This is Why Multifamily Developers Have Soured on the Sunbelt

For years multifamily developers and owners have flocked to the Sunbelt cities to invest, drawn by the region’s fast-growing markets, great fundamentals and light regulatory touch. All that development, however, has taken a toll and this year, apartment rent growth in the Sunbelt markets is expected to be lower than that of Gateway cities, according to CoStar’s estimates. 

Rent growth for gateway markets will be fairly low, coming in at 1.4% for the end of the year, Joe Biasi, strategic consultant at CoStar Advisory Services, tells GlobeSt.com. But Sunbelt rent growth will be even lower at 0.04% growth, he says. 

This downward slope in rent growth began in Q4, in fact, and investors responded immediately.  For the first time since 2015, Sunbelt multifamily transaction volume was lower at the end of the year in 2022 than at the start. “Investors are looking at these markets like Phoenix and Raleigh and see that their rent growth expectations have gotten turned on their head,” Biasi says. “There is no rent growth and the exits don’t look good either.” 

This trend will continue into 2024, Biasi says, but beyond that the situation will turn again. “For the next two years the Sunbelt will struggle but in the long term a lot of things that made the Sunbelt interesting to apartment investors will not go away. Just because investors are taking a pause now doesn’t mean that is permanent.” 

To understand the region’s seesaw trajectory, it is important to grasp just how fast and furious development has been in the Sunbelt. “It is a little unbelievable just how high construction levels have been,” Biasi says. The share of multifamily construction in the Sunbelt as a percentage of total inventory is 7% right now, compared to 4.4% in Gateway cities. In 2019, product under construction in the Sunbelt as a percentage of total inventory was 4.9%, compared to Gateway cities’ 4%, he notes. 

The pandemic was one reason for the acceleration as more people migrated to states like Florida and Arizona, but there were other longer-brewing reasons as well that explain the rush to the Sunbelt, according to Biasi. 

One simply is that the South is cheaper for both companies and people. Despite the overall surge in rent growth of the last two years, the Sunbelt remains less expensive in terms of rent to income. There have also been a lot of corporate expansions into the Sunbelt, providing better job opportunities. “The Sunbelt has some of the fastest growing educated populations in the country,” Biasi says. “The makeup of those metros have changed significantly.” 

The Sunbelt has less rules around zoning too, which means there are not a lot of constrictions around construction. “A lot of growth combined with not many rules is how we got here,” Biasi says. 

The Sunbelt was set to continue this track but then inflation became embedded in the economy, putting a damper on people’s ability to pay their rent. The problem? Sunbelt developers bet that strong growth and continued spending would keep fundamentals strong. As it turned out, they were wrong. 

But as Biasi predicts, fundamentals and investors will return. “This is a short-term blip due to a huge pipeline.” Also, institutional investors have gotten a taste of the Sunbelt since the pandemic. Before COVID-19, institutional investors had been married to Gateway cities. 

The only longer-term concern about the Sunbelt is its low tax structure, which understandably is a huge draw. But as developers expand they will need services to support their projects, which could be difficult under the current tax regime, Biasi says.