Q&A | Making Sense of the Multifamily Market
As national pressures mount on the economy, the current state of the multifamily market is one of long-term appreciation and opportunistic opportunities. With inflation soaring and interest rates up, questions about the vacancy and rental rates are being raised. In this Q&A, Matthews Real Estate Investment Services™ featured agent, Taylor Avakian has all the updates on current trends and dynamics within the multifamily market today.
What strategies can be made for multifamily owners in the current economic environment?
In terms of strategies that can be implemented during the current economic environment, I suggest most owners still look at writing a significant amount of offers on deals where the prices make sense for the cost of their capital. Whether through equity or debt financing or credit union financing, write offers and keep your finger on the pulse. The last thing you want to do is to take your foot off the gas and have a bunch of fantastic deals you could potentially leave on the table. Remember to follow up with brokers, look at the sales comps, and understand the value of your property and deals, ensuring you keep track of the market.
What future trends are you seeing for multifamily?
Future trends I’m seeing right now are apartments offering unique amenities to drive rents and tenant engagement, as well as increasing the amount of rent you can get for an apartment. You have to be more creative when it comes to attracting the right tenants and adding value in the right ways with the right amenities. This way, you can get the tenant pool and talent you want in your building. There are a lot of distractions and hurdles with the governments and laws that owners must overcome, but if you can attract good tenants and increase your rents year-over-year you will find success in multifamily.
Another trend or strategy I’m seeing in multifamily is investors in the current debt market looking for more stabilized yields and less value-add specifically in Los Angeles. This is because the rent control laws have been so difficult to navigate and execute, a value-add investment is ideal for investors who want a 6% to 8% return, it is sometimes easier to do that with these stabilized deals than the traditional value-add multifamily in Los Angeles.
How will rising interest and mortgage rates impact the housing market?
The housing market is going to be directly impacted by what’s happening with mortgage rates and debt yield spreads rising, which means that for an investor to receive the same amount of return, they need to have a higher going-in cap rate or a higher spread between the current cap rate, market cap rate, and have a direct plan to be able to get there.
Right now, there is a gap between buyer and seller expectations. This has caused the market to slow down because sellers don’t want to sell at today’s prices and buyers don’t want to pay the prices that sellers want. There’s typically a seven to nine-month lag in the cap rate and we’re about five to seven months out before the markets start to even out and expectations for buyers and sellers are on the same level.
Are you seeing any new developments in the pipeline that can help with the affordability crisis in Los Angeles?
Yes, I am seeing quite a bit of new developments in the pipeline that can help affordability in Los Angeles because the city and the state are putting money behind programs that are investing and incentivizing owners and developers to build affordable housing. However, they still make it very difficult for developers to go and execute a building. An example of this is the builder’s remedy, which is not necessarily a law that was put in place to directly benefit developers, but it is directly benefiting developers to build more housing. Interestingly, the cities that were put under this builder’s remedy are fighting back despite needing more affordable housing. It begs the question of what can be done to help with the affordability crisis in Los Angeles.
In my opinion, we need to allow builders to build properties that fit with the neighborhood but let them streamline the process and incentivize them to make money by also providing affordable housing.
How is cap rate compression impacting multifamily? Do you think we’ll see decompression shortly?
Since about 2008, cap rates have compressed from 6% or 7% down to 3% depending on the value-add nature of the building. Right now, we’re seeing cap rates decompress, making the value of the property worth less. When property cap rates decompress it makes the value of a multifamily investment greater because it multiplies the value and NOI of that property on a multiple return basis, which is a cap rate basis.
How do you characterize rental rate increases over the past few months? Do you think it will continue?
In terms of rental rate increases over the past few months, it’s declining in most sunbelt states. In Los Angeles, there’s been a slight increase of approximately 2% but it’s slowed down from the torrid pace over the last ten months. If you look at where rates have gone for one-bedrooms in Los Angeles from 2007 to 2017, average rents went from $1,000 to $1,200, and from 2017 to 2022, it went from $1,200 on average to $1,600, a 33% rental increase in five years compared to a 20% increase over 10 years from 2007 to 2017.
This tells me that it is very unlikely for the rental increase growth to continue in these neighborhoods specifically because we are headed into recession. Also, the demand for this rapid amount of growth, the income, and the economy seems to be very doubtful based upon what the Fed strategies to drive down inflation numbers. If inflation numbers continue to rise, then yes, we will see an increase in rent growth because there’s always going to be a demand.
There’s a huge decline in mortgage applications as interest rates surge – how is multifamily filling this need?
Multifamily has become a place to plant capital. Multifamily is a secure asset that’s going to continue to appreciate long-term and allow you to have some sort of passive income if you buy right. I would say if you were going to try and invest in multifamily in today’s market, buy at the number that makes sense for your investment goals. I would be holding a significant amount of cash ready to strike when the cap rates reach the level where the market dictates it, which will be significantly higher than they are today. So if you’re looking to buy at a higher cap rate at a higher return and you have cash, you will get a better return in six months than you would be getting today. With that being said, I’m seeing a ton of buyers with more money down because of the debt service coverage ratio that’s required and getting a better return at 6% or 6.5% than 4% in bonds. A lot of people would rather put their money in a six-month treasury bill than a 5.5% return apartment building.
Is there anything else you would like to add regarding the current state of the multifamily market?
The current state of the multifamily market is one of disconnect. There is going to be a slowdown in the next six months when sellers and buyers work to get on the same page and figure out the ever-changing market. A lot of people say that they don’t know what the future holds but, I would say we know exactly what’s going to happen in the future. We are going to be in a recessionary environment and prices are going to go down, the value of your property will continue to decline day over the day as interest rates continue to rise, specifically for investment properties. These are investments that have to make money or be some sort of investment vehicle for cash. No one buys multifamily property to lose money so with that being said, I see the multifamily market continuing to grow over the long term because people need housing. After COVID-19, housing became a very strong market to put your money in, and even if you look at where the rents have risen over the last five years you would have made a killer return based on the rent growth versus other asset classes. In the long term multifamily is going to be a very solid investment and there’s going to be a lot of institutional cash coming into this market, but the current state of the multifamily market is going to be one of slow growth with long-term thinking and opportunistic buying opportunities.