REI INK

What’s Driving Strong Investment Demand In the Multifamily Sector During COVID-19?

CBRE Econometric Advisors (EA) Analysis of the Strength of the Multifamily Asset Class by Nathan Adkins, Jing Ren, and Neil Blake The multifamily sector’s share of overall transaction activity has grown steadily over the past 15 years. Starting from a quarter of all transactions in the mid-2000s, multifamily expanded to a third of all transactions by 2016, overtaking the office sector, and giving multifamily the largest share of any property type by investment volume. It remains the preferred sector in 2020 with its share reaching a 20-year high of 36%, underscoring investors’ confidence in the sector. In 2021Q1, the share increased even further, to 38%. A combination of recent robust historical performance, resiliency during the pandemic, and expectations of stable future rent growth are fueling investors’ confidence in the multifamily sector. Supported by demographic trends and a growing preference for urban living, multifamily provided high and stable cash flow yields compared to other CRE sectors over the past decade. In the post-pandemic future, investors see multifamily as a safe, stable asset with less volatility and uncertainty than other sectors. Degree of resilience of multifamily sector varied by class, type and region From Q1 2020 to Q1 2021, the U.S. Sum of Markets multifamily vacancy rate increased by 50 basis points (bps), while rents fell 4.2%. This is a milder response than that experienced during the Global Financial Crisis (GFC), when, within a year, vacancy rose by 180 bps, and rents fell by almost 7%. The Sum of Markets statistics are dominated by large, dense, expensive metros which have been harder hit by COVID-19. These large metros saw many of the urban amenities that attract renters to higher priced markets shuttered in the interest of public health, while simultaneously, the prevalence of remote work made it possible to migrate to cheaper, less dense markets. These smaller metros were only lightly affected by these demand issues and most are well on their way to recovery. Additionally, suburban, Class B/C and mid-size Midwest, West and Southeast multifamily markets have all fared better during the pandemic than Class A apartments in urban cores on the East and West coasts. Performance differences in urban and suburban markets Urban core submarkets, like large, expensive markets, lost attractions such as walkable restaurants, bars, and entertainment venues due to pandemic-related shelter-in-place orders. Meanwhile, unemployment from hospitality and service industries put more pressure on urban core already stretched thin for affordable housing. Consequently, the worst-hit submarkets this year have been the urban cores in San Francisco and New York City, where effective rents fell by more than 15% year-over-year. This disparate impact of the pandemic on urban core and suburban submarkets is most starkly illustrated in their recent divergence in vacancy rates. Urban core and suburban vacancy converged in 2015 and have been essentially the same for the past five years. The flight from the shuttered, expensive urban cores is evidenced by a 180-bps jump in vacancy after Q1 2020, reaching 6.1% in Q4 2020, its highest level since Q2 2010. While, in suburban markets, vacancy has remained on its pre-COVID trajectory. As for multifamily rents, urban core submarkets’ year-over-year rents declined by 12.7% from Q1 2020 to Q1 2021, worse than the 11% peak-to-trough contraction during the GFC. Suburban submarkets have been much more resilient, with rent slipping by only 0.1%, compared to 6.7% during the GFC. Performance by Building Class Social distancing measures also disproportionally affected employment in the services and hospitality businesses, which tend to pay lower wages. In theory, disproportional impact on low-income categories of workers should negatively affect demand for Class B and C multifamily housing, but this wasn’t the case. Higher unemployment rates in the low-wage service industry did not translate into higher vacancy rates in Class B and C. Due to supply constraints, Class B and C have been outperforming Class A since 2015. Rather than seeing this gap shrink with the onset of the pandemic, we saw them diverge further, as vacancy rates for Class A units jumped to 6% in Q1 2021, a 130-bps increase from the year before, while Class B and C vacancy rates stayed relatively stable. One possible explanation for the relative underperformance of Class A in light of these labor dynamics is that high-income renters are more able to work from home, and therefore have more flexibility in choosing where to live and whether to buy or rent housing. Recently enacted government policies, such as eviction moratoriums, also contributed to Class C overperformance. According to a recent U.S. Census Bureau Household Pulse Survey, about 14.5% of all renter-occupied households were behind on their rent payments. For households with an income of less than $50,000 a year, 20.3% were falling behind on rent payments. Performance by Market Despite the ongoing pandemic, out of the 69 multifamily markets tracked by EA, 51 recorded positive rent growth from Q1 2020 to Q1 2021. While some renters chose the suburbs over downtowns within the same metro area, others went further and moved away from gateway cities to secondary and tertiary markets, often to be closer to family. Consequently, markets with the highest annual rent growth in Q1 2021 were mid-tier markets: Riverside, Sacramento, Albuquerque, Tucson, Memphis, and Richmond, where rent grew over 6% year-over-year. With downtown commercial activity severely affected by the pandemic, rents fell furthest in major U.S. metropolitan areas, such as San Francisco, San Jose, Oakland, New York and Boston, where rents fell by at least 6% from Q1 2020 to Q1 2021. We expect this trend will reverse starting in 2021 and throughout 2022, with demand shifting back to major metros. Economic outlook and multifamily forecast According to an advance estimate of the Bureau of Economic Analysis, the U.S. economy grew at 6.4% (annualized rate) in Q1 2021. The April 2021 unemployment rate was at 6.1%, a considerable decline from 14.8% recorded in April 2020, but still above 3.5% recorded in February 2020. We expect the U.S. economic recovery to accelerate throughout 2021 with new household

Read More

Offices Face Quantum Shift Post-COVID

The Metamorphosis of the Office Market by Paul Fiorilla No sector of commercial real estate faces more uncertainty going forward than offices. Companies found during the pandemic that work can be accomplished productively from home, and many workers found that they prefer shorter commutes and more flexibility. Demand for office space will be reduced, and workspaces will be redesigned. The only question is how much of a disruption will occur. Offices have taken quite a hit from COVID-19, even though the measurable cost has been obscured by the long-term nature of office leases. The U.S. office vacancy rate climbed to 15.9 percent as of April, up 280 basis points year-over-year, while sublease space has more than doubled during that time, according to Yardi Matrix. That bump, however, is just the tip of the spear. Only about a quarter of downtown office workers nationally reported to an office as of April, with the percentage closer to 15 percent in New York City and San Francisco, according to security firm Kastle Systems. The question is not whether companies will reduce their office footprint post-pandemic, but by how much. Demand for space barely scratches the surface of the considerations faced by owners and occupiers. The industry must come to grips with a host of factors, including when workers can safely return; how many people will use offices and how often they need to be there; where offices should be located; how offices interact with lifestyle preferences such as commuting and walkability and, how to re-design space to attract and maintain talent while meeting functional needs. The industry is facing a “quantum fundamental shift,” according to Jeff Adler, vice president of Yardi Matrix. “The sector is at the beginning of a wrenching multi-year rethinking of the nature of work. Everything is in play.” Where to Work? The primary question hanging over the industry is how office utilization will change after the pandemic ends. “Every tenant is asking the same questions about how and when to get back,” said Benjamin Breslau, chief research officer at JLL. Breslau said that the percentage of workers reporting to an office is expected to triple by year-end, to 75 percent, and that work-from-home will double to 20 percent of workers from 10 percent pre-pandemic. Many companies have found that workers can be productive from home, but to what extent can it be done without impacting corporate culture and collaborative efforts? A consensus has formed around the idea that most companies will adopt more flexible arrangements, but what that means for office space demand depends on the details. In terms of how much space is needed, there is a big difference between giving employees a choice to be fully remote or requiring them to be in an office part-time. Those decisions are complicated not just by employee preference but by the nature of the job and the industry. Some types of knowledge work (such as programming) can be performed well anywhere, but others are more productive in a collaborative environment. Daniel Ismael, a senior analyst at Green Street Advisors, said the average office worker’s time in the office will likely drop to 3.5 days a week from 4.5 days a week pre-pandemic. While a part of the office space decision will be driven by the type of jobs and corporate culture, companies will also have to bear in mind the preferences of employees, which is another complex issue. If proximity to an office is no longer important, how will that change workers’ preference for where they want to live? In the years leading up to the pandemic, the default assumption was that young knowledge workers wanted to live in an urban environment. Job growth over the last 20 years has been concentrated in urban areas,even in secondary and tertiary metros. However, the pandemic prompted a drop in population in urban submarkets in gateway metros. Young families moved to suburbs to get more space while others who were suddenly unmoored from the need to commute moved to different parts of the country. Some moved to lower housing costs, but part of the movement was driven by the closure of entertainment and cultural venues. When those venues re-open, some will move back to urban areas, but others have left permanently. Companies could deal with this by shifting offices to the suburbs or moving to less expensive metros, or by adopting a “hub-and-spoke” model with a city headquarters and outposts in the suburbs. Mark Grinis, hospitality and construction leader at EY Global Real Estate, said during ULI that a more distributed workforce is at odds with the need for collaboration. Studies done by EY of workplace productivity found that secondary locations—the “spokes”—had the worst performance. Lifestyle Changes COVID-19 has prompted many people to think about lifestyle and where they want to be. Many workers were relieved to avoid long commutes of more than 30 minutes, but “walkable” neighborhoods with access to shopping and other amenities remains popular. Diane Hoskins, co-chief executive officer of design and consulting firm Gensler, said that many are choosing smaller cities and inner-ring suburbs, especially in the technology sector. “There’s a real appetite for reconsidering how cities work,” Hoskins said. “When you look at real estate as an investment in people, you say how do you do it in a way that optimizes … competitiveness to be able to thrive in a global environment.” One difficulty for picking a location is that few metros are configured to meet conflicting worker preferences.  Lifestyle considerations mean that office buildings themselves need to be re-thought to meet the new paradigms. For example, workers may demand less density for health considerations. If workers come to the office less frequently, then more collaborative space is likely needed to make efficient use of the time they are together. Companies may have to redesign space to add amenities to retain workers and/or entice them to come to the office. The myriad redesign changes, and even downsizing, are likely to require costly capital expenditures at a

Read More

Real Estate Investing Outlook

The Pandemic Gave the Real Estate Industry a Crystal Ball to Identify Emerging Trends by Erica LaCentra Despite the global pandemic, the real estate investing space, in particular single-family rental, is booming. The SFR market was one of the best performing areas of real estate in 2020 as it mirrored the strong performance seen with single-family purchases. The thing with SFR is that it is a very attractive asset class for smaller-scale investors or even those looking to have supplemental income. It continues to be a great option for those that are wary of the stock market or investing in other avenues because it is a relatively safe and easy way to invest in residential real estate and has consistent long-term returns. So, let’s talk about what the second half of 2021 and beyond has in store for SFR.    Why Is There Such High Demand? Even pre-pandemic, this was an area of the market that was already experiencing rapid growth due to general demand from many demographics. Millennials that may have been looking for space and the comforts that come with living in a single-family home drove a significant amount of this demand. As this demographic started to get to an age where they are settling down and having families but were not ready or able to purchase a home, renting in the suburbs became a very attractive option. On the flip side, you also have retirees that were looking to downsize and potentially move closer to family as they get older. This was another large segment that was driving demand. Members of older generations who were not interested in owning a home and dealing with the maintenance began looking at single-family rentals to get the best of both worlds. One of the largest issues that continues to face the market is low inventory. There was a lack of supply of single-family houses throughout the country before the pandemic and that demand didn’t go away once the pandemic hit. In fact, it seemed to accelerate demand in this space because of the mass migration that occurred out of major cities to the suburbs when the pandemic hit. This migration of individuals out of cities has only exacerbated the problem. And in turn, it has caused home prices to skyrocket in many areas of the country because there is simply not enough supply to meet demand. How Will Prices Fair? The biggest question on everyone’s mind as home prices continue to climb is, how long will this last? In Q1 of 2021 alone, median home prices were up by around 10% year-over-year. As things look like right now, supply and demand are going to continue to drive home prices up in 2021 and there is no indication that price growth is going to slow down this year. According to a recent Zillow report (Zillow Economic Research) “annual home value growth will rise as high as 13.5 percent by mid-2021 and for home values to end 2021 up 10.5 percent from their current levels.” This forecast also predicted that sales volume will remain elevated throughout 2021, finishing the year at “6.9 million sales, the most since 2005.” It’s hard to say how far beyond 2021 it will continue, but unless there is a large influx of inventory, all signs point to home prices continuing to grow throughout 2021 and even potentially into 2022. And for those individuals that are predicting a flood of distressed assets once forbearance and government intervention is removed, that is starting to seem more and more unlikely. The difference between the Great Financial Crisis and any looming fallout from the pandemic is the tremendous amount of equity that homeowners have. According to Corelogic’s recent Homeowner Equity Report, “U.S. homeowners with mortgages (roughly 62% of all properties) have seen their equity increase by a total of nearly $1.5 trillion since the fourth quarter of 2019, an increase of 16.2%, year over year.” With these gains in home equity, it ensures that homeowners have a reduced risk of being underwater or in the event, they fall on hard times, there are greater options to sell rather than go into foreclosure. Where is the Inventory? So, if future distressed sales are not necessarily on the horizon, what other avenues will potentially play into housing inventory growth? While the home flipping industryis facing its own challenges due to lack of inventory and flipping activity continues to decline due to lack of inventory, new construction is having its moment. Investors looking to flip homes are running into stiff competition for properties and are also finding it challenging to find deals on properties that would provide a reasonable return on investment and are turning to new construction. While new construction is not without its own potential snags, such as constraints due to rising materials and lumber costs, single-family home starts are rising and are projected to continue to rise; thus, providing one of the best areas of opportunity to add additional inventory to the marketplace. There is also the thought that inventory levels may rise as more vaccines become available to the general public. While increases in vaccinations may cause some upticks in inventory due to people returning to cities and leaving the suburbs again for whatever reason, this will probably also not have that large of an impact. Since there was already a lack of supply pre-COVID, the best we can potentially hope for once more folks are vaccinated is for inventory to get closer to pre-pandemic levels. What About Commercial Real Estate? By all indications, many segments of commercial real estate should recover from the devastation that the pandemic caused. Areas of the market, such as the multifamily space, have already started to rebound, and look as though it will likely come out of the pandemic unscathed. In fact, multi-family housing is poised for remarkable growth throughout the remainder of 2021. Demand in this segment of the market shows indications of increasing as vaccinations increase and people and workforces begin migrating

Read More

Investors Face Challenges Today, See Better Times Ahead

The RealtyTrac Investor Sentiment Survey™ by Rick Sharga Individual investors today face unprecedented challenges in the real estate market. Limited supply, soaring prices, and unprecedented competition from both institutional investors and traditional homebuyers. How do investors feel about market conditions today? Is the investment market better or worse than it was a year ago, and will it be better or worse six months from now? What are the biggest barriers to success for investors? And are they anticipating relief to come in the form of an influx of foreclosure properties? RealtyTrac recently completed its first RealtyTrac Investor Sentiment Survey™, surveying 150 individual real estate investors across the country to find out how they viewed the market, what problems and opportunities they faced, and what their impression was of today’s environment for real estate investing. These investors are representative of the majority of real estate investors—the typical mom-and-pop investors who purchase between 1-10 properties a year. It is these individual investors who exert the most influence on market conditions. Nearly 90% of the 19 million single family rental properties in the country are owned by these mom-and-pop investors, while the largest institutions—collectively— own less than 2%. The fix-and-flip market similarly is populated by thousands of small investors who average about one flip a month, but who now face competition from the so-called iBuyers like Opendoor, Offerpad and Zillow, who essentially do flipping at scale. The respondents to the RealtyTrac survey were almost evenly divided between fix-and-flip investors and those who purchased properties for the purpose of renting out these homes. How do they view today’s market, and what do they expect in the future? Some of their answers might surprise you. Three Challenges for Investors Today: Inventory, Rising Prices, and Competition from Homebuyers About 45% of investors believed that the investment market is worse or much worse than it was a year ago, but almost 40% believe that conditions will improve in the next six months. The investors cited three primary challenges in today’s market: lack of inventory, rising prices and competition from traditional homebuyers. The lack of available inventory was overwhelmingly cited by investors as the most daunting challenge—over 68% of the survey respondents listed this as one of the three biggest problems facing investors today, and over 60% believe this will still be a problem six months from now. Supply of existing homes for sale is at the lowest levels ever reported by the National Association of Realtors® (NAR). Similarly, the National Association of Homebuilders (NAHB) has reported that new home inventory is at its lowest levels since they began reporting this data in 1973. And even foreclosure inventory is at historically low levels according to RealtyTrac. Meanwhile, demand from homebuyers is growing rapidly. This demand is being driven by three factors. First, historically low interest rates, which improve affordability, and actually make it cheaper to pay monthly mortgage payments on a 30-year fixed-rate loan than it is to pay rent in many markets. Second, demographic trends. Millennials, the largest generation in U.S. history, have the largest cohort of their age group arriving at the prime age for 1st-time homebuying. And Gen-Xers are hitting their peak years for move-up buying. Finally, the COVID-19 pandemic accelerated the transition of urban renters to suburban homeowners, as tenants left high-cost cities (especially New York City, San Francisco, San Jose and Seattle). The unprecedented demand has created an unusual market dynamic for individual investors: instead of competing with larger institutional investors, mom-and-pop investors find themselves competing with more traditional consumer homebuyers. Over 36% of those surveyed cited this competition as one of their three biggest challenges, edging out the fourth most-cited challenge, the rising cost of materials, which was cited by just over 32% of the respondents. The increase in home prices was identified as the second-biggest challenge (over 58%) by the investors. Fix-and-flip investors found these prices to be more problematic than rental investors, which makes sense since flipper ROI depends to a great extent on the ability to buy a property at enough of a discount to be able to spend money on repairs and still turn an acceptable profit. And while investors generally expect market conditions to improve, they’re less optimistic about home prices. About 56% of those surveyed expect prices to continue to rise over the next six months, with 18% expecting the prices to go up by more than 5% during that time. Interestingly, investors don’t appear to be concerned with their ability to secure financing today, although they’re less certain about that in the future. Only 8% cited access to capital as a barrier today, while over 15% are concerned that it might be an issue six months from now. And, while just under 9% are concerned about rising interest rates today, almost 33% believe that rising rates are coming their way in the next six months. Will Foreclosures Provide Relief? Foreclosure activity today has virtually ceased due to the government’s foreclosure moratorium and the CARES Act mortgage forbearance program. Since these programs began, RealtyTrac data has shown year-over-year declines in foreclosure actions of between 70-80% a month. And the inventory of homes in foreclosure is now at the lowest level ever recorded in the RealtyTrac database. While it’s unrealistic to expect that default activity won’t rise somewhat after these government protections expire, the investors answering the survey aren’t expecting a flood of distressed properties. About 37% of the respondents believe that foreclosure activity will return to its normal, historical level (about 1% of mortgage loans in a given year), while 30% said that foreclosures will surpass normal levels, but remain well below the levels seen during the Great Recession. With a record $21 trillion in homeowner equity, it’s likely that most homes in default will sell prior to the foreclosure auction, and very few will ultimately be repossessed by the banks and subsequently listed for sale. Continued challenges with low inventory and rising prices, higher interest rates, and ongoing competition from homebuyers—and yet these investors

Read More

Invest Properly Today to Sleep Well Tomorrow

Dramatic Changes in the Economy Have Had a Major Impact on Our Industry by Adam Whitmire What is happening to the real estate market? Homeowners are finding it easy to sell their homes. They are also sharply realizing that they are not able to find another one due to low inventory. Is this a bubble, or something more? Since the last recession in 2008, new home starts have been below 50% of pre-recession levels, up until recently, 2019 to be exact. New home starts dropped again significantly during the pandemic. It is what happened next that was so unexpected. After sheltering in place for several months and working from home, homeowners and renters decided to stretch their legs and expand the home front. This meant bigger yards, a home office, and room for social distancing. The shelter in place ended during the summer with lower interest rates and pent-up demand for housing. Not to mention that social distancing does not mix well with high density housing in high density cities. This began the race to the suburbs. Coinciding with the anti-density movement, millennials were already getting older and looking to buy or rent a home. In fact, the moment an apartment renter bought a pet, they began looking for a yard. Add this excitement to the extremely low home production over the last decade, and the many new home sellers that were created from skyrocketing home prices, and you have a mass buying frenzy. Where are we going to get all these new homes? There are many builders anxious to build and sell homes. But they cannot build without materials or lots. During the full force of the COVID-19 pandemic, there was a lot of new home inventory available. We were helping investors purchase new homes as rentals at that time. We tried to get investors excited about the additional selection of homes that would not be available during normal circumstances. However, to no avail, most investors were too afraid of the economic shut down to purchase rental homes. A few months later, all the homes were gone and there was nothing to replace them with, but much higher priced pre-sales. Today, construction materials have skyrocketed. Lumber has increased over 300% and no one can find windows. We have plenty of land. Let’s just develop more lots. Sounds simple, right? Well, if you think waiting 5-6 months for a home to be built is a challenge to your patience, try waiting 18 months to develop a lot. You see, in the olden days, prior to 2008, a local developer could go down to the bank and take out an A&D (Acquisition and Development) loan, buy some land, develop it into lots, and sell the lots to a builder group or a national or regional builder. The problem with that model today is that since the financial crisis, banks stopped loaning money to develop lots. Not to mention, most of the developers went bankrupt or were forced into retirement. And since builders do not like to develop their own lots, here we are with no lots to build on and more housing demand than ever before. Home buyers have noticed that for the last few years as the homebuilding industry has been trying to shake off the dust and ramp production back up, the majority of the homes were priced from $300K – $500K, the price of a typical move up home. Building for less than that just did not make sense financially. The cost of development was too expensive. This left workforce housing and starter homes in short supply. To solve this problem, the industry began building rental subdivisions, commonly termed build-to-rent or build-for-rent. These are communities of single-family homes and townhomes that are only for rent and not for sale. The income valuation of these homes was enough to justify building them. And with the growing demand for rentals, a new asset has emerged. Today, these types of developments have become increasingly popular due to its mitigated risk profile and ability to fill a large gap in the market. These dramatic changes in our economy have had a major impact. One year ago, you could still buy land at a reasonable price. In fact, you could buy homes at a reasonable price. The capital markets were flush with cash and underwriting was still disciplined. Today, equity and debt are being flooded into the market as sensible underwriting has become somewhat hazy. Don’t get me wrong, there is legitimate demand in the real estate market, just below the smoke screen of “everything is a good deal” and “you can charge whatever you want in rent”. I like a growth market as good as the next developer, but this is off the chart. So, are we buying for deals, supplying the gap in the market, or just trying to place debt because we are expecting hyper-inflation? No matter what the future holds, if we invest properly today, we will sleep well tomorrow. Keeping our feet on the ground when the market is flying will only lead to better decisions.    

Read More