362: Multifamily Real Estate is STILL the Place to Be
Catch the full episode: https://www.wealthformula.com/podcast/362-multifamily-real-estate-is-still-the-place-to-be/
Buck: Welcome back to the show, everyone, today. My guest on Wealth Formula podcast is Jay Parsons. Jay serves as senior vice president and chief economist for Real Page. He is leading the economists and industry principle teams to provide deep insights on market trends and consumer behaviors. He’s also a frequent author and speaks on topics affecting multi family apartments and single-family rentals, including rental housing, investment and asset management strategy, rental housing policy issues, risk mitigation and property management. Welcome to Wealth Formula Podcast.
Jay: Thank you and thanks for having me.
Buck: Yeah, absolutely. And you know, this is this is nice to have you on right now because as we talked about a little bit offline, we are, you know, our group this you know, this audience and me, we are heavily involved with multifamily and obviously, we’ve got we had this inflationary sort of unparalleled rate of inflation. Or maybe maybe you can correct me if I’m wrong, but that sounds about right now impacting multifamily rentals. So tell us what’s going on there. I mean, from the buyer and sellers perspective and, you know, just anything right now that that you think that inflation is really affecting the most.
Jay: Yeah, I know It’s a great question. And, you know, I think maybe the best term to describe it is one that we hear a lot these days, which it’s been a roller coaster. I mean, you go back to March 2020, world shuts down, and demand disappears for like two months. Nothing’s happening at all. And everyone’s worried about the, you know, what type of investment activity is going to happen. Maybe the prices are going to go down. There’s no starts that are happening at that point. Now you’re talking May, June all and there’s you know, demand comes back and goes back and it’s like I said, how long is this going to last? Well, it ends up lasting like 18 months. And so we see this unprecedented boom in demand.
I mean, just levels that we’ve never seen before. We added a million net new apartment renters in the US market rate, renters in the U.S. who, by the way, had big incomes staying low, 20% of income on rent and then, you know, you get to then summer of 2022 and things start to slow down. And so now here we are, you know, occupancy rates being coming down, rent growth levels have cooled off, the market’s not collapsing by any means. But certainly we’ve seen a cooling where we’re kind of starting to see a little more normal. And so I think some people kind of forget that, you know, 10% rent go does not.
Buck: Yeah, that’s right.
Jay: It’s getting back to a little more normal. Yeah.
Buck: What what is what is the latest? You know, I guess it depends on the market. But you’re in Dallas. We have a lot of assets in Dallas in our group. What what kind of, you know, rent increases are you seeing in those markets like Dallas and, say, a Phenix or something like that?
Jay: Yeah, in Dallas and most of the controls separating Phenix and Vegas are very different. But most of the country, I think what we’re really seeing is, I would say like what I would call exaggerated seasonality. And by that I mean these last couple of years, we really didn’t see any seasonal pattern, just, you know, initially a big slowdown.
Then we saw this big bounce. So these last so again, the fall winter months, we saw some slight rent cuts in most of the country on a month over month basis. And in Phenix and Vegas, we saw more extreme. It was, you know, booming a couple of years ago and through to early 2022. Yeah, those markets have pulled back much more significantly, still a little bit more sensitive to changes, whatnot. But overall, you know, we’re seeing year over year increases in the low single digits as opposed to the double digits right now.
Buck: Right. Let me ask you a question. So I think this would be helpful to clarify for the audience interest rate, you know, how interest rates work in multifamily. Obviously, we’re looking at today as this morning the Fed ticked up another 25 basis points, but then the ten year Treasury was actually coming down for a little bit. But then multifamily for the most part, is based on something called Sofr. Would you do us a favor, just, you know, because I think most people would not really know very much about this, Give us sort of a sense of how those numbers correlate.
Jay: Yeah. Well, I think, you know, obviously what’s what whether it’s sofr, the interest rates are, you know, the ten year Treasury bond. I mean, everyone’s in multifamily is looking for a comparison point for the cap rate and what we what we’ve seen is that on an on paper there should be, you know, we should be seeing values coming down. Yeah. And in reality that’s really not happening. And the reason for that is because the sellers have to be motivated to sell at these discounts that are required for buyers to make these deals work. Right, Because buyers can’t buy with the cost of debt what it is and the cap rates that we saw in the last couple of years, you know, be seeing sub 4% cap rates when the cost of debt is, you know, five or six, you just can’t do it. And so we’re we’re at this. So so part of what’s really happening here, I think it’s kind of widely misunderstood is that, you know, most investors are locked in at rates that are well below the current rate. So they have no motivation to sell.
So I think the end result is, is just this slowing of just transactions. That’s the real impact. And you know, I kind of laugh. I see people say, oh, you know, we see this publicly traded, it reads like, hey, these values are down 20%. It’s like, I guarantee you if your value is down 20%, you’d have a thousand buyers lined up to buy that asset. Well, that’s not real life. Yeah.
Buck: Yeah, yeah, totally. So let’s let’s drill down a little bit on that. I guess that back up there though, that between buyers and sellers, we’re obviously seeing that there’s just you know, the market is dead, you know, we’re not. But on the other hand, it does seem like there is potentially some distress on the horizon, right? Yes. Do you want to address that? Talk a little bit about that and why we haven’t seen it sort of violently yet.
Jay: Sure. So it’s a great topic. And I think this is you know, I think what a lot of the, you know, kind of more distant observers of multifamily are struggling to grasp, which is that, yes, there’s going to be some distress, but it’s not going to be a market wide collapse. And here’s why. Number one, we mentioned earlier, you know, most owners are cash flowing and locked in a long term debt that is well below the current rate.
So there’s no issue there now where the exceptions are really going be two categories where you’re going to see some pockets of distress. That’s the term like use. There’s going to be pockets of distress. Number one, you’re going to see short term value add investors. You know, these are the equivalent of single family flip players. These are the, you know, two, three year holds and do some CapEx. You’re going to sell the property. Well, you use short term floating debt now. So if you look at the value add buyers from 2021, early 2022 bought at peak prices with the assumption they’re in do big CapEx, raise the Rams ten 20% and then be able to refinance sort of at a still low rate that mass not working anymore.
And so I think by the time you know, you think if they’re in, you know, let’s say two year, you know, locked in for two years and then the rate resets, that really puts us in late 23, early 24 before we start to see some of that distress pop up. So it’s going to happen or you have some buyers, I’m sorry, owners who just can no longer see the cash flow to cover the cost of debt, and they’re going to be forced to sell or is it going to be some, you know, rescue capital mezz debt or the preferred equity, whatnot? And then the other category is going to be pockets of certain types of lease ups where, you know, the lease up is not achieving its proforma targets and you get into a refinancing event. They’re not achieving the rent or the occupancy they need for the to get the cash flow they need. And there’s going to need to be an injection of capital there. So they’re doing capital calls or again, you’re seeing some some distress emerge in some of those situations.
Buck: So based on what you just said, have you guys projected and you said sort of late 23, early 24, is that also when you because of that sort of year, is that when you think the housing market comes back, the multifamily housing market comes back because all of a sudden you have got maybe potentially a little bit of a reset, right? If you’ve got distressed sales and that sort of thing. Or is there is there another answer to that?
Jay: Yeah, no, I think so. I think and, you know, bear in mind, the crystal ball is very fuzzy these days. So, you know, we don’t hold me to this, but I think the second half of the year we’re going to see more sales. I don’t think it’ll be as busy as it was. And 21 we saw record levels of transactions. But I think the thawing I’m sorry, I think the freeze will thaw some by then and we’ll see a little bit of a reset between some buyers and sellers. But again, the vast majority of owners, I think, are still going to say, hey, look, I’m I’m I’m good. So, yeah, I do think we’ll see more opportunity second half of the year.
Buck: You know, one of the things that comes up when we talk about distress is, you know, in this scenario, right? I mean, we have it we had an incredible increase in rates. And so the number of the number of operators that will be in distress is not small. It’s significant. Right. Obviously, lenders don’t want to take these properties back. Do you foresee some kind of, you know, rescue in terms of, you know, the actual lenders? Because, you know, they don’t want to they don’t want to become landlords, right? Yeah, No.
Jay: I think very few actually go that far. Yeah. And the reason for that is, number one, there’s a lot of buzz in the industry right now among traditional equity investors. They’re now looking for preferred equity deals. And so they’re looking to basically slide into the top of the capital stack near the rescue and then position themselves to eventually potentially take over the asset. And there’s I mean, you know, we’ll see if the proof is in the pudding. But, you know, the buzz around the industry is there’s quite a bit of, you know, dry powder looking for that strategy because they see it as a higher yield, lower risk investment than an acquisition at a lower cap rate. So a traditional acquisition. And the other side of it, too, is I think you’re going to see a lot of owners who are reaching distressed who would rather sell and and try to break even as close as possible than just lose everything altogether. So I don’t think we’re going to see a lot that goes truly into foreclosure. And what does is going to be, you know, very unique sort of messy stuff.
Buck: Do you guys even try at this point to, you know, really to predict what rates are going to be?
Jay: No, no. I mean, we’re testing interest rates Is this is like a fool’s errand. It’s like forecasting the price of oil. Yeah. You just guarantee all you’re doing is saying, hey, you know, hold me accountable, something I’m going to be wrong. That’s saying that’s wrong. I try to avoid that as much as I can.
Buck: You could just. Yeah, look at curves all you want, but I’m not going to talk about it right?
Jay: Yeah, I think, you know, I mean, obviously the mainstream expectation is that, you know, rates will be coming down by the time we get into next year. And I think that’s a reasonable expectation. But I know I’m not going to stake my career on it.
Buck: So exactly how you know, one of the things that you mentioned was that generally as a general rule, that maybe some of these rate increases and I’m sorry, not rate, but rent increases have leveled off. And what I find a little bit difficult to understand with that is, you know, unemployment’s really not a problem. Yeah, and wages don’t seem to be a problem.
Buck: So why are rents way or rents leveling off?
Jay: Yeah. You know, I think this is your question is great. It’s my favorite topic because you know, a lot of people still assume that, you know, there’s some sort of jobs to demand ratio and they are all brokers for this in their package. It’s a bogus metric. But, you know, we’ve never before seen a period like this, which is you have great job growth, you got great wage growth. They didn’t quite catch up with inflation. But, you know, it’s still the biggest numbers we’ve seen in 30 plus years. And yet and unemployment’s really low. Unemployment’s low. So 50 plus years and so and yet there’s very little demand not just for apartments but for any type of housing. You are buying houses, not renting, can’t buy homes. And any kind of big net new numbers are obviously not sitting on apartment demand.
So, you know, I think what’s really happening over the last nine, 12 months has been this, you know, low consumer confidence that then manifests in the form of reduced household formation. People just aren’t moving around as much as they were previously. Now, having said all of that, I think all that job growth and wage growth, it creates pent up demand for housing. And so I’m of the view that as we end, you know, we’ll see here in this news we’re about to enter the peak leasing season. You know, April through August is the busy season. And so I’m of the view that we’re going to see some pretty good demand not not not 21 levels come in, but I think we’ll see some solid net new demand for apartments this year from people who said, you know what, last year is too crazy and I’ll wait it out. And now they’re saying, okay, there’s better deals out there. Rents aren’t up as much. There’s more vacancy, more supply, more options. I think you’re are to move around more and we’ll see some better demand.
Buck: In places like DFW. There is overall. Correct me if I’m wrong, but you know, a shortage of multifamily dwellings. So that has got to also play into this, right. I mean, in terms of the pressure going back up.
Jay: Yeah, Well, I mean, yes and no. I mean, there is a shortage. Absolutely. But the problem I think the problem all across the country and in DFW is that the shortage is predominantly impacting the the more affordable end of the market. And you can’t really build affordable housing without subsidies and you can’t build a class C, you can’t build a class B apartment. So most of what gets built is Class A, expensive apartments, and those will get leased up. But it’s but, you know, you’re competing with a fairly finite pool of demand at those price points. And so there’s a little bit of a mismatch there. But only today we just need more housing of all types and that will help Now dance.
You know, the question on the rents, though, is that, you know, what we’re seeing is that with all the supply in the market, the sudden demand, that vacancy has gone up. And so, you know, supply and demand as there’s more vacancy, it puts yeah, it it removes some of the upward pressure on prices. So these things are cyclical, right? I mean, we’re going to see it move up and down. But, you know, right now we’re at a point where, you know, we’re increase in vacancy is going to is reducing the the rent growth.
Buck: Is in the vacancy. Is that you know, how does that work when you look at A-class versus B-class versus C-class? Because you know, the way I think about it, I think of people kind of moving down the ladder. So if vacancy is up in A-class, does that mean that it’s potentially slightly down in B class or how does that work? I mean, just because I think people, including me, sometimes wonder, well, where are these people going if there’s all sorts of vacancy, Right, they’ve got to live somewhere.
Jay: Well, you know, first of all, when I say basically, but it’s going up from the lowest levels in history. And so it’s not up that much. Right. In the grand scheme of things now. And it is it’s changing the same right now in class A, B and C, And so it’s not that they’re really going anywhere. We want to see a lot of move-outs. It’s just that people aren’t really moving in from noticing any net new creation of these last six months. Now, what we do think, I’ll tell you my view is that as more supply is entering the market, the class A level and that’s really going to hitting these next ten, 12 months, you may actually probably be on the end of the first half of 2024.
I think we’ll see much more vacancy in class AA than we do in class B and C, I think B, I mean, the price point and you mentioned, you know, the the maybe the flight to affordability, but the challenge also is that the price point and the difference between A and B and C has gotten so big that they’re really dealing with different demographics. So you’re not going to see a big spike in availability for Class B and C apartments.
Buck: Yeah, that’s right. That’s right. I mean, basically you’re just saying like the people are not going to move down to C-class, right? Right, exactly. Now that makes sense.
Jay: Well, no, in fact, what’s going to happen is the class people are moving around, but they’re going to other class AA property that’s offering a big concession because at least the competition, the discounts are going to be like the best deals are going to go to the higher income renters in class AA properties on a relative basis.
Buck: I’m curious how this you know, I don’t know. I mean, I think it’s all baked in the economy, but the current banking crisis, these that are happening, is that affecting the real estate market at all?
Jay: Yeah, You know, essentially there’s a lot of conversation about this, but as I talk to folks in the industry, it really doesn’t have a direct impact. No. Before I say anymore, I mean, obviously everybody’s really worried about is that there’s some sort of snowball effect to the broader economy. So obviously we want to be careful that doesn’t happen. But on a direct impact basis, it’s pretty muted. You know, Signature Bank was a major multifamily lender in the New York area. So there is, you know, some of that impact. But, you know, all of that’s being picked up by others in terms of servicing. But, you know, in general is you know, in for the multifamily side, you know, the GSEs, Fannie and Freddie are the big players and they’re not impacted by this.
So and there’s a miracle, The Wall Street Journal about commercial real estate exposure among banks. But a lot of that is really on the office side where you’re dealing with high vacancy and, you know, some cases where the owners can’t pay the debt service anymore. So multifamily is not really directly impacted at this point.
Buck: Right. You mentioned Fannie, Freddie and that, you know, leads to another question, which is, you know, one of the things that we’re seeing is that, you know, Fannie is it’s a much tougher deal to work with Fannie and Freddie now, less leverage, more requirements. Do you see that loosening up any time soon?
Jay: I mean, I think it will a little bit. And I’ve heard it and it will a bit. I mean, remember, they have caps. They are supposed to it is supposed to be hit. They can’t exceed. So they do want to achieve certain volumes. And part of their mandate is really to keep the market pretty liquid and especially in, you know, the the more affordable end of the market where they have some mandates to really service. So I think that there’s going to be I mean, obviously they’re still impacted by, you know, higher interest rates and whatnot. But I think I think they’re going to do what they can within reason to to remain active players.
Buck: But, hey, you know, obviously economists don’t like to predict the future, but they do. That’s right. And and so tell me what your how you think this is going give me a one year, a three year and maybe a, you know, five year perspective on multifamily in terms of how you guys are looking. And obviously you’re advising a lot of large groups and that kind of thing. I just sort of I’m kind of curious what your take is even more. You’ve talked about the one year basically. I mean, you’re looking at some dips and maybe it coming back, but, you know, three years from now and in and beyond. Tell us what you guys are projecting.
Jay: Yeah, well, you said I mean, this next year can be choppy. It’s a tough time to enter the market for a short term value add player. That’s been a big part of the market the last really ten plus years. But long term, it’s you know, I think people let’s take a step back and realize that, you know, the structural tailwinds behind multifamily really haven’t changed. You know, the demographic story is favorable. The cost of rent versus own, despite all the rent growth is actually more favorable than ever. You know, the you know, the need to have a home. You can work from anywhere. You can you could shot from anywhere, order food from anywhere, but you got to have a home. And that’s a a big structural driver. The shortage of housing, you know, there’s all there’s numerous factors. Everyone’s worry about millennials are aging. I’m taking my home as well. They forget that, you know, Gen Z is just as big, if not bigger. They’re coming right behind them. Right. So there’s a lot of very positive drivers that will remain factors. And by the way, that’s why you talk to, you know, the largest investors.
I mean, you know, they still love multifamily and these things aren’t going away. There’s not there’s noise. Sure. In the short term. But, you know, these long term factors aren’t going away. So we’re still pretty bullish on the next 3 to 5 years. I don’t think we’re see a thing like we saw. I mean, if you’re a new investor since COVID, you need to sort of take your mind off of what you think is normal. But I think what we’ll see these next 3 to 5 years is more like what we saw in the 2000 decade, 20 tens decade, which is, you know, 3 to 5% rent growth, 95% occupancy.
Buck: Yeah. And would you mind for us like sort of compare and contrast because we you know, we’ve talked about multifamily, but there are some single family investors in that kind of thing. What’s going on in that part of the real estate market right now? Is it pretty parallel? I mean, it seems like it’s it’s a little bit of a different animal.
Jay: It is a different animal. But I’ll tell you, it’s like one of the things that always fascinates me is, is, you know, you have multifamily homeowners, you got SFR homeowners and you got the for sale homebuilding, homers. And what I always try to remind them is like, look, like all of y’all are riding the same basic, you know, you know, winds or you’re on the same or you’re riding the same waves here.
Like they go up and down together. We see demand for all types of housing ebbs and flows together. I mean, you look at the big home homebuying boom of 2021 or even the mid 2000. There was a lot of rental demand at the same time. And so and then when the homebuying stopped, we insulate around demand. So. SFR is really a similar situation right now where there’s not been a lot demand.
At the same time, you have more supply. There’s a lot of, you know, build to rent communities which are obviously had apartment SFR hybrids and then there’s the 100,000 of that coming and coming online. Plus you’ve got you know, we’re seeing more homes and owners who don’t want to sell, who are choosing to rent out their homes for a period times there’s more inventory on the market that’s putting more debt, that’s putting some pressure, downward pressure on rents also. So they’re very different terms who they cater to and demographics. But the overall performance has been very, very similar.
Buck: Just going back to your comment on investors having this is still a, you know, a darling asset in multifamily and that sort of thing. What I mean, there’s got to be a tremendous amount of pent up demand. I know, you know, certainly even in our group, people want to deploy capital. Right. And there’s nowhere to play. And, you know, you hear about larger groups having mandates and that sort of thing, Where where’s that money going? Is that is that you know, where you’re talking about with some people looking at preferred equity and that kind of thing mostly? Or how is that working right now? Because, you know, one theory was that that pent up demand would sort of save the day, but I’m not sure that it really has yet.
Jay: Well, I think what’s happening is, you know, there’s a lot of fact that are, you know, the big an emergency meeting was in January or February, early February this year and in Vegas. And I was really struck by the fact it’s like everybody’s a buyer. There’s so much dry powder out there. You see this anecdotally. But but also, too, it’s like nobody wants to be a dumb buyer, right?
So there’s all this capital, but they’re waiting for the right moment. Maybe they wait too long. We’ll see. But I think what’s happening is a lot of these, you know, asset managers and best managers are telling their investors, hey, you know, sit tight, relax a little bit. These opportunities are coming. The money, the cap, they’re saying at least the capital’s there at the right moment, we’re going to see it. So I ultimately think that, you know, the downside we were see, we mentioned some of this distressed comment. I think there’s a really kind of there’s a hedge, a protection here with all this dry powder that really wants to be investing. But just can’t justify, you know, a four-and-a-half percent cap rate right now.
Buck: Right, Right. Fantastic. Well, Jay, thanks so much for joining us. What do you what do you make of your cowboys this year now?
Jay: Well, you know, every Cowboys fan knows that every year starts with tremendous optimism and ends and terrible defeat. So I’m kind of I’m kind of conditioned to forecast the same for this year.
Buck: Yeah, well, I’m a Vikings fan, so, you know, I don’t want to hear any complaints from you because you win. Anyway. Gee, thanks so much for joining us on while from your podcast. Love to have you back in the near future above that.
Jay: Thank you.
Buck: We’ll be right back.