Why Invest in Multifamily Real Estate?

Multifamily is one of the largest of the four major commercial real estate asset classes – alongside office, retail and industrial. The asset class occupies a growing share of institutional investor’s portfolios and is top of mind for many individual investors looking to capitalize on trends that surfaced during, or have been accelerated by, the pandemic. In this article, we look at the major advantages of multifamily real estate investing, and why we believe it is a particularly favorable time for the sector.

Provides built-in hedge against inflation while reducing risk

The Consumer Price Index (CPI) has increased 5.4% since September 2020. This may sound concerning, but what does it actually mean for multifamily real estate investing?

While office, industrial and retail properties typically have only one or a small handful of tenants locked into long-term leases, multifamily properties often have dozens or even hundreds of individual rental agreements (1 for every unit) averaging 1-year in term, with tenants turning over on a rolling basis. This arrangement provides downside-protection by minimizing vacancy exposure during economic downturns. On the other hand, consistent turnover of leases in a multifamily property allows management to gradually ratchet up average rents in accordance with prevailing market rates and commensurate with the rate of inflation.

For more on how private real estate can serve as a hedge against inflation, please see this article.

Multifamily exhibits low volatility

Peter Linneman, the principal of Linneman Associates, as well as the CEO and founder of American Land Fund and former professor at Wharton School at the University of Pennsylvania, recently described multifamily as a relatively safe investment. According to Linneman, multifamily has one truly unique advantage over other asset classes: the protection of Fannie Mae and Freddie Mac financing, which is predictable and readily available to borrowers large and small.

For context, federal agencies and government-sponsored entities hold 50% of the total multifamily debt outstanding as of Q2 2021.

It’s also worth noting that since housing is an essential function, multifamily tends to be less impacted by fluctuations or structural shifts in the economy. As a corollary, we could say that multifamily should be more resilient through market cycles. This holds true empirically: multifamily has yielded the best risk-adjusted returns since the inception of the NCREIF Property Index (NPI) in 1988*.

Multifamily Real Estate Investing: COVID-19 Update

As of Q4 2020, the U.S. had an estimated housing supply deficit of 3.8 million units, according to researchers from Freddie Mac. The strong demand for this limited supply of housing has contributed to the skyrocketing cost of single-family homes, particularly at the “entry level” for first-time homebuyers.

This affordability gap was further exacerbated during the pandemic. Many renters who would be inclined to homeownership could not afford to do so. Some young adults even moved in with their parents, albeit temporarily. Given the high cost of homeownership and the expected increase in household formation, there’s every indication that demand for multifamily housing will remain strong.

Multifamily Market-Level Insights

EquityMultiple’s Asset Management Team communicates with Sponsors around the country and provides regular portfolio updates for our investors. See below for our insight into a few markets with recent multifamily investments that have performed particularly well during COVID-19.

Multifamily Rent Growth in Richmond, Virginia

Rent growth across the country surged in Q2 2021, especially in Richmond, Virginia. Demand drivers included:

• Strong wage growth
• Increased personal savings over the last year
• A tightened for-sale home market amid rising prices and lack of supply.

In Q2, average rent in Richmond grew 5.2% quarter-over-quarter and 9.9% year-over-year—the highest rates in the city’s history. This is especially encouraging considering Richmond has long been considered a stable rent growth market. The robust renter demand in Richmond has led to a 4.9% vacancy rate, despite a nearly record-setting 3,000 units delivered in the past twelve months. This is the lowest vacancy rate since 2002.

Multifamily cap rates also compressed in Q2, averaging 4.9% in the first half of the year, about 100 basis points lower than the average cap rate in 2020.

Migration to Greenville, South Carolina

Inbound migration to Greenville has been on the rise in recent years. Greenville even topped the list for highest demand for multifamily in the COVID-19 period, according to a CBRE report. REIS projects delivery of 752 units to the metro by the end of this year, with a net total absorption of positive 857 units. Other REIS forecasts worth calling out:

• Vacancy rate is forecasted to trend downward to 5.6%.
• Between 2022 and 2023, REIS projects 1419 additional units will be added.
• REIS anticipates net new household formations at the metro level during 2022 and 2023 will average 2.1% annually, enough to facilitate an absorption rate averaging 729 units per year.

These trends are particularly noteworthy at this time when the forecasts in many markets have lagged as the economy rebounds. Market fundamentals continue to support higher rents going forward.

Cap Rate Compression in Houston, Texas

Houston made our list of markets to watch in 2021. Among other indicators, it has a low unemployment rate, and strong population growth.

Cap rates in the Houston market moved dramatically this year, with Class A stabilized multifamily properties now trading in the 3.5-4% range. In addition, occupancy increased from 88.4% in Q2 2020 to 90.7% in Q2 2021, and rents were up 7% annually.

Demand Returns to Austin, Texas

Demand has returned to downtown Austin, as many urban amenities have now reopened, and new jobs continue to draw new residents. In fact, 57,000 jobs will be created–an expansion of 5.2%, and the fastest annual growth rate in 15 years. This spike in demand has fueled a jump in rent prices, with the average effective rent rising 7.1% in Q2 alone.

Construction activity has also picked up as developers anticipate further growth. In 2021, Austin’s inventory will expand by 4.9%, the fastest growth rate among major U.S. markets.

Low Vacancy Rates in Denver, Colorado

The Denver multifamily market just recorded one of its best quarters in the past five years. Investor sentiment remains high, as rents have increased 10% YTD. Vacancy rates also dropped from 7.1% in Q1 to 5.8% in Q2 – the largest quarterly decrease on record. At the same time, unemployment fell to a 12-month low of 5.9%.

Employment Gains in Phoenix, Arizona

While all top 30 U.S. metros experienced rent growth this year, Phoenix topped the list at 22%, according to Yardi Matrix. This is likely due to the surge in demand and lack of available supply, as Northmarq notes. Much of this demand can be attributed to the promising employment metrics. In fact, Phoenix was the seventh best performing metro in the Sunbelt in June, having gained back 78% of job losses since May 2020.

2022 National Multifamily Investing Outlook

EquityMultiple maintains a bullish outlook for multifamily as we approach the beginning of Q1 2022. We believe the combination of strong rent growth and competitive interest rates near historic lows creates potential for more attractive risk-adjusted returns.

Our team is keeping our eyes on the markets we called out in this article, all of which have experienced significant growth in the past year. However, we can also see similar trends playing out across the country. In August, for instance, multifamily rents rose 10.3% year-over-year, and occupancy grew almost 1% year-over-year to nearly 96% nationwide. On top of this, home prices were up 23.5% YoY in June, a record high.

If home values continue to increase at this pace, we expect even more would-be owners will be priced out of the market. Thus, demand for multifamily has the opportunity to rise accordingly (along with rent prices), in 2022 and beyond.

EquityMultiple makes it easy to invest in multifamily real estate projects from experienced sponsors. If you have any questions about multifamily real estate investing, please feel free to schedule time with Investor Relations or sign up for a free account to start investing today.

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 *https://www.clarionpartners.com/News/CPNewsLibrary/USMultifamily%20Investment%20Opportunity%20Post-COVID_%20Final.pdf

All opinions expressed herein constitute the author’s judgement as of the date of this article and are subject to change without notice. Statements made are not facts, including statements regarding trends, market conditions and the experience or expertise of author are based on current expectations, estimates, opinions and/or beliefs. Such statements are not facts and involve known and unknown risks, uncertainties and other factors. Past events and trends do not predict or guarantee or indicate future events or results.