Despite some reservations before the start of the year, multifamily real estate performed well in 2018. But as we look toward the beginning of the new year, it would prudent of investors and owners to prepare for as the market is expected to shift in a different direction.
Earlier this week, Karlin Conklin, a value-add multifamily expert with a transactional volume exceeding $1.3 billion, outlined three primary factors that could shift the multifamily market in the upcoming year including “pressure from volatile financial markets, a growing housing supply, and emerging development risks.”
Interest Rates And Multifamily
With the economy cruising at a comfortable level, The Federal Reserve has had their foot on the break throughout 2018. It raised the federal funds rate to a 2 percent to 2.25 percent during its November meeting, making it the third rate increase of 2018. A fourth and final increase is expected to come during the Fed’s December meeting. But how will this affect multifamily real estate in the coming months?According to Conklin, debt pricing “looms as the largest multifamily market mover in the coming year… And more so than any other investment, real estate class, or multifamily asset, pricing is tied to debt pricing.” Overall, as borrowing becomes more expensive, the more cap rates will have to be adjusted; and as a result, Conklin sees 2019 as more of a buyer’s market with acquisitions being motivated by assets that are “right priced” to account for rising interest rates.
Supply or Demand?
Throughout 2018, operating dynamics were favorable for multifamily real estate. The combination of increasing rents and high occupancies often resulted in operating expense surpluses. Although, that sweet spot did not last forever. In fact, the industry has started to see a decline in demand, and many markets are now over-supplied. Conklin uses Seattle and Boston has prime examples. Over the last five years, the two markets had “red-hot rent growth” and attracted plenty of developers to capitalize on the high demand and low supply.
Fast forward to November 2018. Seattle and Boston are now pushing through multifamily deliveries that ” put the brakes on rent growth to levels between 0% and 1.5% on a year-over-year Q3-2018 basis, according to Zillow. That compares with annualized rent increases from 2015 to 2017 near 7% in Seattle and 5% in Boston and Nashville.”
In summary, it’s important for investors, owners, and developers to realize how new deliveries are, and will, impact asset values in their current and prospective markets as demand and supply begin to invert.
Beyond the macroeconomic factors that consistently dictate multifamily trends, variables such as trade tariffs, labor shortages, and local government regulation will shape the path for multifamily real estate’s near future.
On a national level, trade tariffs on materials such as steel, lumber, and electronic components have bumped the cost of construction line items by more than 10 percent year-over-year. There has been a specific labor shortage in the construction sector due to a rise in labor costs. The National Association of Home Builders reported in a recent survey that 69% of its members were experiencing delays in completing projects on time due to a shortage of qualified workers, while other jobs were lost altogether.
Post-recession rent growth has put housing affordability in the spotlight, and local governments in some markets are responding with affordable set-aside mandates and rent control proposals. For example, many cities in California have seen the number of citizens vying for citywide rent control vastly increase. Fortunately for multifamily investors and professionals, rent control propositions in California have generally been unsuccessful.
Overall, Conklin still sees opportunities for new construction and renovation in 2019, but with a thinner margin of error.
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