Multifamily remains a popular market for commercial real estate investors. Despite rising interest rates, the sector’s fundamentals remain strong. Investors are expanding their search for Class-B apartments in order to save money. This is according to the sixth annual Powerhouse Poll Outlook, which was released by Berkadia this February.
Berkadia surveys mortgage bankers and investment sales advisors twice a year. The most recent Powerhouse Poll surveyed 144 respondents. It was conducted between December 2022 and January 2023.
This poll reflects the difficulties multifamily investors face due to higher interest rates.
Ernie Katai is the executive vice president and head for production at Berkadia. He said that the multifamily sector, despite higher interest rates, is still a strong one.
Katai stated that interest rates are making people unhappy and gnashing teeth. “But 95% of the county’s apartment buildings are still occupied,” Katai said. We are seeing rent growth that is just a little lower than historical norms, 3.3% instead of 3.5% year-over-year. We just came off a period with incredible rent growth. The market is fundamentally strong. Because rates have risen, we are seeing a halt in multifamily sales and investment activity.
Katai stated that he expects investors will return in greater numbers to multifamily markets once interest rates stabilize. But when will that happen? That’s uncertain.
Katai stated that the market might not see interest rates stabilize in June this year. It all depends on the Federal Reserve Board’s decision to stop raising its federal funds rate. Many economists predict that this will occur in the second half this year. However, no one knows for sure if this is true.
Investors are facing a part of the problem. Interest rates of 2% and 3% are too tempting for many people. Katai stated that historically, higher rates would have been considered low even today. It was unreasonable to think that historically low interest rates would stay in place for too long.
Katai stated that uncertainty is the worst thing for the market. It paralyzes activity. The national players will eventually start transacting again. Then, I believe we’ll see a little bit of a herd approach. Investors have money that they want to put into the market. You must be able to start things again. It’s not FOMO or fear of missing out. Fear of making a mistake is what it is.
Here’s how Katai’s “fear to make a mistake” works: Investors who don’t do any deals now won’t get into trouble. If they close a deal and it ends in a loss, they could be in trouble. They could endanger their bottom lines. Investors are more inclined to wait for uncertain interest rates and play safe.
Katai stated, “That’s what leads towards paralysis.” “It’s just the mindset right here.”
When will multifamily investment sales increase? Katai stated that interest rates must stabilize and that owners need to accept the fact that multifamily properties may not be as valuable as they were a year ago.
Katai stated that while people might have believed their property was worth $100million a year ago, it may be only $80 million today. “Real estate can be described as math. It’s not complicated. It’s not difficult to see it from the perspective that you own a house. Your house might have been worth $350,000 last year, but now it is worth $275,000. You might think, “I’m not going to move now.” Multifamily owners think that way. The industry is a little over-spoiled. It had a great run.”
The numbers
What were some of the most interesting results from the Powerhouse Poll?
Respondents were not surprised to be concerned about interest rates. Berkadia’s poll found that 54% of respondents believed that inflation, interest rates, and fears of recession would have a severe impact on investment activity in the coming year. Additional 45% stated that these economic concerns would have a moderate effect on multifamily investment activity in 2023.
51% of respondents believed that the country would fall into recession within the next 12 months. 36% stated that the country is already in a recession. A total of 12% stated that the country would not experience a recession in the next 12 months.
Another interesting result was that 59% of poll respondents predicted that Millennials would make up the largest percentage of multifamily renters in the next two-years, while 31% predicted that Gen Z will be the market leader.
What about what renters want? According to the Berkadia poll, 66% of respondents stated that security and location are the most important factors for renters when looking for multifamily properties. Only 26% of respondents said that interior and communal amenities were the most important, while only 2% stated that renters are more focused on smart-home technology.
An evolving mindset
What will investors be looking for when they are ready to again close multifamily transactions?
Katai points out the increasing popularity of Class-B apartment assets.
Investors used to consider multi-family properties in Class A as the best investment option. Investors today realize that Class-B apartments are more affordable than ever.
Katai stated that there is a larger pool of potential renters. “Most renters reside in Class-B apartments. Why not invest in something similar? It’s hard not to support that mindset.”
Katai stated that the Class-B market for apartments looks particularly attractive today, given inflation. Many renters will consider Class-B spaces as a way to save money on rent, as the cost of so much is rising. These properties may not have the latest amenities like rooftop pools decks or concierge services. Katai stated that Class-B space is available for rent if the units are clean, safe, and secure.
This makes apartment properties at a more affordable price attractive to investors.
Is there a recession coming? Are we already in recession?
One of the most interesting results of the Powerhouse Poll was that a high percentage of respondents predicted that the United States would experience a recession within the next 12 months, and a smaller number of respondents said that the country is already experiencing a recession.
Katai said, however, that he was not sure how deep any recession would be.
Katai stated, “It feels like we are already in recession because our business in last year’s fourth quarter fell off a cliff.” “There were very few transactions. Everyone was down by double-digit amounts. A recession is when it strikes your house. Many producers feel the same way. But is it really a recession? It is difficult to say.
What kind of multifamily deals are being closed when investors make multifamily transactions? Katai stated that larger deals are not always better. Multifamily transactions today are more likely to be closed by smaller investors than larger institutional investors.
Katai stated that Berkadia is very busy. “People are trying figure out the values of their properties. There is a lot to be said about deals, but not as many fish. Owners want to know the market’s opinion of their properties. They take a step back when they see the numbers. Nobody is staring at the walls. But execution is still far away.
Safety is vital
The importance of security for renters was another interesting response to the Berkadia survey. Katai claims that this is the first time that safety has been mentioned as something investors are most concerned about.
Katai stated that this is not surprising. Many major cities feel less safe after COVID than they did before the pandemic.
Katai has seen this firsthand. He lives in Chicago, and notices that downtown isn’t quite as bustling as it was before the pandemic.
Katai stated, “It bums my out a bit.” I love the city’s hustle and bustle. I will finish my dinner at a restaurant, walk home, and not see anyone else. This is Chicago. What’s happening? The cities are not yet back to their pre-pandemic activity levels.”
However, this doesn’t mean that downtown multifamily markets are dead. Katai claims that younger adults still rent in the middle of larger cities. According to the Berkadia poll, large metropolitan areas still see the highest number of multifamily transactions.
The poll showed that suburban areas saw the highest number of multifamily transactions while secondary metropolitan areas had the second-highest.
Katai stated, “That caught my eye.” “If you recall, during the heights of COVID suburban occupancy levels were at an all-time high. People wanted more space. To see suburban activity drop down to number three? This caught my attention. That will be an interesting trend if it holds in our June poll.