Over the past three decades, investors who turned to multifamily housing have benefited from its ability to generate superior risk-adjusted returns across market cycles. The resilience of the sector, particularly during economic downturns, helps explain this performance and is the reason multifamily is considered more recession resistant than other property types. This was demonstrated during the 2008-2009 Financial Crisis, where multifamily rents declined more modestly than all other major property types and then recovered more quickly, achieving cumulative rental growth more than 3-5x these other property types (as shown below).
This is highly relevant now as we face a market with unprecedented uncertainty and where, once again, multifamily stands out for its potential to generate attractive relative returns.
Admittedly, the current downturn spurred by COVID-19 is not a normal, cyclical swoon. There are many unknowns, including the duration, severity, and lingering impact of the pandemic. Nonetheless, multifamily properties have performed remarkably well thus far through the first four months of the pandemic. Rent collections and occupancy remain near pre-COVID levels, thanks in part to the strength of the government response, including a record $2 trillion stimulus package passed under the Coronavirus Aid, Relief, and Economic Security (CARES) Act.
Stimulus aside, there are fundamental reasons why multifamily has consistently withstood market turbulence, all of which are applicable to our current situation:
- People need a place to live. Travelers can stop traveling, shoppers can curtail shopping, and offices can go unoccupied; but, as illustrated by demand for rental units in previous down turns, people need a place to live.
- Affordability of home ownership has declined. Affordability, already a concern across the country pre-COVID, has now become more of an issue. Many tenants who, under different circumstances might have become homeowners, will remain renters for the foreseeable future because of diminished personal wealth and uncertain financial prospects. In short, during periods of economic stress, people's propensity to rent increases.
- Not nearly enough affordable homes. New housing supply has been relatively muted over the past decade, and much of the limited new supply has been in Class A properties, supporting supply-demand dynamics in relatively older, Class B & C quality multifamily assets.
This is not to say that near-term risks are not present. They are, including the potential for declining occupancy, increasing tenant defaults, and stagnating rental rate growth. One other typical real estate risk however, risk of oversupply, has in fact subsided post-COVID given the more challenging landscape for construction loans on new developments.
The multifamily sector is also distinguished from other property types for the ample supply of attractively priced debt financing, thanks to government agencies such as Freddie Mac and Fannie Mae. While lending activity and subsequent transaction activity has all but stalled elsewhere in the real estate market, agency-backed mortgages have allowed multifamily assets to not only transact, but to do so at close to pre-pandemic financing terms. Notably, the existence of such a strong financing market also makes multifamily one of the most liquid private real estate asset classes, facilitating transactions otherwise challenging without a loan and creating a robust transaction market.
Moreover, with borrowing rates currently at historic lows, using prudent levels of leverage can be highly accretive to investment returns. As illustrated below, the spread between multifamily cap rates - a measure of property yield - and 10-year US Treasury yields, is the widest it has been in two decades.
Multifamily - Achieving Compelling Returns
Given the potential return characteristics of multifamily, it is not surprising that competition for deals is high, making it important to select the right markets - something we will discuss in next week’s newsletter and here on Cadre Insights - and equally important to find ways to add value through operational and physical improvements. However, in a world where interest rates are near zero, and the risks of other property types are hard to quantify, we believe multifamily can achieve compelling returns - making multifamily an important property type to include in constructing a diversified real estate portfolio for today’s market environment.
Allen is the President of Cadre. He is the former CEO and President of Four Seasons and former CEO of Prudential Real Estate Investors.
The views expressed above are presented only for educational and informational purposes and are subject to change in the future. No specific securities or services are being promoted or offered herein.
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Any discussion regarding “Opportunity Zones” — including the viability of recycling proceeds from a sale or buyout — is based on advice received regarding the interpretation of provisions of the Tax Cut and Jobs Act of 2017 (the “Jobs Act”) and relevant guidances, including, among other things, two sets of proposed regulations and the final regulations issued by the IRS and Treasury Department in December of 2019. A number of unanswered questions still exist and various uncertainties remain as to the interpretation of the Jobs Act and the rules related to Opportunity Zones investments. We cannot predict what impact, if any, additional guidance, including future legislation, administrative rulings, or court decisions will have and there is risk that any investment marketed as an Opportunity Zone investment will not qualify for, and investors will not realize the benefits they expect from, an Opportunity Zone investment. We also cannot guarantee any specific benefit or outcome of any investment made in reliance upon the above.
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