Thoughts Regarding the State of the Multifamily Industry
The multifamily sector experienced several headwinds over the course of Q1 2023, but MBP believes that embedded in the data are several sources of optimism. While most investors are focused on interest rates and the lending environment, MBP believes that one of greatest challenges has been the abundance of new units coming online during 2022 and 2023.
While multifamily demand soared during the pandemic, it has since slowed and could decelerate further if the economy weakens as expected in the second half of the year [1] . U.S. household formation between September 2020 and December 2022 totaled roughly 4.2 million, but that formation has dropped over the course of Q1 2023, meaning that apartment deliveries could play a larger role in rent increases than in recent years [1] .
The slowing demand comes as roughly one million apartments are under construction across the US with almost 900,000 units coming online by the end of 2024. In Dallas, there are approximately 36,000 units scheduled to come online over 2023 [1]. While this might present short-term occupancy headwinds, MBP believes that the DFW market can easily absorb these new units and the robust demand was the basis for developing these units.
MBP believes that the development is an indication of positive investor sentiment as there are many tailwinds for the DFW market. For example, as of April 2023, Texas still has over 1 million job openings, and Dallas’s year-over-year job growth again leads the US [2] . Even against the backdrop of rising rates and tightening lending, the DFW job market is still expanding quickly, adding 16,900 jobs in January alone [2] . The DFW metroplex added nearly 226,000 jobs over the trailing 12-month period ending January 2023, roughly double the average annual gains before the pandemic, according to the US Bureau of Labor Statistics [2] .
Adding further support to this case is the recent Census Bureau estimate, which listed Fort Worth as the metroplex that experienced the nation’s largest population increase over 2022 [3] . This jump in population moved Fort Worth to number 13 on the list of largest US cities, the fifth Texas city in the top 15 [3] . This means that one-third of the 15 largest cities in the US are located in Texas.
It is important to note that, while vacancy rates have ticked up slightly ending Q1 2023 at 4.4%, this is still below the long-term average of 5.4% [4] .
The Federal Reserve continued its battle against the self-inflicted inflation it created over 2020 through 2022. Over the course of Q1 2023, inflation data showed that the Fed’s rate hikes, and tightening policy are yielding results, as inflation fell to 5.00%, the lowest level since March 2021. Still, there have been casualties. The tech industry has shed over 102,000 jobs through April 2023 and is on pace to surpass the highest annual total for the sector announced in 2001. US based employers announced a total of 89,703 cuts in March alone, up 15% from February and 319% year-over-year [5] .
While this may seem like negative news, MBP believes it is an indicator that the economy is responding effectively to the Federal Reserve’s current monetary policy, signaling that further rate hikes and tightening may not be necessary. This is because the Federal Reserve relies on the conventional wisdom that a tight labor market leads to rapid increases in wages, which translates to an increase in consumer demand, fueling inflation further.
As the Federal Reserve continued to wage war on rising prices, cracks began to emerge in the banking system. The first of these cracks presented on March 8th , when Silvergate Capital Corp. declared plans to voluntarily liquidate itself after suffering losses following the collapse of the disgraced cryptocurrency exchange FTX.
Two days later, US regulators closed the doors on Silicon Valley Bank (“SVB”), a prominent lender among tech start-ups and VC firms in San Francisco. Four days after the closure of SVB, US regulators shut down Signature Bank, another institution with significant exposure to the cryptocurrency industry. Finally, the failures of these regional banks created a perfect storm for First Republic Bank, where customers and investors panicked causing a run on the bank and resulted in regulators stepping in, again.
To date, First Republic Bank, SVB, and Signature Bank are currently the second, third, and fourth largest bank failures in US history, respectively, after Washington Mutual. When combined, the three institutions held assets of $532 billion, surpassing the $526 billion owned by the 25 banks that failed during the 2008 financial crisis.
One of the common threads amongst these failed banks is that their assets were heavily invested in long-dated Treasury bonds and mortgage-backed securities, which exposed them to large unrealized losses due to the unprecedented rise in interest rates over the course of 2022-Q1 2023. The inverse relationship between interest rates and treasury values left many banks with losses on their existing Treasury positions.
The failure of these regional banks has prompted many investors to speculate on the potential for a credit crunch. It is certainly true that regional banks play a vital role in the US economy, providing lending to many small businesses, and are a significant source of capital for the Commercial Real Estate sector. However, recent data from research firm MSCI indicates that regional banks hold a relatively small percentage of apartment loans. Over the last decade, regional banks account for only 10%-20% of first mortgage originations to multifamily borrowers [6] .
MBP believes that this is again an unexpected source of optimistic news. As lending standards have tightened and the cost of capital has risen, bank originations on new construction have dropped considerably, down approximately 60% year-over-year [4]. We believe this is an indicator that the headwinds presented by hyper supply in certain submarkets could be limited to the short-term.
Additionally, the impact of tightening lending standards does not impact multifamily alone. While home prices hover near all-time highs and mortgages remains significantly elevated, the barrier to home ownership continues to worsen. These dynamics continue to create demand tailwinds for the multifamily sector.
Higher interest rates continue to make renting more economical than owning. As of the first quarter of 2023, the average multifamily rent is $699 less than the total median monthly home payment [4] . Average rent-to-income ratios in Dallas, MBP’s target market, remain healthy for all renters averaging 27.1% as of April 2023 [1] .
There is no denying that the economy is in a transitional period, still recovering from the overabundance of liquidity and historically low interest rates which fueled unprecedented inflation. However, MBP believes that there is evidence to suggest that the multifamily sector is both resilient and well positioned to weather a potential recession. While the short-term may be volatile, MBP believes that investors with a long-term focus will continue to benefit from allocations to multifamily over the course of 2023 and 2024, especially as debt maturities force owners into distressed sales.
1 Yardi Matrix. (2023, May). National Multifamily Report (Yardi Matrix Industry Report). Retrieved from Yardi Matrix database.
2 GREA. (2023, April-May). Multifamily Market Report (GREA Industry report for Dallas-Fort Worth). Retrieved from GREA, LLC database.
3 Dean, J. (2023, June 3). Fort Worth posts nation’s largest population increase in 2022, Census Bureau estimates show. Bizjournals.com. https://www.bizjournals.com/dallas/news/2023/06/03/population-fort-worth-census-bureau.html
4 Newmark. (2023, May). United States Multifamily Capital Markets Report (Newmark industry report). Retrieved from Newmark database.
5 Challenger, G. & C. (2023, April 25). Job cuts rise 15% in March 2023, up 319% from same month last year, highest Q1 since 2020. Challenger, Gray & Christmas, Inc. https://www.challengergray.com/blog/job-cuts-rise-15-in-march-2023-up-319-from-same-month-last-year-highest-q1-since-2020/
6 Shaver, L. (2023, May 8). Bank failures make construction loans even more challenging. Multifamily Dive. https://www.multifamilydive.com/news/multifamily-finance-apartment-construction-starts/649487/
