Over time, an investment in multifamily properties has proven to be lucrative for real estate investors and a good way to diversify a larger investment portfolio. But, at the dawn of 2022, there are a number of headwinds in financial and investment markets. Inflation and interest rates are rising, supply chain and staffing shortages are impacting businesses, and the stock market is off to its worst start since 2009. Some of these trends will almost certainly have an impact on multifamily investment returns in 2022.
In this article, we are going to discuss the outlook for multifamily investments in 2022. First, we will describe why real estate investors like multifamily in general and then the positives and negatives for the multifamily market in the upcoming year. By the end, readers will have the information needed to help determine if a multifamily investment in 2022 is a good fit for their personal commercial real estate preferences.
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Why Investors like Multifamily Housing
First, everyone needs a place to live. As such, they are likely to prioritize their housing costs in times of economic distress. This can be seen during the height of the pandemic when multifamily occupancy levels stayed relatively stable when compared with office or certain types of retail properties.
Second, the barriers to entry for a multifamily unit are much lower than those in the single family housing market – especially when it comes to cost. As the prices for single-family homes continue to outpace wage increases, they become less and less affordable. This is particularly true in large metro areas in Florida, Texas, California, and New York (Miami, Dallas, Austin, New York City, Los Angeles) that have seen major population increases. In light of this affordability issue, multifamily presents a more affordable alternative.
Third, real estate investors like the scale and efficiency of owning a multifamily property. All of the units are located in one place, which makes leasing, repairs, and property management easier and more cost effective.
Finally, multifamily properties are always in high demand with individual and institutional real estate investors alike. This gives them a degree of liquidity when compared to other property types. In addition, they tend to sell for higher prices/lower cap rates, which helps to turn a profit.
These facts are true for all multifamily properties. But, as commercial real estate investment opportunities are considered over the next year, investors should be aware of the tailwinds and headwinds they may face.
At the outset of 2022, multifamily investment performance will be aided by three major positives.
Fundamentals Remain Strong
In their 2022 multifamily outlook, CBRE notes that “the U.S. multifamily sector is poised to finish 2021 with overall occupancy and net effective rents above pre-pandemic levels. While certain markets face challenges, the overall health of the sector will lead to a record 2022.”
Investor Interest Remains Robust
Given the strong fundamentals and wide availability of debt, it is expected that investor interest will remain strong, especially in non-coastal markets and in properties with a strong focus on ESG concerns. Specifically, CBRE writes:
“We predict U.S. multifamily investment volume will reach a record of nearly $213 billion in 2021 (year-to-date volume totaled $179 billion through Q3 2021), well above 2019’s level of $193 billion. For 2022, we expect at least a 10% increase from 2021 to $234 billion.
While capital continues to flow from both domestic and foreign sources, the targets seem to be shifting. Investors find strong non-coastal markets more acceptable than ever and there is also a growing trend toward favoring ESG compliant assets, especially from European investors.”
Demand and Delivery
Continued growth in household formation and a strong pipeline of new products coming on line signal continued growth. Specifically, CBRE writes “the growing economy is boosting household formation, which had been artificially suppressed by the pandemic. New households are catalyzing demand for rentals, which is expected to match the pace of new deliveries in 2022. We forecast multifamily occupancy levels to remain above 95% for the foreseeable future and nearly 7% growth in net effective rents next year.“
Despite the rosy outlook, there are also a number of potential headwinds that real estate investors must be aware of.
From a commercial real estate investment standpoint, there are three challenges that investors should be aware of, and actively seek to mitigate, throughout the year.
Borrowing Costs Are Rising
Given the record high inflation print, the Federal Reserve has signaled that they intend to raise interest rates several times over the year. In addition, they will cease their quantitative easing program, which will have the same impact…to drive rates higher. This will increase borrowing costs, which will decrease the amount of cash flow available to distribute to investors. Properties financed with variable rate debt will be especially vulnerable in a rising rate environment.
Acquisition Costs Are Rising
Because demand for multifamily rental units has been so strong, real estate investors have bid them up to record prices, especially in non-gateway markets like Atlanta, Denver, and Phoenix. A higher acquisition price means that return on investment can be somewhat limited to the upside and/or that profitable deals may be harder to find.
Migration Patterns and Unit Preferences Are Changing
The pandemic has upended many facets of life, but it could be argued that one of the positives that has emerged is the increased adoption of remote work. This fact alone has sparked two trends.
First, individuals are increasingly choosing their city of residence based on where they want to live, not where they need to live for work. As a general rule, this has driven people away from dense city centers in cold climates and towards more affordable – and warmer – destinations in the south and west.
Second, multifamily resident preferences are changing because they are spending more time in the unit. They want things like high speed internet, home offices, AV capabilities, and more outdoor space.
Multifamily investors should be cognizant of these real estate trends and allocate capital to properties that are in sync with them.
So, given the outlook for the multifamily real estate market in 2022, it only makes sense to ask…how should this impact my investment strategy over the coming year? We think there are three things to consider.
Fundamentals Are More Important Than Ever
In any sort of turbulent market environment, the attention needs to go back to the fundamentals of property underwriting. Multifamily properties should be underwritten with conservative growth and vacancy rates as well as data based rental amounts. Value-add investment properties should include realistic costs for improvements – accounting for inflation – and specific attention should be paid to the terms of debt to mitigate the risk associated with rising interest rates.
Pay Attention to Migration
As the population continues a general shift to the south and west, demand for multifamily rental properties will continue to be strong in these areas. But, this is not a secret. So, the risk/return profile for these properties may not offer enough incentives to make an investment.
But, there is another migration pattern that is expected to continue in 2022, from suburbs back to cities. CBRE writes:
“Downtown multifamily properties are filling back up and occupancy rates are nearing pre-pandemic levels, spurred by a confluence of factors: fewer restrictions on urban amenities, higher vaccination rates, a growing willingness to use public transit, the reopening of college campuses and more workers returning to the office.
Urban areas saw an average vacancy rate increase of nearly 200 bps during the peak of the pandemic. As of Q3 2021, urban vacancy rates average 5%, just 70 bps above their pre-crisis level, and are expected to fall to 4% by the end of 2022. By contrast, suburban properties fared better, as both secular and cyclical factors—income uncertainty, a preference for outdoor options, a need for more space and more millennials with growing families requiring schools—drove demand for apartments in lower-density and lower-cost submarkets.”
So, real estate investors will be well served to look at downtown, or downtown adjacent properties, which may actually offer a more attractive risk/return profile.
In real estate investing, certain markets, like many in New York or California, are known to have a significant number of regulations that must be followed by property owners. In their 2022 outlook, CBRE notes:
“Markets with increased regulation—particularly those with new or proposed rent controls—limit the income opportunities from rent growth and require greater operational efficiency to drive NOI.”
In other words, the cost incurred to comply with increased regulations can put a cap on net operating income, which mandates greater operational efficiency to improve. These markets may be tough for smaller investors because they don’t have the scale necessary to drive said efficiencies.
When multifamily properties are underwritten conservatively and purchased at a good price, the outlook for 2022 suggests that multifamily investors can continue to expect healthy returns over the coming year.
Against a backdrop of continued economic uncertainty, the outlook for multifamily investment appears to be strong for the coming year. Driven by rising single family home prices, strong fundamentals, and a wealth of new products coming online, multifamily investment sales are expected to set records in 2022. In addition, occupancy levels are expected to remain strong and rents are on the rise.
While the outlook is favorable, potential real estate investors must have a plan for the challenges presented by rising interest rates and acquisition costs and changes in the migration patterns of renters driven by the increased acceptance of remote work.
Interested In Learning More?
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