The biggest tailwind for multifamily real estate investment continues to be rent growth. According to realtor.com, median rent for rental units of up to two bedrooms in the top 50 metro areas of the U.S. hit a record peak of $1,941in July 2022, the 17th consecutive month of increases. That increase represented a 22.4% increase from the prior two years.

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What goes up, however, must come down—or slow down, to be more accurate: The red-hot rent growth of the past three years is showing signs of moderation. In September 2022, the same realtor.com report shows two consecutive months of declining rent growth, down to 7.8%, which remains a historically very high percentage for growth. According to CoStar’s third-quarter2022 report on rent growth in the U.S., demand was up 9.2% year over year, but that figure reflects an 11.4% decline from the end of the first quarter; it’s the third consecutive quarter of declining demand. The decline is worth watching as rent prices remain very high and markets that have more units scheduled to be delivered by year-end may feel a greater pinch.

However, the same report states that the Sun Belt states, including Florida and Texas, continue to exceed the national average. Even as rents cool somewhat, that data supports our long-term optimism that we are focusing on the best markets for continued returns. A normalization of rents across the board is healthy from the unsustainable spikes we saw in 2021.

It may sound counterintuitive, but inflation operates as both a headwind and a tailwind for multifamily investments. The Consumer Price Index, which measures average changes over time in the prices of goods and services, is aggregated to track inflation rates. Because one of the biggest components of the CPI is housing and rent, increases in demand for rental housing are helping to create inflation. From an investment perspective, in order to beat inflation, it helps to be where the highest inflation is occurring, and that’s multifamily housing.

The cost of building materials has increased 35.6% since the start of the pandemic, according to the National Association of Home Builders. The need for qualified labor predated the pandemic and skilled jobs remain difficult to fill, with Home Builder magazine asserting that the construction industry needs 2.2 million net hires from 2022 to 2024 in order to fill demand.

As we noted above, these higher costs have been more than covered by the increase in rental revenue, but we have been studying and working with these cost issues for years. In 2017 and 2018 valuations for value-add projects were starting to compete with, or overtake, valuations for newly built projects, a trend that was amplified by investor demand as capital flooded the market in 2020 and 2021. That is why it made sense for us to shift our internal focus on ground-up development, which would cost less to develop and command premium rents.

Many economists disagree on the timing, duration, or depth of recession. And at Freedom Venture, we don’t make predictions, but we do feel confident that if and when one occurs that it’s very unlikely to be a real estate-led recession like the one we experienced in 2007-09, which was triggered by a subprime mortgage crisis, among other issues.  

In place of predictions, we look to the probabilities and anticipate that valuations are at the high end of their expected range, and those will moderate over time. CoStar’s national director of multifamily analytics, Jay Lybik, said the combination of all-time high rent prices, “tempered consumer demand” and a record 450,000 units expected to be delivered by the end of the year could mean a sharp rise in vacancy rates in the next six months, according to Globe Street.  

According to historical economic data, the percentage change in the median sales price of houses in the U.S. outpaced the percentage change of the CPI in each of the past five decades—even the 1970s, the most inflationary period of the past 40 years. During this challenging period, when we’re seeing inflation rates reminiscent of the ’70s, data like this is a useful reminder of how the hard assets of real estate build value over the long term.

Now is the time to be cautious, be judicious with leverage and buy only assets with potential for good cash flow at stabilization. We’ll approach the coming months the same way we always have, with a risk-management mindset and a focus on creating value in multifamily investing that leads to real wealth for our investors.  

As the storm clouds of an economic downturn created gusting headwinds challenging all asset classes this year, CRE players expressed confidence that the high-flying multifamily sector—which has seen unprecedented rent growth during the past two years—is prepared to weather the storm.

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“Multifamily should remain a preferred investment destination in the near-term given its strong defensive characteristics, liquidity provided by government-sponsored enterprises and continued disruptions in other property types,” says Mike Wolfson, director of Capital Markets Research at Newmark, a sentiment shared by many market analysts. “Past pauses in the capital markets, such as those immediately following the 2016election and COVID-19 lockdowns, have been very short-lived for multifamily in particular,” Wolfson added.

As the economy began to sour in Q2 2022 and speculation over the scope of the downturn intensified, buyers and sellers in the multifamily sector migrated into two camps: those who feel compelled to close deals now seeing opportunity ahead, and those who are deciding to pull back and wait for the next cycle.

However, the consensus projection is that tightness of supply in the housing market will continue, delays in new construction will persist and would-be first-time home buyers facing sticker shock from home prices averaging $450,000 still will need to find apartments to live in.

On the financing front, we’ve seen lenders taking a much more conservative approach to underwriting, reducing leverage levels to 50% to60% of cost. We believe the dislocation in the debt markets will provide opportunities for preferred equity positions over the next 12 to 18 months at even more protected positions within the capital stack at higher yields.  

We have seen these cycles of lenders pulling back before. In2015-16, new fiscal policy required additional capital reserves from banks that issued construction loans—a challenge for developers trying to secure construction financing. A similar situation emerged from May 2020 through early 2021 amid the pandemic. And we expect it to persist over the next year to 18 months as the Fed battles inflation by raising short-term borrowing rates.  

Longer term, we see significant tailwinds for multifamily investment and development. The U.S. still has a shortfall of nearly 4 million multifamily and single-family units. The interim slowdown in single-family for-sale development will exacerbate this problem. So, while we expect to see increased vacancies and concessions as we head into mid-2023, we anticipate strong long-term demand.  

As investment managers in the multifamily real estate space, we have experience in navigating dramatic market cycles. Today, we’re using that expertise to scrutinize the big picture and the smallest details to find the best investment opportunities. Our priority continues to be protecting and growing the wealth of our investors. Now, more than ever, we believe that our investment partners will value the extensive risk-mitigation efforts that have positioned us as a leading investment manager. We value your partnership as we overcome the adversity and seek out new opportunities together.