The multifamily market remains a darling of commercial real estate investors. Even with rising interest rates, the fundamentals of the sector remain strong. And investors are increasingly broadening their search to sink their dollars in Class-B apartment buildings.
Those are some of the key points from the sixth annual Powerhouse Poll Outlook released this February from Berkadia.
Berkadia surveys investment sales advisors and mortgage bankers two times a year. This most recent Powerhouse Poll included the opinions of 144 respondents and was conducted from December of 2022 through January of 2023.
The results of this most recent poll reflect the struggles that multifamily investors are facing because of higher interest rates.
But Ernie Katai, executive vice president and head of production for Berkadia, said that the multifamily sector, despite the higher interest rates, remains a strong one.
“People are lamenting and gnashing their teeth because of interest rates,” Katai said. “But apartment buildings are still 95% occupied across the county. We are seeing rent growth of just a little less than historical norms, 3.3% versus 3.5% on a year-over-year basis. And we just came off a period of amazing rent growth. The market is fundamentally strong. We are just seeing a pause in investment activity and multifamily sales because rates have bounced up.”
Katai said that he expects investors to return in greater numbers to the multifamily market once interest rates stabilize. When that happens, though? That’s uncertain.
Katai said that the market might not even see interest rates stabilize in June of this year. It all depends on when the Federal Reserve Board decides to stop boosting its federal funds rate. Many economic analysts are predicting that this will happen in the second half of this year. But no one knows for certain if this is true.
Part of the issue investors are facing? People are spoiled by interest rates of 2% or 3%. Historically, though, even today’s higher rates would be considered low, Katai said. And it was unreasonable to expect those historically low interest rates to stay in place for much longer.
“The one thing the market hates is uncertainty,” Katai said. “It paralyzes activity. At some point, the national players will start transacting again. Then I think we’ll see a bit of a herd approach. Investors have money they want to get out into the market. Someone must be brave enough to get things started again. It’s not FOMO, or fear of missing out. It’s fear of making a mistake.”
Here’s how Katai’s “fear of making a mistake” works: If investors don’t make any deals now, they won’t get into trouble. But if they close a transaction and that deal ends up in a loss? They could damage their bottom lines. Many investors, then, prefer to play it safe and wait out the uncertain interest rate environment.
“That’s what leads to paralysis,” Katai said. “It’s just the mindset right now.”
When will we see more multifamily investment sales? Katai said that interest rates need to stabilize and owners need to accept that their multifamily properties might not be worth as much as they were one or two years ago.
“People might have thought there their property was worth $100 million a year ago but maybe it is only worth $80 million today,” Katai said. “Real estate is just math. It’s not overly complicated. Look at it from the perspective of owning a house: Maybe your house was worth $350,000 last year and now it is worth $275,000. You might think, ‘I’m not going anywhere now.’ Take that to the multifamily level. That’s what multifamily owners are thinking now. The industry is a little spoiled. It had a great run.”
What were some of the more interesting results from the most recent Powerhouse Poll?
- Not surprisingly, respondents were concerned about interest rates. According to Berkadia’s poll, 54% of respondents said that interest rates, inflation and fears of a recession would have an extreme impact on investment activity this year. An additional 45% said that these economic concerns would have a moderate impact on multifamily investment activity in 2023.
- A total of 51% of respondents said that they believed that the country will fall into a recession in the next 12 months, while 36% said that the country was already in one. A total of 12% said that the country would not see a recession during the next 12 months.
- In another interesting result, 59% of poll respondents said that Millennials will make up the highest percentage of multifamily renters during the next two years, while 31% said that members of Gen Z will lead the rental market.
- What about want renters want? The Berkadia poll found that 66% of respondents said that location and security were the most important factors to renters looking for a multifamily property. Only 26% said that interior and common-area amenities were the most important factors, while only 2% said that renters are focused first on smart-home technology.
An evolving mindset
When investors are ready to close multifamily transactions again, what will they be looking for?
Katai points to the growing popularity of Class-B apartment assets.
Not too long ago, investors considered Class-A multifamily properties to be the best home for their investment dollars. Today, though, investors realize that a far greater number of renters can afford Class-B apartment units.
“It’s a bigger pool of potential renters,” Katai said. “Most renters live in Class-B apartments. Why not invest in something like that? It’s hard to argue against that mindset.”
The Class-B apartment market looks especially inviting today when you look at inflation, Katai said. As the price of so much continues to rise, many renters will look to Class-B spaces to save money on rent. These properties might not feature the latest amenities such as rooftop pool decks or concierge services. But if the units are safe, secure and clean, renters are eager to snap up Class-B space, Katai said.
And that makes these more modestly priced apartment properties attractive to investors.
A recession on the way? Already here?
One of the more interesting results from the Powerhouse Poll was the high number of respondents who said that the United States will see a recession during the next 12 months and the respondents who said that the country is already in a recession.
Katai, though, said that he wasn’t entirely sure how deep any recession will be.
“It feels to many in this business that we are already in a recession because our business in the fourth quarter of last year fell off a cliff,” Katai said. “There were minimal transactions. Everyone was down double-digit numbers. A recession is when it hits your house. A lot of producers feel that way. But are we really in a recession already? That is harder to decide.”
And when investors are making multifamily transactions, what kind of deals are closing? Katai said that bigger deals are not necessarily better today. Today’s multifamily transactions are more commonly smaller deals closed by private investors, while larger institutional investors are mostly waiting out the uncertainty.
“We are actually very busy at Berkadia,” Katai said. “People are trying to figure out what the values of their properties are. There is a lot of conversation about deals, but there aren’t as many fish on the hook. Owners want to know what the market thinks their properties are worth. When they see the numbers, they step back. No one is sitting around staring at the walls. But the execution is not there yet.”
The importance of safety
Another interesting response in the Berkadia survey was the importance of security for renters. Katai says that this is the first time he’s seen safety pop up as what investors think renters are most concerned about.
Katai said that this isn’t surprising, though. After COVID, the streets of many major downtowns feel less safe than they did before the pandemic.
Katai sees this firsthand. He lives in Chicago and notices that downtown still isn’t as busy as they were before the days of the pandemic.
“It bums me out a bit,” Katai said. “I love the hustle and bustle of the city. But I’ll finish dinner at a restaurant and walk home and not see anyone out. This is Chicago. What’s happening? The cities are still not back at their pre-pandemic activity level yet.”
This doesn’t mean, though, that the multifamily market in downtown areas is dead. Katai says that younger adults are still renting in the middle of bigger cities. In fact, the Berkadia poll found that large metropolitan areas are still seeing the greatest number of multifamily transactions.
The poll listed secondary metropolitan areas as seeing the second-highest amount of multifamily transactions, while suburban areas were seeing the third-highest.
“That caught my attention,” Katai said. “If you remember during the height of COVID, suburban occupancy levels went through the roof. People wanted more space. To see suburban activity drop to number three? That caught my eye. If that holds up in our next poll in June, that will be an interesting trend.”