The U.S. multifamily-housing market has been a star performer among commercial real estate asset classes for the better part of a decade. The question that mortgage brokers and lenders keep asking themselves is, will it last?
Steve Guggenmos, Freddie Mac Multifamily’s vice president of research and modeling, spoke with Scotsman Guide about how the apartment market fared through the first 11 months of 2019, as well as its outlook for this year and beyond.
How well did multifamily fare in 2019?
The multifamily market has been on quite a run for a while. Recently, the typical expectation at the beginning of the year has been that there would be some moderation because new supply has come into the multifamily market. And then, as we approach the end of the year, we end up in a place where we’re pretty close to previous years and the market has performed pretty well. The long-run story is that there is a ton of demand out there and it continues to exceed supply. That’s creating a situation where the market continues to perform pretty well.
Do favorable demographics help to bulletproof the multifamily sector from risk?
I’m reluctant to say ‘bulletproof.’ One thing that we’re careful to say is that, when there is growth in the single-family home-purchase market, that does not mean the multifamily market won’t continue to perform well. Demographics continue to be favorable both for single-family ownership as well as for multifamily. There may not be the incredible growth rates that we saw during the 2010-2012 period, but there certainly still is continued growth in demand.
Is there any part of the multifamily market that is overbuilt?
There are places where it takes a little bit longer to lease up [a building] but, overall, there continues to be absorption in the newer units as they’ve come online. Even in the suburbs, we’ve seen the development of new communities and, in the right places, those properties perform pretty well. There is strong demand for housing near amenities, whether it’s retail or restaurants, or the proximity to work and transportation.
Demand is certainly something that we look at from our credit-risk perspective. When properties continue to get absorbed, we try to learn what’s driving that.
Is the demand highest in the area of affordable apartments?
Demand for Class B and Class C apartments is high. These more- affordable properties are continuing to perform well. You can look years back and see that Class B and Class C vacancy rates were higher than they were for Class A, and now they are basically equal with Class A — and sometimes better — in terms of occupancy.
Then, the [annual] rent growth is about 1% higher in the more- affordable space. And that’s because there is so much demand and the units are occupied, and new households are forming.
What is the outlook for this sector in 2020?
A meaningful change in 2019, from the prior year, was interest rates. Interest rates in November 2018 were more than 100 basis points higher than where they are [in November 2019]. And so, when we put together the story of how rents and vacancies are performing, and then we look at where rates are, that feeds into valuations and affects the credit-risk spreads and cap rates, which have been a little higher than the average.
Looking to 2020, cap rates could compress a little bit and that means that valuations could be higher a year from now. And valuations and property prices drive the size of the origination market — how much demand there is for debt. So, that points to growth in the market.
So, basically, both asset prices and investor demand could rise in 2020?
Yes. On the fundamentals side, there are not that many asset classes where you see the robust and stable cash flows that you see in multifamily. That draws investors. They don’t see that in a lot of asset classes.