The strength of the national multifamily market has been driven by a number of factors, especially job and wage growth. Nationally, annual job growth has been 1.5 percent and annual wage growth has been 2.9 percent, according to the U.S. Bureau of Labor Statistics.
Another factor affecting the multifamily market is homeownership. In the United States, homeownership reached 65 percent in 2008, dropped to 60 percent in 2015 and rebounded to 65 percent at the end of 2017, according to the U.S. Census Bureau. Strong demand, low vacancies, good rental growth and a vibrant sales market have characterized the market.
Susan Branscome, NorthMarq Capital
During the last 10 years, the millennial population has primarily rented housing and baby boomers have been downsizing to apartments or condos. These trends have contributed to the multifamily market’s strength. We see the millennial sector housing choices changing with much of the generation getting married and starting families.
Last year represented the third-best year in history for multifamily property sales volume, according to Dave Lockard, senior vice president in the multifamily brokerage division of CBRE.
Another factor affecting multifamily markets is a slowdown in new construction. Higher construction costs and more conservative commercial bank construction financing have led to fewer developments. The cost of materials and labor has increased, making it more difficult to justify development.
Banks have experienced more lending regulation, causing apartment developers to place more equity in projects and leading to lower returns for developers. Also, short-term and long-term interest rates have increased, making the cost of borrowing higher. These increases will lead to higher capitalization rates and lower values, contributing to fewer feasible projects.
The peak of new construction in the United States was March 2017 when nearly 50,000 units delivered. In contrast, the monthly average for the fourth quarter of 2017 was 28,700 units.
Long-term permanent financing is plentiful with Freddie Mac and Fannie Mae getting their share of the originations market. Life insurance companies also favor multifamily as a property type upon which to lend. Loan-to-value (LTV) ratios range between 65 to 80 percent, with lower LTV transactions commanding the best interest rates, usually by life insurance companies.
Bridge lenders prefer multifamily as well, but unless a property is a value-add, turnaround-type property, bridge lenders are not the best lender choice. CMBS lenders have difficulty competing with these lenders for long-term loan opportunities in the multifamily space.
Local factors
Cincinnati, with a population of 2.2 million and an average household income of $80,000, has been considered a strong Midwestern market in which to develop and invest in multifamily properties. Cincinnati is in the top 25 largest metropolitan statistical areas in the country, with nine Fortune 500 companies headquartered in the city including Kroger, Macy’s, Procter & Gamble and Fifth Third Bank.
Cincinnati’s unemployment rate sits at 3.7 percent, in comparison with Ohio’s rate of 4.8 percent and the nation’s rate of 4.1 percent. According to Lockard, apartment vacancies have remained in the 6 percent range with a slight uptick of about 10 basis points during the fourth quarter of 2017.
Average annual rental growth in Cincinnati since 2010 has been 4.3 percent. Rents are approximately $1 per square foot for suburban properties and $1.61 per square foot for the central business district (CBD). The Class B market, which tends to house more workforce residents, has been very strong and there is a lack of available housing in this sector in Cincinnati with remarkable demand.
Capitalization rates for Class A properties are currently in the 5 to 5.75 percent range with Class B cap rates in the 5.5 to 6.25 percent range. Predictions are that cap rates will not change much this year, although we should witness an increase in cap rates at some point with sustained higher interest rates.
There are a number of other factors besides interest rates that are affecting cap rates, including the strength of the market, potential rental growth and returns on alternative investments.
The Cincinnati CBD has enjoyed strong occupancies and rental increases with some high-profile projects coming online, including North American Properties’ Encore Apartments on Sycamore Street and Rookwood Properties’/North American Properties’ to-be-built, 18-story luxury tower anchored by a Kroger.
Development outlook
Flaherty & Collins Properties is developing two new multifamily projects, Fourth & Race in downtown Cincinnati and Riverhaus in northern Kentucky. The demand for rental housing downtown appears to remain strong, leading to the conclusion that these properties will lease up quickly at pro forma rents.
Cincinnati is expected to experience a lower level of multifamily property sales volume this year based upon the fact that there are fewer loan maturities. Although vacancies are expected to increase as much as 1 percent, Cincinnati will remain a healthy market.
The development pipeline has leveled off with fewer projects, which makes sense based upon the earlier cited factors. Rental increases for 2018 are expected to be 2.5 to 3 percent, according to Lockard. All in all, Cincinnati will continue experiencing a strong multifamily market.
— By Susan Branscome, Senior Vice President, Managing Director, NorthMarq Capital. This article originally appeared in the April 2018 issue of Heartland Real Estate Business magazine.