Monthly Economic Insights- March 2024
Interest rates are still relatively high. What is the outlook for the multifamily housing sector?
As we stand at the convergence of a surging stock market, stabilizing inflation, and persistently high interest rates, many investors are keenly searching for opportunities that balance risk with growth potential.
One sector that may deserve closer examination under these economic conditions is multifamily housing. Since “owner rents” are typically a significant component of overall inflation calculations, we thought it might be good to take a brief look at the trends in this industry and what they could mean to investors.
The stock market's robust performance in recent years, particularly in a period where inflation seems to be held at bay, paints a picture of economic optimism. However, the central bank's strategy of maintaining high interest rates (for now) introduces a layer of complexity and creates a nuanced landscape for investment, especially in the multifamily housing market.
Why multifamily housing? The Multifamily Housing sector, characterized by rental properties with dozens, hundreds, or even thousands of units, currently stands out for several reasons:
- Multi-year low valuations. Most publicly traded multifamily REITs (Real Estate Investment Trusts) are down 30% or more from their peak (some more than 40%). This has been driven by higher interest rates and new supply of multifamily housing (apartments, etc.)
- Resilience. In the last 25 years, vacancy rates have ranged between 5%-9% across the industry (we are around 6% today). We would expect vacancy rates to remain relatively low today as the spread between the monthly cost to own a home vs to rent is at an all-time high (around $2700/mo to buy vs $1850/mo to rent) even exceeding the 2006 housing bubble ($1500/mo to buy vs $1050/mo to rent). This is likely a favorable backdrop for rental demand.
- Supply growth appears to be peaking. Starts (new construction) peaked in mid-2023 as rates were increasing as well as the cost to build. This peak in starts should lead to a peak in deliveries (i.e., finished product) around the middle of this year (2024), with a significant decline in deliveries expected in 2025. Supply growth in the US is expected to peak at a little under 3% in 2024, fall to less than 2% in 2025, and likely decrease further in 2026 (estimates are calling for sub 1.5% supply growth).
What are the challenges for the sector?
- Operating expenses have been increasing: more specifically, property taxes and property insurance have increased materially in recent years.
- Some operators have seen an uptick in bad debt expense (tenants unwilling or unable to pay their rent on time).
Bottom Line: Investors eyeing the multifamily housing market would typically consider several factors such as:
- Location. Areas experiencing less supply growth today or slowing supply growth are key. Another consideration is population growth/migration patterns driving higher rental demand.
- Interest rates. Softer fundamentals and higher borrowing costs have negatively affected property values and created buying opportunities.
- Diversification.* Including multifamily housing in an investment portfolio offers diversification benefits, mitigating risk by spreading exposure across an asset class with good underpinnings.
While multifamily housing could be an appealing avenue for investors in a landscape marked by a strong stock market, moderating inflation, and elevated interest rates, it will likely require a longer-term investment horizon since new building activity needs to continue to slow with the Federal Reserve potentially cutting interest rates as a secondary driver to these bond-like investments.
— Marcus Scott, CFA, CFP®, Chief Investment Officer (CIO) for Country Club Trust Company
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The opinions and views expressed herein are those of the author and do not necessarily reflect those of Country Club Trust Company, a division of Country Club Bank, or any affiliate thereof. Information provided is for illustrative and discussion purposes only; should not be considered a recommendation; and is subject to change. Some information provided above may be obtained from outside sources believed to be reliable, but no representation is made as to its accuracy or completeness. Please note that investments involve risk, and that past performance does not guarantee future results.
*Please note that the diversification concepts discussed do not necessarily guarantee a profit or eliminate all risks including the potential for loss of principal.