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CRE Industry Faces Dramatic Changes in Multifamily Supply, Financing Environment

While Over-Optimistic Developers Could Cause Apartment Glut; Rising Employment Could Offset Much of the Supply Risk
February 5, 2014
The U.S. apartment market continued to see robust growth in 2013, but investors are keeping a wary eye on looming changes going into 2014, including the impact from rising supply, rising interest rates and the prospects of restructuring the nation’s two biggest government-sponsored enterprises (GSE’s) Fannie Mae and Freddie Mac.

For the top 54 U.S. metros, CoStar Group forecasts more than 240,000 new multifamily units will be added in 2014, and a combined nearly 350,000 units in 2015 and 2016. Those projections are on top of the more than 200,000 new apartment units developers added between 2012 and 2013.

The supply wave already is affecting some market indicators, including gradual reductions in rental growth and increases in vacancy, according Luis Mejia, CoStar’s director of U.S. research, multifamily. The aggregate fourth quarter 2013 CoStar data for 50-unit-plus properties shows a year-over-year effective rent growth pattern that is consistent with increasing competition. As landlords adjusted concessions to lure renters, annual effective rent growth declined from 4.9% in the first quarter to 2.7% in last quarter of 2013, after peaking above 7% in 2012.

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Several major U.S. markets will see a significant infusion of new apartment units. The building permit data from the U.S. Census Bureau show that Dallas, Houston, Austin, Raleigh, Charlotte and Seattle together account for more than 50,000 units authorized year-to-date as of November 2013.

"In other markets with typically higher development barriers like New York, Los Angeles and San Francisco, supply pipelines are quickly filling. In New York alone, permits for more than 23,000 units were issued year-to date as of November 2013, a more than 45% increase over the permits issued in the same period in 2012,” said CoStar’s Mejia.

The same is happening with Los Angeles and San Francisco, which together approved nearly 20,000 units during a comparable period, 25% more than a year earlier.

"Some of these units will hit the market in 2014, putting additional downward pressure on effective rents," Mejia said.

Will Strengthening Economy Match Swelling New Supply?

At the same time too, strengthening economic momentum in 2014 could bolster apartment performance in the coming year. It's possible that rising employment growth could offset much of the supply risk from the dramatic rise in apartment construction, according to The Barron, Burkons & Wintermute Group, an investment brokerage team based in Independece, OH affiliated with Marcus & Millichap.

Of course, economic growth is raising pressure on interest rates, a pressing factor for investors. However, rising interest rates could encourage more investors to look beyond core markets and asset classes, according to Barron, Burkons & Wintermute

"The return to a normal credit environment does suggest incremental increases in financing rates going forward, but the good news for investors is that NOI growth, real estate cap rate spreads and lender spreads provide a healthy buffer against future bond yield increases," noted John J. Kerin, president and CEO of Marcus & Millichap in the company’s 2014 forecast released last week.

"More importantly, further increases in interest rates will likely reflect strengthened job creation and economic momentum rather than Fed policy speculation," Kerin continued. "In addition, a low-inflation environment with greater political certainty and less fiscal tightening will prevail in 2014: Domestic and cross-border investors will fuel capital allocations to U.S. real estate assets compelled by the need for safety, a strong income return, and yield compared with alternative investments, and this competition will exert downward pressure on cap rates."

National housing vacancy rates in the fourth quarter 2013 were 8.2% for rental housing and 2.1% for homeowner housing, according to the Department of Commerce’s Census Bureau. The rental vacancy rate of 8.2% was 0.5 percentage points lower than the rate in the fourth quarter 2012 and 0.1 percentage point lower than the rate last quarter.

However, the new construction cycle and nascent rise in renter household formations may herald a new phase of expansion for apartments. The big story in 2013 focused on investors expanding interest beyond five-star properties and the threat of new supply and price fatigue in Class A assets, but the brisk lease-up of newly delivered Class A units has eased investor concerns somewhat, according to Barron, Burkons & Wintermute.

"The conversation for 2014 may well focus on positive demographics, immigration, pent-up demand, and the role Echo Boomers will play in establishing new households," Kerin noted. "The single-family sector has staged a durable and beneficial recovery and will compete with apartments, but housing demand appears more than sufficient for both."

Money Still Flowing as More Lenders Surface

The potential tapering of government-sponsored enterprises (GSE’s) Fannie Mae and Freddie Mac remains the subject to much speculation, but it did not hinder their multifamily lending activity in 2013. Preliminary reports indicate that the agencies continued to dominate the multifamily sector with more than $55 billion in financings last year.

However, according to a recent report by Jones Lang LaSalle, national banks, financial institutions, CMBS and life companies continued to increase their share of the multifamily lending market in 2014, filling in the gaps where the GSE’s can’t or choose not to compete.

"Fannie Mae and Freddie Mac offer extremely competitive pricing and accessibility to plenty of capital which is why they remained highly active in the market 2013,”said Faron Thompson, who heads up JLL's Capital Markets Group in Atlanta. "We could see the GSE’s reduce their volumes another three to five percent this year, but more importantly, we expect them to have a tighter definition of affordability. Therefore, a certain number of properties at the higher end will no longer be eligible for GSE financing, allowing life companies and others to further enter that space."

The Mortgage Bankers Association (MBA) projects originations of multifamily mortgages to grow $116 billion in 2014.

Among the top commercial and multifamily mortgage origination firms surveyed by the MBA, 85% of respondents anticipated growth of five percent or more of CMBS loans and 60% expect a decreased number of financings from Fannie and Freddie.

"As the apartment supply cycle continues to unfold, timing will be critical," said CoStar’s Luis Mejia. "If supply peaks in 2014 and demand continues to hold strong, rent growth and vacancy may not suffer significantly. Conversely, if lenders continue to dole out money and developers remain excessively optimistic, supply could suddenly get out of hand and market deceleration would be more noticeable."

Editor's Note: This article has been updated to clarify that John Kerin is President and CEO of Marcus & Millichap and that the Barron, Burkons & Wintermute Group is an investment brokerage team based in Independence, OH affiliated with Marcus & Millichap.

Keep up weekly on national news, trends and property leads with the Watch List Newsletter, a weekly pdf that includes other news and leads not found on the CoStar Group web news pages. Sign up for the Watch List E-Mail Alert. A new issue is published Monday mornings.
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