Multifamily Housing in the Pandemic: Setting the Stage for 2021
COVID-19’s impact upon the multifamily sector has been driven by a combination of pre-existing conditions and entirely new, unprecedented market forces, which together create an uncertain outlook for 2021.
Fortunately, multifamily properties have proven resilient through November. Despite slightly weaker rent and occupancy metrics, capital market transactions have rebounded and prospects for the sector are positive, as evidenced by stable cap rates and property valuation index increases.
Though the usual forces of supply and demand apply, performance in the multifamily sector over 2021 will be driven in great part by the government’s policy response to the pandemic and the speed in which a vaccine can be produced and distributed.
A quick look back
At the beginning of 2020, multifamily was regarded as one of the two clear leaders in commercial real estate, trailing only the warehouse/logistics sector. The Real Capital Analytics Commercial Property Price Index (CPPI) for multifamily indicated a 9.6% gain in values year over year, and it was one of two sectors where annual rent growth exceeded annual expense growth.
Concerns in the sector revolved around two factors, the first being oversupply of Class A units in urban cores. Evidence of this trend could be seen in submarkets such as downtown Nashville and midtown Atlanta, where units under construction exceeded five percent of existing inventory.
The second concern focused on rising construction costs associated with land acquisition, construction labor and building materials, which were affected not only by high demand but also supply chain issues related to international trade. These rising costs demanded higher rents to ensure profitability, which directed construction efforts to submarkets where those rents could be achieved, not necessarily to markets where demand was greatest for multifamily housing. In fact, the largest component of demand in the sector was (and still is) for Class B and C workforce housing. But the rents necessary to justify the rising costs of construction did not — and still do not — exist without government subsidies.
The pandemic response — CARES Act and politics
The prospects for multifamily dimmed considerably in March as the first wave of what would be 20 million total job losses crashed down on the American economy. Rapid action in the form of the CARES Act, signed on March 27, provided an initial lump sum payment to many renters and augmented the unemployment benefit to those who had lost their jobs, directly addressing the first new concern driven purely by COVID-19: widespread rent collection losses.
This assuaged the short-term fears of renters to some degree, but did little to pacify apartment owners and developers, who lobbied in vain for direct assistance at the Federal level. This effort continues today through the National Multifamily Housing Council (NMHC) and other industry trade groups.
Conventional wisdom in March suggested that the pandemic would be short-lived, and the CARES Act unemployment booster of $600 per week was set to run only through July. Though multifamily rent collections fell roughly in line with 2019 figures from March to July, there was an expectation that collection rates would fall substantially in August with the expiration of the CARES Act subsidy. That expectation has proven unfounded, and 2020 collections have remained very near the levels seen in 2019, as seen in the chart below from the NMHC.
Source: NMHC.org, "NMHC Rent Payment Tracker," November 6, 2020
That said, it is important to understand that the great majority of units in the NMHC collection survey are nationally managed and tracked by large property and data groups. Smaller complexes, along with Class C units, may be underrepresented in the sample. Since “mom and pop” developments and Class C units are exactly the types of projects that would be impacted most by the massive job losses in the hospitality and service industries, it is likely that collection loss is greater than that indicated by the NMHC survey. Rent collection is a very real concern, and the longer the virus threatens the economy, the more likely it is that collection losses increase.
Closely related to the issue of rental collection is the existing moratorium on evictions for tenants who have not paid rent, the second multifamily issue directly driven by the pandemic. Created by executive order and carried out through the Centers for Disease Control on August 8, the order suspended evictions of non-paying tenants through the end of 2020.
As no additional stimulus measures have been approved, and with the transition of the presidency in a state of flux, it is impossible to say what may or may not be available to renters and landlords by year-end. Though both Nancy Pelosi and Mitch McConnell agree that a stimulus package is necessary, the gulf between their respective ideas of what would be feasible is very wide.
President-elect Biden’s stance on issues concerning multifamily is detailed in a summary presented in the October 2020 issue of Multi-Housing News. Regarding rent payments and evictions, Biden has supported an emergency housing support program that would prevent evictions and allow for some sort of rent forgiveness, clearly championing the plight of the renter. However, Biden has also proposed several affordable housing strategies that could signal opportunity for multifamily developers, including a $20 billion increase in the National Housing Trust Fund, expansion of the Low-Income Housing Tax Credit (LIHTC) Section 42 tax credit program by $10 billion, and an increase of up to $640 billion to improve public housing.
The fact that most of these initiatives are due for cuts in the 2021 budget, the uncertainty of action in Washington, and increasing vitriol in Congress make for a hazy outlook in 2021 for multifamily.
Looking ahead — five trends
Given these many uncertainties, what trends are clear in the multifamily sector? Here are five that will significantly impact performance in 2021 and beyond.
1) Multifamily cap rates remain stable
At the U.S. investment grade level, PWC reports multifamily cap rates moved a scant three basis points from 2Q (5.19%) to 3Q (5.22%). Real Capital Analytics’ Hedonic Series National Multifamily Cap Rate moved from 5.0 to 5.2 percent, a move related to quality of assets traded, not market conditions. Similarly, RERC’s southern first-tier multifamily cap rate index rose 20 basis points from 5.5 to 5.7 percent.
2) Despite higher costs, construction is still robust
Per CBRE Research, multifamily construction starts are up approximately 20% year over year as of September. This includes a dip in unit construction during April and May. Some developers have stated that now may be the best time to build, as the 12-to 18-month construction window should be more than enough to get past the pandemic. That said, late 2021 and 2022 starts could wane as evidenced by slowing permit volume, down 22% year over year as of September.
3) Metrics vary widely among different classes and geographies
Class A properties show evidence of negative rent and occupancy growth, particularly in urban core markets. As previously mentioned, these are exactly the same markets that carried oversupply November 2020 Multifamily Housing Outlook risks before the arrival of COVID-19. Conversely, Class C properties generally are exhibiting rental growth and higher occupancies. Even with a wave of January evictions, the shortage of workforce housing could actually strengthen the rent rolls of Class C properties in the longer term. This supply issue was also present before the pandemic and will be a major focus of the next administration in Washington.
4) Multifamily properties are trading
The RCA Multifamily Commercial Property Price Indices (RCA CPPI) rose 6.7 percent year over year in 3Q 2020, vastly outperforming the all-property index gain of 1.4 percent and ensuring the sector’s place as a preferred product type. Though volume was down 67% in 2Q 2020, the decrease improved to -51% in 3Q 2020. As opposed to the last recession, liquidity is readily available.
5) Demographic and socioeconomic trends support the multifamily sector
Though older Millennials may be moving into suburban single-family housing at a greater rate, home prices have increased approximately 10% and the median price of an American home is over $300,000, per the National Association of Realtors1. There were over five million more unemployed people in October compared to February, and the first Generation Z members to test the waters of the workplace are finding slim pickings. A lack of affordability and changes in preferences bode well for the prospects of the multifamily sector.
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