“To remain competitive, originators also need to embrace the role of technology in streamlining the lending process.”

Whether working with multifamily properties in city centers, suburbs or more rural settings, it is crucial for commercial mortgage brokers to be aware of market trends and to tailor financing solutions that align with the evolving needs of borrowers and lenders. By delving into the details of a project, originators can better meet the demands of today’s dynamic markets.

Financing strategies

One of the most important issues for commercial real estate investors is to develop the right financial strategy. Mortgage brokers must be adept at crafting financing strategies that not only meet the financial needs of borrowers but also align with the risk appetite of lenders. From government-sponsored programs to bridge loans, traditional bank loans and other products, the array of financing options can be overwhelming.

The government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, are quasi-governmental entities that guarantee third-party loans and purchase loans on the secondary market. Loans guaranteed by the GSEs tend to offer attractive terms such as competitive interest rates, higher leverage and favorable underwriting standards. Borrowers who qualify for GSE loans benefit from lower costs and extended repayment periods.

While GSE loans are popular, not all borrowers qualify. Traditional bank loans, even though the underwriting tends to be more stringent, can provide alternatives. But these mortgages often come with higher interest rates and lower leverage. For borrowers who may not meet GSE or bank loan criteria, the exploration of alternative financing vehicles such as private equity or nonbank lending institutions becomes essential. These options may offer more flexibility but often come with higher costs.

Consider a scenario where a small-scale multifamily development project doesn’t meet the criteria for a GSE or bank loan due to its size. In such cases, commercial mortgage brokers can showcase their ability to address diverse financing needs by guiding clients toward alternative financing solutions, such as private loans, crowdfunding or community development programs.

Risk mitigation

A paramount consideration in multifamily housing finance is risk mitigation. Originators must conduct comprehensive due diligence on both the property and the borrower. This includes an evaluation of the property’s location, local market conditions and potential for income generation. Protecting a client’s investment and minimizing potential risks requires a proactive approach.

For instance, consider a multifamily project that’s located in an area prone to natural disasters. Implementing risk mitigation strategies — such as being prepared for how underwriters will assess a property, securing robust insurance coverage, incorporating resilient building materials, and conducting thorough feasibility studies of the property and geographic area — can enhance the project’s ability to withstand unforeseen events.

In a real-world scenario, a 50-unit apartment complex faced significant challenges. It was the borrower’s first venture into property management, so lenders had concerns about the efficiency of the operation and the future satisfaction of tenants. These concerns left lenders worrying about the long-term value of the asset.

Strategic approach

With this particular deal, a mortgage originator who was equipped with a strategic approach to risk mitigation recommended forming a partnership with an experienced property management firm. The strategic partnership contributed to improved tenant satisfaction, resulting in lower turnover rates and increased lease renewals.

Daily operations were streamlined, ensuring timely maintenance, rent collection and adherence to regulatory requirements. A rigorous tenant screening process was implemented to identify potential challenges. Historic data from the property management firm demonstrated successful tenant retention, efficient operations and increased property value over time.

The proactive screening process led to a reduction in tenant-related issues, fostering a more stable and harmonious community within the multifamily complex. Continuous improvement encouraged the borrower to invest in ongoing education and training in property management practices. In time, the borrower developed a proficiency in property management, addressing initial challenges and building a solid track record. Over a three-year period, the property’s annual appreciation rate grew from 5% to 20%.

By leveraging historic data, introducing proactive measures and fostering a commitment to continuous improvement, the broker helped the borrower reach his goal while also contributing to the long-term success of the multifamily project. It underscores the importance of comprehensive risk assessment, as well as the power of data-driven decisionmaking, to ensure the viability and profitability of a multifamily investment.

Regulatory landscape

Beyond strategic planning, commercial mortgage originators must also be aware of the regulatory environment. The multifamily housing sector is subject to a complex regulatory system that varies across jurisdictions.

Originators have to stay informed about local, state and federal regulations that govern multifamily housing developments. It is imperative that properties are always in compliance with zoning laws, building codes and environmental regulations.

For instance, consider a scenario where a neighborhood opposes the development of apartments. This resistance might stem from concerns about increased traffic or noise, or changes to the community’s character.

In such cases, effective communication and collaboration with local authorities, community leaders and residents become crucial. Providing examples of successful resolution strategies, such as community engagement initiatives or modifications to project plans, can shed light on the navigation of regulatory challenges.

In another regulatory context, understanding the intricacies of affordable housing tax credits and how they can be used to incentivize multifamily development in certain areas can be instrumental. By incorporating such details, mortgage originators can highlight their expertise in navigating complex regulatory landscapes.

Changing technology

To remain competitive, originators also need to embrace the role of technology in streamlining the lending process. The integration of digital tools for loan origination, document processing and communication can enhance efficiency and reduce turnaround times.

Consider a scenario in which a mortgage company adopts artificial intelligence (AI) systems to streamline the initial stages of the loan application process. Through AI-driven chatbots or virtual assistants, prospective borrowers can engage in real-time conversations to share basic information, such as income, credit history and property details. This not only expedites the data collection process but also provides a more user-friendly and accessible experience for applicants.

Furthermore, the integration of blockchain technology in document processing can revolutionize the verification and validation of financial documents. Blockchain’s decentralized and secure ledger system ensures that all parties involved — including borrowers, lenders and regulatory bodies — have access to the same unalterable information. This significantly reduces the risk of fraud and errors in document handling, leading to a more transparent and trustworthy lending process.

Communication is another critical aspect of the lending journey. The use of cloud-based collaboration tools allows mortgage brokers to communicate seamlessly with clients, underwriters and other stakeholders. For instance, adopting a secure platform for document sharing, virtual meetings and real-time updates ensures that all relevant parties are on the same page throughout the lending process. This enhances communication efficiency while also contributing to a more collaborative and transparent client experience.

Economic perspective

Like technology, the economic landscape plays a pivotal role in the success of multifamily housing projects. Mortgage originators must be aware of economic indicators, interest rate trends and overall market conditions.

For instance, during an economic downturn, originators might proactively advise clients on interest rate locks to secure favorable terms. Providing examples of past economic scenarios and the corresponding strategic decisions made can offer valuable insights into the importance of economic considerations in multifamily finance.

During the Great Recession, the real estate market faced unprecedented challenges. Multifamily projects were particularly vulnerable as tenants faced financial hardships. In this tumultuous environment, a savvy mortgage broker advised a client to pivot from high-end luxury apartments to affordable housing.

By utilizing historic data that indicated a surge in demand for affordable housing during economic downturns, the originator guided the client through a strategic shift. The result was not only a successful weathering of the recession but the establishment of a profitable portfolio of affordable housing units.

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Mortgage originators who successfully navigate the multifamily landscape understand the intricacies of market trends, employ strategic financing approaches and mitigate risks. They also stay abreast of regulations, leverage technology and factor in economic considerations. To be competitive, originators need to embrace these insights and craft innovative solutions that contribute to the growth and success of multifamily housing projects. ●

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Another 500 bps of rate hikes later, it’s fair to say that the Fed has been able to get a handle on inflation while the labor market has remained surprisingly resilient. This brief backdrop is important for understanding the highly rate-sensitive nature of the real estate industry.

With the 10-year Treasury yield hitting 4.98% in October 2023 — and the average 30-year fixed mortgage rate briefly topping 7.75% that same month — higher financing costs coupled with a scarcity of available housing inventory has led to a significant slowdown across the residential real estate sector. Additionally, after more than a decade of ultra-loose monetary policy, sellers don’t want to give up their low mortgage rates, which has only exacerbated the already adverse housing supply conditions.

Consequently, these factors have provided an uplift to the multifamily housing sector as potential buyers are priced out of the purchase market and funneled into the rental market. Unfortunately, this is a lose-lose scenario for many households. On one hand, a median-income household that made a 20% downpayment on a median-priced home in the U.S. in third-quarter 2023 had a mortgage-to-income ratio of 35%, according to Attom. On the other hand, Moody’s data found that the national median rent-to-income ratio of 30% was only slightly better at that time, illustrating how discretionary budgets are being constrained on both fronts.

Renters can be thankful that multifamily supply conditions are not nearly as bad as they are in the owner-occupied market. For instance, as the chart on this page shows, Moody’s expects that 2023 will be a banner year for multifamily completions at nearly 250,000 units, which will help to keep annualized growth for asking rents from exceeding 1%.

Strong capital flows into the multifamily sector are a good omen for those stuck waiting in the rental market as the incremental supply created by developers eventually tends to place downward pressure on rents. In summation, while many potential homebuyers may be unhappy with their current living arrangements, it would behoove them to remain patient and continue saving for a larger downpayment. They’ll be better positioned to capitalize when the right homeownership opportunity presents itself. ●

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The caps, which have been set annually since 2015, are based on projections by the Federal Housing Finance Agency (FHFA) about the growth of multifamily originations next year. The FHFA has said that it anticipates that the combined $140 billion “will be appropriate given current market forecasts,” adding that it will still monitor the multifamily market and raise the caps if deemed necessary.

“We know the multifamily market faces significant headwinds, which makes Freddie Mac’s countercyclical role critically important to lenders and borrowers,” said Kevin Palmer, head of Multifamily for Freddie Mac. “We continue to maintain a laser focus on providing liquidity, stability and affordability to the market, and FHFA has again set strong requirements that create the conditions for us to deliver on our priorities.”

“A cap of $70 billion for each of the GSEs is reasonable, given the challenging market conditions and high interest rate environment expected in 2024,” said Bob Broeksmit, president and CEO of the Mortgage Bankers Association. “We appreciate FHFA’s ongoing flexibility should adjustments to the caps and mission-driven requirements be necessary and believe exempting loans supporting workforce housing from the cap levels will help to ensure GSE financing is a viable option for housing providers in the current environment.”

To keep the government-sponsored enterprises’ missions of affordable housing and serving underserved markets on track, the FHFA, as it has in previous years, will require that at least 50% of their multifamily business is mission-driven, affordable housing. Additionally, loans classified as supporting workforce housing properties will be exempt from the volume caps (all other mission-driven lending will remain subject to the limits).

“The 2024 multifamily loan caps, coupled with the exemption for workforce housing properties from the caps, will promote the Enterprises’ continued strong commitment to addressing the need for affordable rental housing,” said FHFA Director Sandra L. Thompson. “The workforce housing exemption should encourage conventional borrowers to commit to preserving rents at affordable levels for extended periods of time.”

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This close relationship holds true within cross-border real estate investments, just as it does nearly everywhere else. Investors from the U.K. are an active group when it comes to outbound activity, directly purchasing some $13 billion in real estate outside British borders in 2022, according to CBRE. The vast majority (83%) of this capital was deployed in other parts of Europe, but American assets gathered their fair share of British attention as well.

During the year ending in second-quarter 2023, investors with ties to the U.K. poured roughly $1.3 billion into 22 U.S. commercial properties, per MSCI Real Assets. That dollar amount was good for No. 6 among the top countries for acquisition volumes into the U.S. during this period, up three spots compared to their ranking for the 2022 calendar year.

According to MSCI data, the country’s most active U.S. buyer in 2022 was London-based GSA International Ltd., a major worldwide name in student housing. GSA accounted for six of the 25 stateside acquisitions by U.K. investors last year, and it has been assertive in the flourishing U.S. student housing space since its entry into the market in late 2020. The latter half of 2022 continued this pattern, highlighted by the August procurement of the 796-bed Waterloo Tower in Austin and the October purchase of five other premium assets comprising 1,600 beds in Austin; Flagstaff, Arizona; and Charleston, South Carolina.

GSA carried this momentum into 2023, with the company announcing this past January that it had closed more than $550 million in financing facilities across the U.S. through a joint-venture partnership with Morgan Stanley Real Estate Investing. GSA officials touted their ability to secure new lending partners in the current economic climate as a testament to the quality of the company’s track record, the quality of its target assets and the stability of the student housing space. Indeed, having expanded its footprint to more than 18,000 beds across 32 cities in 23 states, GSA seems poised for further growth in a burgeoning sector and appears to be a British-based player to watch.

It’s worth noting that U.K. involvement in U.S. commercial assets has slowed of late. During the four quarters ending this past June, investments from U.K.-based funding sources fell by 39%, MSCI reported. That’s a sizable decrease at face value, but it’s not as brow-raising as one might think.

For one thing, the slowing commercial real estate climate has pushed most cross-border investment into the red across the board. Only three of the top 25 foreign sources of capital grew their U.S. outlays during these four quarters, and the U.K.’s year-over-year decrease in this time frame pales in comparison to that of fellow heavy hitters Germany (-91%) and South Korea (-92%).

Furthermore, British real estate investors appear to be just as motivated as they have been in recent years. According to CBRE’s Investor Intentions Survey released this past March, investors from the U.K. expected to maintain comparable levels of activity this year as in 2022, offering optimism as further data for this year’s transactions becomes available. ●

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The firm owns and operates a $2 billion portfolio of about 7,000 units in a wide swath of the country that includes Pittsburgh, Cincinnati, Indianapolis, Kansas City and Denver. Milhaus is also well established in the southern U.S., with properties in cities such as Charlotte, Tampa, Memphis, Dallas and Phoenix.

“We have seen strong demand … for conservatively underwritten, appropriately leveraged deals.”

Chris Beres, the company’s vice president of investor relations, spoke with Scotsman Guide this past July. He discussed the firm’s perspective on the multifamily sectors in the central and southern areas of the country, as well as prospects for real estate developments in federally designated opportunity zones.

How is the multifamily sector holding up in the secondary markets that you serve?

I think “holding up” is a pretty good term, considering all the headwinds that have impacted the real estate industry in the last 18 months or even longer, with the pandemic, rising interest rates and inflation. But multifamily demand still remains strong, particularly in the secondary markets where we are hyperfocused on building properties where there is a favorable supply-and-demand dynamic. We have seen strong demand — whether from population growth or lack of supply or both — for conservatively underwritten, appropriately leveraged deals, which are performing well in today’s higher interest rate environment.

Where are you seeing the most demand?

It is a good story across both the Midwest and the Sun Belt. Dallas has definitely been a star for us, where we delivered our first project in May — a $59 million, 279-unit property that is already 50% leased. We are seeing very strong, continued growth in the Dallas market. There is always a lot of supply in the area, but there is also plenty of demand. We also are seeing strong demand for Class A suburban properties in places such as Cincinnati, Indianapolis and Kansas City, where there are more naturally affordable price points with rents relative to local incomes. So, we are continuing to see growth in our suburban markets.

How has the lending environment changed this year?

On the debt side, we have been very fortunate. Milhaus has a great pool of diversified lenders, ranging from small local banks to regional banks, super regionals, nationals, life insurance companies and other sources. We’ve been able to get good terms. I think underwriters are very focused on sponsor quality and that helps us out quite a bit. We are still seeing attractive debt-term sheets.

On the equity side, it’s been a little bit more challenging in some cases, although we’ve been able to close deals already this year and we should be closing more in the very near future. But it takes five times the work to find partners. A year ago, you would go out to 12 sources, and you’d have four or five term sheets without too much work. Now it requires a lot more effort. There is still a lot of capital out there, but it’s mostly on the sidelines and being very selective.

One area of focus for your company is qualified opportunity zones. Explain how that works.

The opportunity zone program incentivizes investment in lower-income census tracts that were federally designated to be part of the program. The incentives are in the form of some really fantastic tax benefits. Investors with capital gains can deploy those capital gains into a qualified opportunity zone fund. This allows them to defer the payment on the capital gains until 2027. But by far the biggest benefit is that once an opportunity zone investment is held for 10 years, there are no capital gains on the investment. So, effectively, the entire investment return can be realized completely tax-free.

How many of these projects are you developing?

We’re expecting the total value to exceed $1 billion. Our projects are across seven states, ranging from Arizona to Indiana, Kansas, Missouri, Ohio, Texas and Florida. This program really has delivered in terms of bringing investment into these underserved markets. The projects will create 6,000 construction jobs; 75 full-time, on-site employees; and 3,500 units that will house about 5,000 residents. They will add more than $200 million of spending power each year to these areas. I think this program is doing a lot of good for these communities because the opportunity zones are not just bringing in residents and economic spending, they are also developing jobs in underserved areas. That makes this program especially powerful. ●

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Just like any other commercial real estate asset class, however, the heightened inflationary and interest rate environments are impacting the senior housing sector and its financing prospects. For mortgage brokers working with clients in this space, there is much to be aware of when structuring and closing deals.

Positives and negatives

According to Green Street’s recent U.S. Senior Housing Outlook report, senior housing occupancy levels at the national level have recouped slightly more than half of the decline experienced early in the pandemic. At the end of last year, national occupancy was in the high-80% range, about four percentage points below the pre-pandemic level.

The near-term risk of oversupply in certain markets is low as it will reportedly take several years for supply growth to catch up with demand. Rent and occupancy growth is anticipated to average 6.5% per year through 2027. There’s a strong likelihood that the national occupancy rate will reach a new record high, with a forecast average of 92% in 2027. Additionally, net operating income (NOI) forecasts call for sectorwide growth of 20% in both 2023 and 2024.

While occupancy and NOI expectations showcase the post-pandemic resilience and ability of the senior housing sector to rebound, owners and operators are still experiencing significant challenges. Interest rates are an obvious pressure. According to a March 2023 survey of industry executives conducted by the National Investment Center (NIC), 51% of respondents indicated that rising rates are impacting their ability to recapitalize assets. And 36% of respondents cited elevated interest rates as a challenge when purchasing new properties.

As the NIC survey showed, however, interest rates aren’t the foremost challenge faced today by senior housing owners and operators. Rising operational expenses topped this list, cited by a whopping 92% of respondents. Notably, the proportion of organizations that reported rising operator expenses as a significant challenge increased by 15 percentage points from the month prior.

Staff turnover was the second-largest concern, mentioned by 88% of executives. Being able to recruit and hire community and caregiver staff was the third-greatest challenge, with 82% of respondents currently impacted.

Financing outlook

Senior housing certainly isn’t immune from the impacts of the Federal Reserve’s efforts to quell record-level inflation. Although the most recent quarter-point increase this past May (the Fed’s 10th consecutive hike since March 2022) might be one of the last, it took the fed funds rate to a target range of 5% to 5.25%, its highest level since August 2007.

Unsurprisingly, the cost of mortgage debt for senior living facilities has grown in line with interest rate increases over the past year, heavily impacting owners and their assets. In some cases, the cost of debt coupled with the rising cost of construction has delayed timelines for new projects, while in other cases, it has rendered them completely unfeasible.

Additionally, while debt remains available, it is more limited. This has led to a decrease in sales transaction volume, with the exception of distressed assets.

Amid these capital-market dynamics, lenders are now likely to place greater emphasis on the quality of sponsors. Because senior housing is an incredibly specialized field within commercial real estate, ensuring the success of assets typically requires deep market expertise.

Thus, lenders that remain active in financing these projects today are looking to work with owners and operators with experience in the field. They are likely to prioritize opportunities to finance well-maintained and well-managed properties over alternatives, and mortgage brokers can expect more rigid loan qualification parameters, including in facility acuity levels.

Possible path

While many lenders have slowed their activities in this sector, there are financing options available today for numerous types of senior living centers. These include nursing homes, board and care homes, intermediate care facilities and assisted living facilities.

Given an environment in which lenders have either expanded their underwriting guidelines or pulled back on dealmaking, the U.S. Department of Housing and Urban Development (HUD) can be an ideal alternative for owners and operators. While other capital sources adjust and tighten their underwriting metrics in times of economic decline or volatility, HUD financing is countercyclical and its underwriting guidelines do not change.

HUD’s 232 loan program is government-insured financing that offers a fixed rate and full amortization, with the rate determined by market conditions at the time of the rate lock. These loans are nonrecourse and long term in nature — up to 40 years for new or substantially rehabilitated properties, or 35 years for non-rehab acquisitions that can be funded by Ginnie Mae mortgage-backed securities.

The loan review period typically spans 60 days, once the application has been picked up by the HUD underwriter, and the queue is markedly shorter than in prior years. Current interest rates range from 5% to 6%. A mortgage insurance premium is required, equating to 1% of the loan amount at closing and between 0.45% to 0.65% annually.

HUD-approved lending partners will continue to be active at this time, even as others slow or curtail their activities. These capital sources will be an important lifeline for the senior housing industry during this period of economic uncertainty. ●

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The COVID-19 pandemic hit this sector disproportionately hard due to the initial lack of preventive health measures, the severity of infections and persistent staffing shortages. The sectorwide vacancy rate jumped from 10% in 2019 to 17% in early 2021 before vaccines became widely available among residents and staff. But as COVID concerns gradually faded, other emerging macroeconomic factors (geopolitical conflicts, persistent labor shortages, and higher costs for labor and building materials) continued to shake up the sector’s fundamentals.

Moody’s data shows that senior housing construction deliveries in 2021 were down to less than 60% of their pre-pandemic average while starts fell to a five-year low. Last year, as the cost of capital shot up and credit availability tightened, deliveries were only 10% of their 2021 level. While senior housing construction activity slowed, demand rose steadily as confidence in the safety of these facilities gradually returned amid robust need from the U.S. senior population.

Census data shows that the number of Americans who are 65 or older reached 55.8 million — or 16.8% of the nation’s population — in 2020. The rapid growth of this demographic since 2010 is being driven by aging baby boomers, who began turning 65 in 2011. This combination of persistent demand and reduced supply growth caused the senior housing vacancy rate to decline for eight straight quarters, by a total of 390 basis points (bps), to reach 13.2% in Q1 2023.

Across the four senior housing types, memory care facilities were under the most pressure during the pandemic due to their need for specialized living designs and trained staff members. Memory care lagged the other three subsectors with the highest level and steepest increase of vacancy rate during the pandemic era. At the other end of the spectrum, independent living facilities — which are the most affordable of the senior housing types — have been the most resilient.

Need-based demand and weak construction activity have continued to cause excessive supply to be absorbed. Across the board, vacancy rates dropped during the year ending this past March, led by memory care (-240 bps) and assisted living facilities (-200 bps). Independent living (-190 bps) and skilled nursing facilities (-150 bps) weren’t far behind.

The senior housing sector usually registers its largest rent increases in the first quarter, when repricing occurs as regulatory and budgetary considerations take effect. In Q1 2023, rents for the four subsectors jumped by 3.5% to 3.7%, the highest annualized growth in Moody’s 10-year tracking history. Strong demand tightened market conditions and justified rapid rent growth.

Moreover, rising inflation and elevated interest rates have forced the adjustment of rent to account for higher operational and capital expenses. Over the past four years, rents for assisted living and independent living units have grown the most due to their relatively lower rent levels. Cumulative rent growth has reached 10.5% for assisted living, 9.6% for independent living, and 9% for both memory care and skilled nursing facilities.

How long will the boom last? Although the answer may depend on the interplay of factors such as the cost of goods and services, the availability of mortgage credit and the supply of skilled labor, the need for senior community support services will continue to rise as baby boomers retire and age. The passage of the Inflation Reduction Act (which will lower medical expenses for senior citizens) is likely to produce some long-term benefit for the sector’s recovery.

Across various regions, Midwest and Northeast senior housing markets were hit hardest during the pandemic but have been leading the recovery up to present day. A full understanding of the senior population, especially at the local level, will be critical for investors to turn a profit during an approaching economic downturn. ●

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Even through all the recent economic ups and downs, there have been bright spots for commercial real estate — one being multifamily housing. The apartment market remains a hot commodity for those looking to buy into the sector, but brokers need to help their clients know where to invest.

“The bottom line is that smaller households combined with a growing population equates to the need for more housing units.”

Builders and developers entered 2020 scouring for land and trying to assuage a bevy of community and environmental concerns. They were then buffeted by a labor shortage as the residential real estate market took off during the throes of the COVID-19 crisis, due in part to historically low interest rates and a renewed focus in working from home.

On top of such changes came soaring construction costs, with the price of lumber jumping by 182% during a seven-month period starting in October 2020. At the same time, supply chain freezes pushed up the cost of nearly everything else while greatly limiting its availability. Now, partly in an effort to fight these elevated prices, mortgage brokers and their clients are faced with higher interest rates and tighter borrowing standards, both of which will make financing a new project or acquisition more difficult.

Silver lining

Indeed, between October 2021 and October 2022, mortgage rates more than doubled. Meanwhile, the cryptocurrency movement — once one of the hottest asset classes of the pandemic era — was in free fall due in part to the bankruptcy of the cryptocurrency exchange FTX.

At the same time, the stock market failed to complete a late-year rally after the major indexes dropped more than 20% this past summer. This makes commercial real estate (and multifamily housing in particular) look good compared to the risk inherent in other asset classes.

At the same time, the stock market failed to complete a late-year rally after the major indexes dropped more than 20% this past summer. This makes commercial real estate (and multifamily housing in particular) look good compared to the risk inherent in other asset classes.

As JPMorgan Chase & Co. noted in its 2023 commercial real estate outlook, “Multifamily [housing] is currently the highest performing of all asset classes.” The bank was referencing Moody’s Analytics data that placed the U.S. multifamily vacancy rate at 4.4% in third-quarter 2022 — a five-year low — and its analysts included both multifamily and affordable housing as top real estate trends for this year.

Even brick-and-mortar retail has appeared to stem the tide of rising vacancies. As noted by Moody’s, national vacancy rates for neighborhood and community shopping centers stayed flat at 10.3% for the fifth straight quarter to end last year. Regional and super regional mall vacancies rose slightly to 11.2% in Q4 2022, identical to the levels seen at the end of 2021.

There is a silver lining to most clouds. In this case, as higher interest rates push up the cost of multifamily developments and stricter lending standards lower investment returns, the same trends will compel more Americans to remain renters — many in multifamily properties. Underlining this point is a June 2022 report from John Burns Real Estate Consulting, which estimated that owning a single-family residence cost $839 per month more than renting one.

Never in the past two decades has it been so relatively expensive to own a home versus renting one, the report showed. As a result, renters are staying put.

Where to invest

It’s little wonder that, despite the challenges, multifamily mortgage lending was projected to finish last year at nearly $440 billion, up more than 700% from the height of the financial crisis in 2009. Mortgage brokers will want to help their clients who are interested in this sector to make the right decisions. And probably the first question their clients will ask is, “Where do I invest?”

The answer might not be what you expect. According to national real estate brokerage Redfin, apartment rents increased 9% year over year in September 2022, significantly slower than earlier in the pandemic but still a healthy clip. And although much publicity has been focused on the post-pandemic flight to the suburbs, large and medium-sized cities (many in the Sun Belt) made up the bulk of Redfin’s list of the fastest-growing markets for rental income.

The top location was a surprise: Oklahoma City at more than 24% growth this past September. Pittsburgh came in second as rents there increased by 20% year over year. Indianapolis; Louisville, Kentucky; and Nashville rounded out the top five. New York City rents grew by more than 15%, enough to earn eighth place on Redfin’s list.

In other words, millions of people still crave the urban lifestyle. Also, today’s multifamily operations do not always house full-time residents. For more than a decade, urban housing has amassed an entirely new source of demand from short-term rental sites such as Airbnb, as well as short-term corporate housing platforms like Blueground.

By any measure, demand is robust for multifamily units. When it comes to mixed-use properties, demand for the retail spaces beneath these homes seems to have held up remarkably well. Temporary tenants, who presumably like to get out and about, may be helping to make up for fewer office workers in city centers by fueling demand for ground-floor restaurants, shops and convenience stores. In general, the economic future for brick-and-mortar stores continues to brighten.

Sales growth for these stores outpaced e-commerce growth in 2021. Total retail sales were up 6.5% year over year in November 2022. And the National Restaurant Association reported that sales at eating and drinking establishments reached $90.4 billion in November 2022, a fourth consecutive month of significant increases. This volume was more than $37 billion higher than in November 2020, when the pandemic was raging.

Affordability struggle

The strength and durability of multifamily housing might seem to fly in the face of one trend: The size of U.S. households has been shrinking for decades, from an average of 3.3 people per household in 1960 to only 2.5 people per home last year.

While there are plenty of ways to extrapolate this data, the bottom line is that smaller households combined with a growing population equates to the need for more housing units. But with fewer people in each home, there are fewer people available to pay a mortgage and other household expenses.

Affordability, therefore, is the No. 1 issue for the majority of American households that rent. Multifamily properties presently offer the best deal by far. We may not become a nation of communal living, but we will likely be sharing more walls for a long time to come.

This issue is one to keep in mind for commercial mortgage brokers and borrowers who are interested in the multifamily sector. Consider that this past November, Fannie Mae and Freddie Mac were given the green light to guarantee mortgages of more than $1 million in select locations. This move probably won’t do much to make a “McMansion” more affordable, but it does illuminate just how expensive it has become these days to buy a home in desirable parts of the country. Owning a single-family house is simply not an option for many people.

As 2022 came to an end, lumber prices returned to pre-pandemic levels and 30-year fixed mortgage rates inched down after peaking above 7% in November. Early this past January, they had fallen below 6.5%, partly because the inflation rate appeared to peak in October and was beginning to fall. Many market observers expect a lower inflation rate to reduce pressure on the Federal Reserve to further raise rates.

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Although it’s impossible to know what the long-term trajectory will be for inflation and interest rates, mortgage brokers should understand that the argument for multifamily housing investments remains convincing. The long-term trends in household formations favor multifamily and the demand for rentals is strong. Prices for single-family homes continue to be out of reach for many buyers, requiring a greater focus on renting. As the pandemic fades and supply chains get back on track, developers and builders are finally catching a break. And that’s a good thing for investors, tenants and the economy at large. ●

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Nationwide asking rents averaged $1,701 in the opening month of 2023, unchanged from December to halt a two-month streak of month-over-month declines. On a year-over-year basis, however, rents continued to slide, with January’s decline at -5.5%, down 70 basis points from the month prior.

With the U.S. economy still uneven, household formation slowing and the banner growth of the past two years proving unsustainable, experts continue to ponder how much demand will fall by and how much rents will be impacted. But January’s signals were encouraging, with overall rent growth holding steady in most of the top 30 apartment hubs tracked by Yardi.

Indianapolis continued to lead the pack in year-over-year rent gains by a wide margin at 10.5%. It was followed by Kansas City (8.3%), San Jose (8.1%) and Miami (7.5%). Some markets where rents tracked above norm in 2022 (such as Miami; Tampa; Nashville; and Orange County, California) have fallen back in line with historic averages. Beyond that, however, growth remains steady even as it decelerates.

Demand indicators are staying healthy as well, with 269,000 apartment units absorbed nationally in 2022. At least 10,000 units were absorbed in several metros, including Dallas, Houston, Austin, Atlanta, Chicago, Miami, Los Angeles and Washington, D.C.

Several potential impediments to renter demand remain, including the lingering problem of inflation. If the encouraging January rent figures prove transitory, waning demand could dovetail with other concerns within the apartment industry, including increasing expenses for property owners.

Such expenses, including property taxes, insurance and renovations related to climate change, have property owners and landlords concerned. Joanna Zabriskie, CEO of BH Companies, called 2023 “the year of expense control” due to spiraling costs.

All of this, in turn, could combine with high financing costs to give investors pause and hinder transaction volume. Early-year returns point to a soft landing for the apartment segment, but with so many fundamentals in flux at present, multifamily is an interesting sector to watch as 2023 unfolds.

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If all these landlords follow the recommendation, then there won’t be alternatives to which renters can go, and the landlords will have market power.

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