The multifamily sector, which has been known to outperform other major commercial real estate sectors, is on track to continue this positive trajectory. A notable increase in the sector’s cumulative return premium since the financial crisis of 2007-2008, coupled with younger generations renting longer, as well as the number of downsizing empty nesters increasing, are just a few of the factors leading us toward what Dr. Peter Linneman has called “the golden age of multifamily investing.”
At Capital Square, the majority of our investment portfolio is multifamily assets. As chief strategy and investment officer of the company, I play an integral role in sourcing well-located, Class A and B apartment communities located primarily in the Southeast to provide compelling opportunities for our individual investors. We strongly believe that the multifamily asset class has, and will continue to, weather any industry storms due to a number of factors.
No Room: The Supply And Demand Of Multifamily Housing
Demand for apartments has continuously outpaced supply. According to the National Multifamily Housing Council (NMHC), America needs 4.6 million more apartments by 2030. This high demand is largely due to the ideas around homeownership shifting as Baby Boomers and Millennials — two of the largest generations in recent history — alter how our country lives. Millennials are delaying purchasing a home due to lifestyle choices and student debt, while the number of Boomers with empty nests seeking to downsize is increasing.
The National Multihousing Council projects that the U.S. needs to build 328,000 new apartment units annually through 2030 to meet demand — but that mark has only been hit three times since 1989. Between 2011 and 2017, only 243,000 new units were completed yearly, leaving an average annual shortfall of 29.8%. This, combined with the fact that almost 50% of apartments in the United States were built before 1980, creates exceptional demand for quality multifamily products.
Compelling Fundamentals: In addition to the apartment shortage, there are several other reasons that multifamily can be a potentially lucrative asset class for the right investor:
• One of the largest asset classes: Housing accounts for approximately 33% of consumer spending.
• Rent growth potential: Regular rent increases and value-add opportunities, like interior renovations, offer predictable growth potential.
• Strong demand for quality apartments: Nearly half of all U.S. apartments were built before 1980, further adding to the demand for more modern multifamily units.
• Potential hedge against inflation: During the inflationary crisis of the 70s, the median rental rate increased by a yearly average of 8.5%, well above inflation. Today, with modern technology, pricing tools and the relative short lease terms (compared to office, industrial or retail), multifamily assets can be an even greater hedge against inflation.
• Favorable government financing: With inexpensive capital and favorable financing widely available, multifamily has a competitive advantage versus other investments.
• Low vacancy: Even in a pandemic, people still need a place to live. In the third quarter of 2020, the U.S. multifamily vacancy rate was 6.4%, the lowest point since 1985.
Additionally, multifamily has the advantage of the liquidity of its renter base. Office buildings typically only house a few tenants, while an industrial building may be rented by only one company. If that company goes out of business, this could be a big problem for the building’s owner.
A multifamily building, however, can still be a potentially strong investment, even if net operating income (NOI) falls. Assuming a 2.5% growth rate over the next eight years, a property’s NOI could fall by 10% this year and 8% in 2022, but a multifamily investor could still witness a 9.5% internal rate of return, according to Dr. Linneman’s calculations.
Built On A Stable Foundation
In today’s modern era of commercial real estate investing, multifamily has generally outperformed the other major commercial real estate sectors (office, hotel, industrial, retail) with its stable foundation as an essential asset, the increase in rental demand from younger generations and Baby Boomers and the lack of quality multifamily units.
Regardless of the state of the economy, people will always need a place to live. With much of the country in flux as it continues to recover from the unprecedented events of Covid-19, this new golden age of multifamily investing could be right for those individuals with a certain amount of risk tolerance and a long enough hold horizon.