Inside Multifamily’s Supply Problem

Multifamily, most would agree, has a supply problem right now. There is too much development in the pipeline and it is likely to keep rent increases moderate for the foreseeable future. But is the issue overstated and are worries concerning supply overblown?

The answers to these questions depend very much on the location and timeline being considered, and as Jay Parsons, senior vice president and chief economist at RealPage, puts it, “Oversupply is a more nuanced topic than we give it credit for.”

“Supply is a different factor in different places and in many parts of the country. In low- and middle-income neighborhoods we aren’t seeing a lot of supply. Where we do see a lot of supply is not just the Sunbelt but across the country — in and around downtown neighborhoods, in other wealthier suburban pockets. Supply will not have the same impact in every part of the country,” Parsons says.

There is also variance on type of property. Affordable housing, for example, is fairly immune. The longer horizon and greater stability provides somewhat of a buffer against short-term market fluctuations.

“With public funds, there is no turning on a dime, so we’re locked in for quite a while,” says Rochelle Mills, president and CEO of Innovative Housing Opportunities. “In many ways it’s more stable. Our occupancy rates are 98% and higher and we have waiting lists up to 10 years.”

Jay Lybik, national director of multifamily analytics at CoStar Group, says that while there is indeed a supply problem currently, it’s different from gluts of the past and needs to be understood as such.

“If you went back to the late 1990s there wasn’t much of a price difference between the new garden and the existing garden product being built. The pain of oversupply was being felt across the sector,” Lybik says. “The biggest difference we’re seeing today is the pain is isolated at the top end, because the price difference between the top end and the middle of the market is pretty large ($600). $7,200 a year in housing expenses is a lot of money and so it creates a ‘moat’ to the middle of the market.”

Paul Fiorilla, director of research for Yardi Matrix, points out that while deliveries are high, they are not necessarily surplus to requirements over the long term. The National Multifamily Housing Council has estimated 3.5 million new multifamily units will be needed to meet the demand over the next decade.

“There are more than one million units under construction, which is the most it’s been in decades, but there’s a lot of demand. That’s why rents went up a combined 22% in 2021 and 2022, because there was more demand and supply of housing of all types,” says Fiorilla. “We under-built coming out of the global financial crisis and we’re catching up now. New supply is needed.”

Roughly 350,000-400,000 multifamily units have been built per year over the past six or seven years, and Yardi Matrix forecasts that 485,000 units will be completed this year and 500,000 in 2024. After that, deliveries are set to decline to about 400,000 due to the impact of higher construction financing costs and tightening bank credit.

RealPage is predicting that multifamily starts drop 30%+ in 2023 versus 2022, with the drop-off accelerating in the second half of the year. Completions are on track to peak in the second half of 2023 through 2024.

“It’s just too difficult an environment today to maintain 2022’s blistering pace,” Parsons wrote in a comment piece for GlobeSt in June.

“Much of what broke ground already in 2023 were deals that were largely worked in 2022 before the fall of Silicon Valley Bank and Signature Bank put pressure on even healthy banks to curtail lending. Plus, developers have the added challenge of trying to find equity and debt at the same time supply hits 30-year highs and rent growth drops off.”

The total number of units under construction doesn’t tell the full story, Parsons also points out: it’s the relative expansion rate that matters more. At peak, new supply expanded the U.S. multifamily stock by 6.5% in 1973. At peak in this cycle, the inventory expansion rate will measure 2.2%, according to analysis of U.S. Census Bureau data.

Geography matters hugely when discussing supply versus demand. The Sunbelt is the poster child for the oversupply problem but many other parts of the country are faring much better.

“The Midwest is holding up the best right now. Deliveries on Sunbelt are up 60% from 2019 before the pandemic. In the Midwest and Northeast, deliveries are up only 8%. Chicago, Indianapolis, Columbus and Cincinnati are above their pre-pandemic five-year averages. Even markets like Washington, DC, are not stellar but are not bad,” Lybik says.

The supply under construction is concentrated in 10 or 12 of the most rapidly growing markets, Fiorilla says. The number of units coming online is concentrated in places like Austin, Phoenix and Denver — the fast-growing Sunbelt and Mountain West markets where there are growing populations and rapid job growth. “They’re looking to add supply to meet the demand in those markets. In the short term, the supply in those markets is going to outstrip demand. Demand is now decelerating to normal levels, and supply growth is really high, so in places like Austin, Charlotte, Denver and Nashville, Miami they’re going to see some increase in vacancy rates and rent growth will slow down,” he says.

“Demand is strong across the country with exceptions like San Francisco. Demand in New York City is extremely strong while there’s not a huge increase in the supply.”

Jimmy Holloway, chief investment officer and principal at Home Communities Company, a development and investment management company in Birmingham, AL, seconds the point that the supply issue is not uniform across the country. “Depending upon the area there is still a need for housing. In the Southeast the market demand is still there, it’s just getting pricing to line up to a return that makes sense,” he says.

Situations vary even within markets, Fiorilla says. “There are some sub-markets and neighborhoods where there could be a lot of supply in the market, but you could go to some other parts of the metro and there will be little to nothing.”

Adam Perry, senior vice president, development and construction, at Cityview, also says the supply issue is very “sub-market specific.” In Los Angeles, where he operates, there does not seem to be an oversupply as it was absorbed during the pandemic, especially in the downtown area. Creative leases also helped to soak up excess supply, he says.

“Los Angeles is still very supply constrained when you look at the number of jobs created/brought in versus the number of new houses units being built. There’s a huge spread between those two metrics,” he says, adding that the strong return to offices in the city has also helped.

It’s a different story in Northern California, which is dominated by tech companies that have more of a relaxed policy when it comes to working from the office or remotely. “We see depressed rents in those markets and a ton of supply coming online. Oakland and San Francisco are tough markets — major cities in the Bay Area that have not fully recovered from the pandemic yet. [But again] it depends on where you are, properties in Denver and Oregon are performing well, for example,” Perry says.

“Where” matters, and so does “when.” Timing is everything and there is a general consensus that even in the areas where oversupply is causing headaches, they will abate.

“There will be a tightrope we’re walking for the next 12-18 months in terms of, ‘do you buy now or continue to wait until rent growth is more stable?’ But once the supply is soaked up, we will see rents returning to level or above the national average rent growth,” says Lybik. “There will once again be good investment locations.”

Fiorilla predicts: “Over the next year or two, the big increase in supply will have an effect on occupancy rates and rent growth, which will slow in many markets until those new units get digested. Long term, those [over-supplied] markets will be fine. Rent growth goes in fits and spurts.”

Parsons of RealPage agrees that oversupply is a short-term concern but less of a long-term issue. “There’s going to be more supply than demand over the next couple of years, the demand will be there. It just may take longer than the developers want and they may not get the rents they initially expected to get,” he says.

And in the meantime, patience is in order.

“Strategy is important now. If you have a long-term view and [are] not in a position where you have to sell in the short term where you would see price compression, you’re going to be OK,” says Parsons. “For those who have [the] ability and flexibility to ride this out they will be rewarded for that. There’s a tongue-in-cheek saying in the industry: survive until ’25. That’s because in 2025 we’ll see significantly less supply and by that point the market will see more demand drivers.”