January 29, 2020
A year ago, as we entered 2019, trade talks with China were tense, the Federal Reserve announced that it would increase interest rates three times before the end of the year, and the federal government was in the middle of a shutdown. That these factors had little impact on multifamily speaks to the strength and resilience of the sector.
As we enter 2020, the Federal government is operational, talks with China have improved, and the Fed is so far taking a hands-off stance on interest rates. As such, it’s time to look ahead, and determine how current trends will impact multifamily construction, rents and investments in the coming year.
According to Marcus & Millichap’s just-released “2020 Multifamily North American Investment Forecast,” it’s anticipated that fundamentals will continue to support this robust sector. Additional factors impacting the industry will include:
- Continued household formation
- Increasing demand for, and scarcity of, workforce housing
- Rent-control legislation
- Financing and available capital
Certainly, other issues will affect the apartment sector over the next 12 to 18 months. However, the above will determine supply and affordability, two trends that are shaping the industry.
Household Formation, Unit Deliveries and Workforce Housing
Apartment demand comes from household formation, and there was a great deal of that in 2019. U.S. households increased by 1.35 million, thanks to continued job and wage expansion. Yet, only 1.17 million single-family and multifamily dwelling units were delivered.
Things aren’t likely to change in 2020, not with household formation growth forecast at 1.45 million, and approximately 1.25 million new dwelling units to be delivered. As tight as the market is now, demand will outstrip supply by another 200,000. Furthermore, most of that supply will consist of Class A product, while much of the demand is coming from middle-class to upper-lower-class households that can’t afford Class A rents. This will mean continued workforce housing scarcity.
We can talk about the social justice of workforce housing. But at the end of the day, it’s a math equation. The figures need to make sense. And right now, they don’t.
A primary reason is high development costs charged by municipalities. According to a National Multifamily Housing Council (NMHC) study, approximately 35% of development costs consist of so-called “soft costs,” the price tag attached to permitting, entitlements and zoning. This is in addition to rising material and labor costs. Developers need to recoup their investments, and absent tax breaks or subsidies, this means market-rate projects.
Additionally, not as many apartment-dwellers are moving into homeownership. First-time homebuyers are finding it difficult to qualify for home mortgages. Fewer starter homes are being built, due to limited capital availability. As a result, middle-income households remain renters, meaning lower vacancies and less available supply.
Rent Control Legislation
In 2018 and 2019, Oregon, California and New York passed laws to cap rents, with more states likely to do the same in 2020. Certainly, apartments can, and have performed well in such situations, but statewide rent legislation could mean more documentation and paperwork for operators and investors.
And, while rent-control legislation is thought to help reduce housing costs, the action actually exacerbates both affordability and deliveries. Because of the uncertainty inherent with rent control, developers will go elsewhere, to metros and states without rent caps. It is likely that fewer units will be built in states with rent-control legislation than if legislation did not exist, and the decrease in new supply will lead to rent increases.
Finally, increased housing costs can lead to higher costs of living, something corporations take into account when attracting and retaining talent. If employees can’t afford to live in certain locations, they’ll migrate elsewhere, with companies following them. The end result is that states with higher housing costs could end up with slower economic growth, as both housing developers and corporations choose other, more business-friendly areas in which to operate.
Capital Markets and Investments
The 2020 capital markets outlook is one of enhanced liquidity thanks, in part, to increased GSE lending caps. While capital will continue to be plentiful, underwriters are expected to apply conservative standards to the loans they make, depending on economic momentum and global issues. As such, developers and investors should expect to add more equity to any multifamily deal.
Basically, lenders are interested in financing smart investments. Equity or debt isn’t interested in the quality of granite countertops or the size of a swimming pool. The point here is that if a developer is building a product the market needs, and can achieve rents that will make the math work, the capital will be there.
We believe job creation and household formation will continue driving demand for housing, especially rental housing. We’re also anticipating an uptick in secondary market multifamily investments and developments, due to population migration. And overall, apartment demand should continue to be fueled by a slower move to homeownership.
Wild cards are in play with this forecast, however, and include:
- Geopolitical pressures. Ongoing trade wars, the upcoming U.S. election and a slowdown in the global economy can create uncertainty. Uncertainty, in turn, can hinder investor and business-sector decision-making.
- Construction costs. Labor costs are increasing as contractors struggle to find qualified workers. This, coupled with growing material costs, is slowing the pace of development, meaning fewer deliveries and project delays. While we anticipate an increase in construction completions in 2020, much of this represents a rollover of a portion of the delayed 2019 pipeline.
- Federal Reserve policies. Fed Chairman Jerome Powell indicated that few changes to the interest rate are expected in 2020. This could change, however, if the above-mentioned geopolitical scenarios mean increased risks to the U.S. economy.
To conclude, multifamily investors and developers will face many unknowns in the coming year. However, we believe that the continued strength of employment, combined with positive demographic drivers, will reinforce apartment demand and will favor multifamily real estate.
To learn more about our 2020 multifamily sector forecast, please click on this link.
For comments, questions or concerns, please contact Amy Sorter