The increased cost of home ownership, strong renter occupancy rates, and steady rental rate growth continued to make the multifamily sector attractive to investors through the end of 2022 – and we do not see that changing much as we enter the new year. That said, while the sector has experienced substantial rental rate increases in recent years, we do anticipate that rates will begin to moderate in most markets.
Construction starts showed signs of slowing at the end of 2022 and will likely face continued downward pressure from higher borrowing and construction costs. This potential slowdown in new supply will likely support the sector’s strong fundamentals and rental demand in the near term (giving new supply time to be absorbed before another wave of deliveries). Construction delays decreased in 2022, but according to a survey by National Multifamily Housing Council, 84% of its respondents still report some level of delays. As a group, we saw 2021 and 2022 marked by some construction delays, so it would be welcome news if development timelines got back on track in 2023 – and that appears to be the case.
Fed policy and changes in interest rates have caused some disruption in valuations, acquisition lending, and planned recapitalizations, which will continue to slow transaction volume in the sector in the near term. And as some debt becomes due, tightened lending standards in 2023 could lead to gaps in proceeds which may require additional equity or longer runways. It is our belief this scenario could yield some interesting investment opportunities in 2023.
If a recession (or any meaningful slowdown takes hold), we can expect a slight uptick in overall market vacancy rates and a less robust rental rate growth (For example, Freddie Mac projects a gross income increase of 3.5% and vacancy rate of just above 5%). In other words, it should be expected that rental rate growth that outpaced historical averages in previous years is likely to moderate to lower levels in 2023 (but remain positive). We are seeing some signs of this. For example, per RealPage, asking rates fell by 0.4% in December 2022 nationwide. However, an inadequate housing supply could provide somewhat of a natural floor to rates in the near term. Per Yardi Matric, US rents rose by 6.4% in 2022 after a high of 16% in 2021. Given the expected delivery of 440,000 units nationwide in 2023, this may further contribute to a lessening of the rapid rental rate growth of previous quarters.
Our snapshot view of the sector in early 2023 leaves us with the following few themes, currently:
- Rent growth will remain positive, but not at the historically high levels of previous quarters.
- The sector will see tightened underwriting standards both on the lending and acquisition side.
- If there is an economic slowdown and as new supply is delivered, vacancy rates may increase (or absorption rates will flatten) in the short term.
- Higher borrowing costs (and tightened lending standards) will slow the previous development spikes in some markets.
- Investor demand for multifamily assets will remain strong, especially in growth regions. However, transaction volume may slow a bit in the near term.
- Given the large wave of luxury and high-amenity projects that have come online in recent years, there may be some opportunities in value-add and more dated, affordable (Class B) multifamily assets.