By John Foresi, CEO of Venterra Realty
As we think about the macroeconomic backdrop and how it will affect operations and the multifamily industry more broadly, it becomes increasingly clear that a recession is pretty much unavoidable. The risk of a debt crisis has not gone away, and the ratio of global debt-to-gross domestic product (GDP) now stands at an astronomically high level of 352 percent, according to the Institute of International Finance.
Notably, today’s investor and consumer sentiments are quite different than when the market was stronger. The risk became greater in the post-Global Financial Crisis era, but what we saw over the decade that followed was central banks around the world failing to hit their inflation targets, while interest rates were kept low as they continued trying to kickstart inflation. This scenario never quite materialized, but it did incentivize increased debt levels.
John Foresi, Venterra Realty
The problem now is that inflation is high enough such that debt is being treated very differently, and the risk has taken center stage. Net interest paid by the U.S. government, in absolute dollars, is already 20 percent above pre-pandemic highs, according to the U.S. Department of Treasury. That is before the higher rates we see today start to really bite as government debt continues to roll over. This increases the risk of a deeper recession as well — there simply isn’t enough “gas in the tank” from a fiscal standpoint to stimulate demand thanks to high debt levels and the change in market sentiment.
The 2023 Rental Market
With two significant headwinds, 2023 will resemble 2022 more than 2021. According to Bloomberg, a recession hurdle is anticipated, with Wall Street assigning this outcome a probability of 65 to 70 percent. With regard to the multifamily industry, that translates to slower income growth among renters, as well as less disposable income and less demand as people decide to take on roommates or even move in with family members.
The second headwind involves supply. According to U.S. Census Bureau data, as of October 2022, 910,000 multifamily units were under construction across the country. Further, more than 790,000 single-family homes are currently being built, per the U.S. Census Bureau. Not all of them will deliver within the next 12 months, but we are seeing pandemic shortages easing, meaning construction is progressing at a quicker pace. Nationwide, we will see an increased supply of housing delivered to a weak economic backdrop.
That is the nationwide story, but it isn’t uniform, and supply growth is only dangerous when it exceeds demand. Markets with sustainable demand drivers, particularly in the Sun Belt region, are likely to outperform their peers, as their fundamentals haven’t changed. But it is safe to say that industrywide, the rental market in 2023 will be more difficult to navigate than in years past.
Recession Brings Opportunity.
Short-term players and capital sources wielded strong impacts throughout the multifamily industry until early 2022, when funding markets for those strategies started to freeze. The absence of liquidity and short-term debt strategies means better-priced opportunities for buyers as sellers become more motivated. We don’t see the private lenders and other short-term funding sources executing an “extend and pretend” strategy this time around.
These situations are ideal for those buyers with a more extended focus that can leverage their long-term access to capital to acquire high-quality assets at attractive valuations.
In the near term, the build for rent (BFR)/single-family rent (SFR) sector presents significant opportunities and threats. The opportunities exist because this space represents a newer type of product targeting a different market segment.
The flip side is that BTR/SFR also represents a challenge to traditional business. At Venterra Realty, to minimize this risk, we have adjusted our underwriting standards and the analysis underpinning it to account for the presence of these deals in our markets. We take pains to ensure that we get complete views of the supply picture in our decision-making processes.
Another opportunity is the electrification of transportation. This is top of mind for future renters, and the reality is that most existing apartment products do not have the infrastructure — car charging ports, billing systems — to support future demand. This presents a significant opportunity across the industry for differentiation.
Renter Growth
During an economic downturn, the headship rate, or the pace at which new households are formed and people move out on their own, tends to slow or reverse, leading to falling occupancy and moderating rent growth. On a national scale, we should not be surprised to see negative rent growth in 2023, consistent with experience during similar times.
Additionally, single-family homes have become increasingly unaffordable due to the Federal Reserve’s rate hikes. Rising home prices, up about 40 percent as of fall 2022 relative to pre-pandemic levels, have combined with increased mortgage costs (up roughly 300 basis points over the same horizon) to erode affordability.
Combined, these two factors ensure that the cost of the typical home, in terms of the monthly payment, is up roughly 60 percent compared with pre-pandemic levels. Suffice it to say that incomes have not kept up. We are already seeing some modest adjustment in the single-family home market, but the affordability issue will work to support rentals in the near term.
What Renters Want
Value for money will be crucial for renters in the coming year, as many will take a hard look at their expenses. People will always need places to live, so the question is: “What are they getting for the rent they are paying?”
This puts a magnifying glass on the level of service, number of amenities and other varying factors. Renter expectations and standards are higher now than in previous years, meaning that all the factors that play into creating an asset, such as location and amenities, will become even more important to prospective tenants.
— Venterra Realty is a multifamily investment and management firm based in Houston, Texas.