considered the thresholds where overbuilding risk exists.” Except for a handful of Southwest and energy markets, as well as select Southeast markets, Conway says there still exists a healthy balance between job growth and multifamily construction activity across a majority of markets in SunTrust’s footprint. He points to Atlanta, as an example, with its jobs-to-permits ratio of approximately seven-and-a-half-to-one due to strong job growth that exceeded 85,000 in 2015. “The measure that SunTrust focuses on as a more forward-looking metric for overbuilding risk in multifamily real estate is jobs-to-permits, and not so much the ‘rate of change’ year-over-year,” Conway says. “The Beige Book also highlighted some concerns about the rate of increase in multifamily rents as an item to monitor.”