Multifamily Challenges Include Rising Costs, Slowing NOI

A 7.1% increase in total operating expense is adding to the challenges multifamily investors are facing along with a glut of new units, according to a new report on the state of the nation’s housing in 2024 by the Joint Center for Housing Studies of Harvard University.

Rising insurance premiums were the main culprit for the higher costs. They rose 27.7% year over year in January 2024, especially in the Southeast with its greater exposure to natural disasters. The report cited RealPage data showing that per unit property insurance costs in the 50 largest metro areas have more than doubled since the start of the pandemic, with Florida most affected.

In addition, net operating income growth has slowed, achieving just 2.8% in 1Q 2024 compared to 24.8% in late 2021.

The report warned that these conditions have increased the risk of multifamily loan delinquencies. “Nevertheless,” it added, “delinquencies remain well below the 90-day peak of more than 4 percent reached during the Great Recession and are relatively low overall.”

Short-term loans are at greatest risk. Loans coming due in the near future will encounter much higher borrowing costs and the possibility of lower property values in light of rising capitalization rates. Such loans are generally held by banks or investor-driven lenders or in commercial mortgage-backed securities (CMBS).

“The 30-day delinquency rate for CMBS loans has increased for six consecutive quarters, hitting 4.3 percent in the fourth quarter of 2023, according to MBA. However, CMBS are a small share of all multifamily loans, and the most recent delinquency rate is only slightly higher than the pre-pandemic average,” the report said.

Another challenge investors face is higher interest rates and high treasury yields that have raised the cost of equity. “Apartments now need to provide greater interest returns to compete with Treasury notes. Consequently, projects are less financially feasible, and demand for multifamily investment is slowing.” This has led to a fall in property prices reflecting rising capitalization rates, beginning with a 14% slump in late 2023 and continuing in early 2024.

On top of this, borrowing and lending have slowed, with 46% fewer mortgage originations than in 2022. Multifamily debt outstanding has fallen off along with investment. The report cited MSCI data showing a 45% year-over-year plunge in multifamily transactions. New construction starts are also down. “This suggests an imminent downturn that may be difficult to reverse quickly enough to meet future demand.”

On the renters’ side, demand remains strong, the report noted. In 2023, renter households increased by 514,000, the highest annual increase since 2016. This lifted the number of renter households to 44.5 million in 2023. Growth is coming from the large millennial and baby boom generations, as well as Gen Z.

However, supply is still way ahead of demand for new apartments, which has affected rent growth. An influx of new multifamily units pushed the national rental vacancy rate to 6.5% in 1Q 2024. Vacancies in professionally managed buildings jumped to 5.9%. “As a result, rent growth slowed to 0.2 percent year over year in the first quarter of 2024 after reaching a record high of more than 15 percent annually in early 2022,” the report stated.

“According to the Survey of Market Absorption, 52 percent of new units were leased within three months of completion in the third quarter of 2023, down from a high of 75 percent in the third quarter of 2021. This indicates a slowdown in the market’s ability to absorb the rush of new units.”

In time, this could create the risk of a dangerous cycle. A drop in new construction and rising demand could set the stage for another round of rapid rent increases, adding to the affordability challenges the nation faces, the report warned.