Despite some near-term challenges, multifamily growth prospects and fundamentals remain healthy. Construction is normalizing, demand is robust, distress is concentrated and troubled properties will be recapitalized as institutional investors deploy dry powder, according to a recent Trepp analysis of the multifamily investment landscape.
Nearly 592,000 multifamily units were completed last year, a 50-year high. This supply wave has been largely concentrated in Sun Belt markets, which has resulted in owners dealing with higher vacancies and downward pressure on rents. Markets like Boston, Chicago, San Diego and Washington, D.C., where growth is slower and barriers to entry are higher, have held up much better, said the report.
“We have strong conviction that the investment thesis surrounding the sector and the Sun Belt region will play out over the next three to five years,” said the report. ”However, during this market reset, it is our view that it will take several more quarters of demand exceeding supply before rent growth accelerates in a meaningful way.”
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One of the multifamily sector’s primary challenges is higher operating expenses. Trepp’s line-item expense data report shows individual operating expenses for multifamily properties have increased from 16.5% to 99.5% during the past five years. Repair and maintenance costs are up 16.5%, real estate taxes are up 16.6%, utilities are up nearly 21% and property insurance expenses have doubled, the report said.
In addition, financing issues resulting from a reset in floating-rate debt may have impacted many owners, said Trepp. The company’s data shows there were more than 5,100 multifamily properties with a debt service coverage ratio (DSCR) below one within the securitized universe and the Sun Belt markets had the highest concentration of underperforming loans. Particularly, Houston, San Antonio, Atlanta, Dallas/Fort Worth, Phoenix, Miami and Charlotte all reported some of the highest percentages of outstanding loan balances with DSCR below one among major metros, according to the report.
Shining some light at the end of the tunnel is a slowdown in multifamily construction activity. The current construction pipeline is 750,300 units, which is scheduled to deliver over the next two years, a meaningful dip compared with the recent wave of new supply.
Recent rapid declines in the 10-year Treasury yield also could present an opportunity for owners to refinance existing debt, which may lead to better loan performance, according to Trepp.
By examining data from public multifamily REITs, Trepp developed some insights into the multifamily investment landscape, including that despite increased competition for newly built units, occupancy levels remain healthy. Net operating income remained positive during the fourth quarter for almost all REITs, except notably MAA, which maintains a portfolio primarily in the Sun Belt region.
Meanwhile, positive rent growth for renewal was partially or completely offset by rent declines for newly signed leases, said Trepp. Resident turnover was historically low as residents opt to stay in their units longer, which reflects delays in marriage and starting a family.
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Kristen Smithberg
Kristen Smithberg is a Colorado-based freelance writer who covers commercial real estate, insurance, benefits and retirement topics for BenefitsPRO and other industry publications.
