As much of the commercial real estate market languishes, the multifamily segment seems to be enjoying its time in the sun. From the Twin Cities—where 67 percent of all new building permits last year were for multifamily, the highest in 22 years, according to Housing First Minnesota and Axios—to continued rent growth in cities such as Dallas and Denver, the case for investing in multifamily assets remain highly compelling. Above the immediate trends that may drive region-specific performance, there are three long-term financial trends that will influence multifamily commercial real estate investing: inflation, rising interest rates, and demographic shifts.
Inflation Risk Management
During inflationary economic periods, residential rental properties outperform other CRE segments due to the short-term nature of residential leases. When residential leases come to term, rent increases are able to reset the balance between rental income and rising operational expenses. For residents, inflation will coincide with higher salaries allowing them to afford higher rents.
Through the pandemic, nationwide asking rents increased 21 percent, while household incomes increased at approximately the same rate. Current rent expansion is less aggressive, but across the U.S. rents are still growing by 4.8 percent compared year-over-year. Though the Fed’s actions to combat inflation will eventually work, target inflation is unlikely to return to sub-2 percent and rent levels will be able to continue to adjust.
Impact of Interest Rates and Demand
Multifamily assets sit in a sweet spot compared to other real property opportunities because demand for housing remains strong and new supply is still extremely limited.
In fact, even with some markets experiencing record new building over the last few years, there continues to be a severe housing shortage across the U.S. According to the latest Freddie Mac research, the U.S. will continue to have an estimated housing shortfall of 3.8 million units, and housing demand is set to outpace housing supply for the foreseeable future.
Rising interest rates will aid in continuing to widen this gap. As rates increase, the cost of capital increases, and new construction becomes difficult to pencil for developers. This means that we will see smaller development pipelines, making an already supply-constrained market even tighter.
Demographics and Housing Shifts
In the single-family home market, the combination of rising interest rates and low supply, which is keeping housing prices elevated, has made the cost of owning increasingly difficult. So, in the face of higher down payments and monthly mortgages, households are renting longer. By mid-2022, the share of homes purchased by first-time buyers declined from 34 to 26 percent, the lowest level in at least four decades.
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