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 formation rising and the reopening of major metros spurring recovery in the multifamily sector. The long-term outlook for multifamily remains strong, with national rent expected to recover to pre-COVID levels in Q1 2022 and vacancy to recover to pre-COVID levels one quarter after, with secondary markets leading the recovery, followed by major metros.
While the multifamily sector is seen by investors as the CRE leader in the stable cashflow yield, several key trends require further monitoring and analysis.
The pandemic accelerated single-family housing demand and the rise of homeownership. Due to the unique combination of remote work, accumulated personal savings and low mortgage rates, many millennials used 2020 to start looking for their first house. While the current scarcity of affordable single-family housing prevented many first-time homebuyers from buying a home, this is a trend that will inevitably increase as the millennial cohort ages. Landlords and investors need to start thinking beyond millennials and looking at the preferences of Generation Z; the most diverse and the best-educated generation yet.
