Dodge Data Economist: Multifamily Development Wave Has Lenders Wary

ATLANTA — Lenders are understandably exercising caution when it comes to financing multifamily housing development projects, says Robert Murray, chief economist for Dodge Data & Analytics, which tracks construction starts across commercial real estate.

“Notwithstanding the pickup in activity we had in 2018 and notwithstanding the fact that millennials are still looking at apartments as opposed to single-family homes, we view multifamily housing as one of the more vulnerable parts of the construction industry right now.”

Robert Murray, Dodge Data & Analytics

The insights from Murray came during his mid-year outlook presentation before approximately 60 people who gathered at Le Meridien Perimeter in Atlanta on Friday, June 14. The attendees were largely building product manufacturers, with additional representation from financial services and construction staffing services.

In 2018, construction starts in the multifamily sector totaled 534,000 nationwide, according to Dodge. The projection for 2019 is 495,000 units, which would equate to a 7 percent decrease. As for 2020, the decline could be as much as 15 percent, according to Murray.

The national apartment vacancy rate for the first quarter of 2019 stood at 4.8 percent, up 10 basis points from 4.7 percent a year earlier, according to Reis, which tracks apartment completions and occupancy. Net absorption totaled 37,159 units in the first quarter of 2019, lower than the previous quarter’s absorption of 49,558 units. The 2019 figure was “weaker than most first quarters,” says Reis.

Lending Standards Tighten

The Federal Reserve conducts a survey of bank lending officers every quarter. Specifically, the survey asks whether they are tightening lending standards in the current period compared with the prior three months. Standards for multifamily loans and land development loans have tightened since the second quarter of 2015. For commercial real estate loans, standards for non-residential building eased in the first half of 2018, then tightened the next three quarters, according to Dodge.

Activity within the multifamily sector is dominated by high-rise activity in major markets, according to Murray. For example, City View Tower at Court Square is a $700 million, 702-unit multifamily project in Long Island City, N.Y. that has been under construction since February 2018. In Chicago, construction recently began on the multifamily portion of One Chicago Square, a $652.8 million project comprising 870 units.

Noting the surge in multifamily housing development in 2018, Murray said that residential building experienced a 7 percent increase last year in dollars spent on construction starts. By comparison, commercial building experienced a 4 percent spending jump in 2018. Murray said the Tax Cuts & Jobs Act of 2017 led to a pickup in overall economic growth that benefitted the industry. He expects commercial building to level off and decline into 2020.

The slowdown in the pace of construction starts isn’t unique to the multifamily sector, says Murray, who points to a similar trend across all property types. For instance, a 3 percent increase in construction starts across property types in 2018 was well below the 7 percent increase recorded in 2017.

“We’re still holding to the notion that construction cycles play out in predictable manners,” said Murray. Residential building typically leads the cycle, followed by commercial and then institutional. Dodge classifies institutional building as publicly financed projects, such as transportation, schools, hospitals and sports arenas.

For measuring projects in the planning stage, the data company has compiled its Dodge Momentum Index (DMI) since 2012. This index offers insight on what lies ahead for nonresidential buildings, excluding manufacturing. After a decline in the third quarter of 2017 the DMI experienced renewed growth through July 2018. Since then, the DMI has settled back through May 2019. Commercial building activity is down 20 percent since July 2018.

Economic Headwinds, Tailwinds

For Murray, one of the easier ways to address the various influences on the economy is to identify tailwinds and headwinds. The first tailwind Murray cited is GDP growth, which was 2.9 percent for full-year 2018. In the first quarter of 2019, GDP growth was up 3.1 percent on an annualized basis. For full-year 2019, Dodge projects GDP growth of 2.4 percent, trailing off to 1.5 percent in 2020.

Another tailwind has been long-term interest rates, which have stayed relatively low (the 10-year yield is current hovering around 2 percent). The Federal Reserve has indicated that any hike in the fed funds rate — the interest rate at which depository institutions lend reserve balances to other depository institutions overnight — is on hold for now. In December 2015, the Federal Reserve began tightening monetary policy, followed by eight additional rate hikes through December 2018. The current fed funds rate is 2.5 percent.

As for headwinds, Murray first cited that the lift to the economy from the Tax Cuts and Jobs Act is now waning. In addition, material prices are still rising, the construction labor market remains tight and trade tensions with China have increased. The Producer Price Index for construction materials jumped 6.4 percent in 2018, according to the U.S. Bureau of Labor Statistics. Increases in steel and aluminum pricing are largely to blame.

Another headwind is that the federal budget deficit will approach $1 trillion in fiscal year 2019, which ends Sept. 30. This deficit may limit government spending, said Murray. With a slower economy, the market fundamentals for commercial and multifamily building are expected to weaken.

— Kristin Hiller

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