Multifamily Rents to Jump as Renters Remain Stuck

Dave:
Hello everyone and welcome to the BiggerPockets Podcast. I’m your host Dave Meyer, and my friend Henry Washington is here with me today. Henry, good to see you.

Henry:
You as well my friend. Glad to be here.

Dave:
Do you invest in multifamily?

Henry:
I guess the technical answer to that is yes, I invest in small multifamily, so my largest multifamily unit, I have two or three different eight-unit buildings, but I don’t have a building above eight units.

Dave:
But that’s technically multifamily. And just for everyone listening, the traditional cutoff is at four units, and that might sound really arbitrary, but it’s actually not. It comes from lending. Anything that is four units or fewer is considered residential property, and so you can get a traditional mortgage on those types of properties. Anything five or above, usually, you’re going to have to get a commercial loan. So, that’s why we make that designation. And today, we’re actually going to be talking about the big ones. We’re going to be talking about five plus properties and what’s going on with rent there because the commercial market with these bigger properties and the residential market actually perform really differently. Oftentimes, one market’s doing well, the other one’s not. And that’s kind of what we’re seeing right now. The residential market is doing its thing, it’s chugging along, but multifamily, there are a lot more question marks right now about what’s happening and what’s going to happen in the near future. So, we are going to bring on an expert to talk about this.

Henry:
Today’s episode we’re going to be talking to Kim Betancourt, who is the vice president of Multifamily Economics and Strategic Research at Fannie Mae. And she’s going to go over the ins and outs of this asset class and talk to us about what she sees in terms of rent growth, in terms of vacancy, and many other factors that could play into how multifamily is going to do over the next several years.

Dave:
All right. Well said. With that, let’s bring on Kim Betancourt, vice president of Multifamily Economics and Strategic Research, that is a cool title, at Fannie Mae.
Kim, welcome to the show. Thanks for joining us. We are going to jump right into sort of the macro level situation going on in multifamily. Where are we with rents as we’re recording this at the end of February 2024?

Kim:
So, it’s a little too early yet to get rent data for January, and clearly, for February. But where we were at the end of the year, at the end of 2023 was that on a national level we had seen negative rent growth. So, rents were estimating declined by maybe 66 basis points, ending the year at just under 1% year-over-year rent growth. And so what does that mean? Well, normally rent growth tends to be between 2% and 3% on an annual basis. As you can guess, it usually tends to track inflation, sometimes slightly above, maybe slightly below, but somewhere in that range.
So, as you can tell last year, even though inflation was up, we definitely saw that decline in rents. Again, that’s at a national level. It really does depend where you are. I’ve been saying that this is really a tale of two markets. So, in some places there was rent growth and in others, there was negative rent growth. For example, it’s estimated that rent growth was maybe negative by over 3% in Austin just in fourth quarter of last year alone, but was positive in other places like St. Louis and Kansas City and some other places. So, it really does depend where you are. Primarily, it is in markets that seem to have either undersupply, so not enough supply, rent is higher. Oversupplied, a lot of new units coming in online, rent growth has been lower.

Henry:
Do you feel like the slight rent growth decline is due to such a big steep rise in rents after the pandemic? We’re just coming down off that high.

Kim:
It’s partly that. It’s also partly this new supply I’m talking about. So, some of the data that we’ve seen, it shows that, for example, rent growth on new leases has actually been declining. Instead, where the rent bonds have been coming is for people that are renewing their rents. And I believe what that’s due to is that people came in 2021, 2022, they remember getting really sock with rent increases when they changed apartments. And so, what they’ve probably thought is, “Hey, you know what? I’m going to try to stay where I am, even if that’s going to cost me maybe 2% or 3% or 4% of an increase, that’s probably better than what I remember paying.”
Not realizing that actually in a lot of places, especially in a market with a lot of supply, they probably could have not paid as high of a rent increase, but it’s because of that new supply. Again, it depends on what market you’re in. Some markets have seen a lot of supply. We actually estimated that more than 560,000 new units were added last year, which is much higher than we’ve seen last year or the year before 2022, it was about 450,000 new units. And before that, it was under 400,000. So, it’s been definitely increasing.

Dave:
Kim, I’d love to dig into that a little bit. For those of our audience who might not be as familiar with the sort of construction backdrop that’s going on in the multifamily space, can you just give us a little historical context?

Kim:
Yeah, sure. And actually, it’s important to remember the timeline is very different for multifamily new construction versus single family. So, in a lot of times, single family, those properties will go from a hole in the ground to a house that’s built in the matter of a few months. But in multifamily it tends to be a much longer timeline. Now, again, depending what kind of property where you’re located, but on average is anywhere from 18 months to three years, and it’s a little closer to the three years usually. So, that’s a much longer timeline.
So, a lot of these units that are coming online, they were started a long time ago. So, a lot of multifamily builders, they’re having to figure out in the market where they are, when they’re going to be coming online, what are the demand drivers. So, that leads to part of the issue in multifamily where you’ll see that certain markets may get out over their skis in terms of supply, but then what happens is the market self-corrects and you’ll see that just in a few years, a year or two, then that market might actually be undersupplied again. So, it can be more volatile than you’ll see on the single family side. They can sort of turn that on and off a lot more quickly than in the multifamily space.

Dave:
And so, given that timeline, which is super important context for everyone to understand, it sounds like we’re still working our way through this glut of construction that could have started 12, 24 months ago.

Kim:
Right. So, not only are we working through it, but actually there’s still not enough housing, believe it or not, being built to meet the expected demand. Part of the issue is that there’s more than a million units of multifamily rental underway, and that sounds like a lot. But in reality, we still have a housing shortage. The problem is that there’s a lot of new supply in about maybe 20 metros, and within those metros it’s concentrated in a handful of submarkets. So, that’s part of the issue is that it’s not evenly distributed. It’s sort of bunched in these markets where there’s been migration, and job growth, and demographics are very important for multifamily. That’s because the person most likely to rent an apartment is between the ages of 20 and 35.
Lots of people rent apartments, but that’s the majority of folks that rent apartments. And so, when builders are looking at where they’re going to build, they’re looking in metros that have a much younger population. So, for example, Austin has a very large younger population, not only because of the university, but they’ve got tech jobs, it attracts a younger demographic. So, there’s been a lot of building there and especially because they’ve also seen a lot of migration in terms of job growth, especially in the tech sector. And so, that was a market that was terribly big, but over the past few years saw a lot of people coming in, so builders have been really building. So, yeah, so there’s definitely an oversupply and I just want everybody to understand that, yeah, there’s still a lack of affordable housing in a lot of places.
When I talk about oversupply, I’m just talking about when you count up all the units, it’s mostly in this higher end, the more expensive units, but that’s getting built. And of course, I sometimes make the joke, it’s a shame we can’t build the 20-year-old building because that is what tends to be more affordable in a lot of places. But when we’re building new, it does tend to be more expensive and the owners are charging the higher rents. So, you’re absolutely right though about it depends on the market, depends where you are because when we talk about certain markets, we never look at states because a state is big, it’s very different. We’re looking at these different metro areas and they’re not necessarily cities even. They are sort of the metro area because the metro will draw people from a wider radius for jobs and lifestyle, things like that.

Dave:
Kim, thank you for explaining that because something that’s sometimes confuses me and maybe it confuses some other people, is that we hear that there’s this national housing shortage. At the same time, we hear there’s an oversupply. And that sounds contradictory, but when you explain that so much of this is just mismatch, both in terms of class where it’s like they might be really high end properties where what we need is class B or class C properties, and in terms of geography, where we might need housing in the Midwest, but it’s getting built in the Southeast. So, that is super helpful. Thank you.

Kim:
Right, and even in the metro that I’m talking about, it’ll be in a handful of submarkets, so that can also be an issue. Maybe we need it a few miles away, but it’s all being built sort of in the same neighborhood, the same submarket. So, that’s another issue as well.

Henry:
All right, we are getting into the dynamics of supply and affordability, but there’s more to come. After the break, we’ll talk about the demographics of who is renting and why, and what Kim anticipates we’ll see in terms of rent growth over the next few years. Stay with us.

Dave:
Welcome back, everyone. We’re here with Kim Betancourt, vice president of Multifamily Economics and Strategic Research at Fannie Mae. And Kim is taking us through the ins and outs of the multifamily space. So, let’s get back into it.

Henry:
So, what I wanted to ask was most of the new construction is around this A class, and that’s where a lot of the units are getting added, but there has to be some sort of trickle-down effect, meaning that if we’re throwing new A class out there, then that gets oversaturated, then technically what they can ask for rent will be less. How does that impact B and C class in affordability there?

Kim:
No, it’s a really great question, and what that is called filtering. So, as the new stuff comes online, then the older properties that were class A, in theory, now become class A-, B+, B, and the class B becomes class C. And you’re absolutely right, the affordability does move in tandem with. What has disrupted that in the past, when interest rates especially were lower, was a lot of properties were getting purchased as value add. You might’ve heard about that. And so, what would happen is people would buy those properties and they would fix them up and turn them from class B to class A or A-, and class C to class B+, that type of thing. There was quite a lot of that going on. And so that sort of also eroded the amount of class B and C already existing out there.
So, that’s been sort of an issue that we’re trying to sort of catch up with. But now, let’s just talk about our new supply. So, our new supply comes online. We have been moving down a little bit, but because there isn’t enough across the country, when I was talking about that housing shortage, it hasn’t really been enough to move a lot of that supply into the class B and C. On top of that, those rents have also been increasing, so not as high as the class A, but they’ve still been increasing. And actually the delta between class A rents and class B rents has been widening over the past few years. Sometimes we think back to the great recession, and what happened was class A rents fell during the great recession, which was 2009 to 2010, we saw those rents drop. And so, what happened was they dropped enough and the differential between a class A and class B wasn’t so great that some people were actually able to do what we call the great move up.
So, people who been in class B moved up to class A because they could afford it now, same with class C to class B. We’re not having that now because again, that delta between the rent levels of class A and B have really widened out over the past several years due to inflation, higher building costs, the increases in the time to bring properties to market and demand from demographics has really pushed up that differential, especially between class A and B. The other thing that we’ve been seeing is that a lot of folks that would normally be moving into that homeownership, first-time homeowners, that age has gotten older over the past few years. So, now it’s currently at around age 36. But we’ve got a lot of people that are still in that younger cohort as well as gen Zers that they’re in rental now.
Some of those older millennials would like to buy a home, but they’re not necessarily able to buy a home for whatever reason. In many places, there’s not enough supply, interest rates are higher. And a lot of people that have mortgages, especially baby boomers, of which I’m one, we got a really low interest rate when we could refinance a few years ago. So, there’s a big portion of folks out there of homeowners out there that have 4% or 3% or lower mortgage rates, they’re not selling. So, everybody’s kind of like in this holding pattern, but the demographics keep adding people to forming households.
So, especially as we have positive job growth, those people tend to form a new household. So, it’s sort of think about it as sort of bunching up and what’s happening is people are getting stuck in rental longer, and we tend to call some of those renters renters by choice. In other words, they could technically afford to buy a home, but for whatever reason, they are not. And so, instead they’re renting a little longer. And so, that’s also been putting a lot of pressure on supply. Because in the past, a lot of those folks would’ve maybe moved into home-ownership or even renting single family homes, and instead they’re staying in multifamily a little bit longer.

Henry:
Yeah, I mean that makes sense definitely with people who have the lower interest rates, they’re not selling. And it’s interesting to see the average age of someone who rents now going up because more people are now choosing to rent. And so, I would assume that that correlates to vacancy and that vacancy would typically now be a lot lower in these buildings. Is that what you’re seeing across vacancy rates?

Kim:
Well, vacancy rates have inched up because of this new supply. So, as we add that extra supply and it’s taking a while to get people in there, it does push up the vacancy rate. But when you look at the vacancy rate for class B and C, that’s really tight. So, you’re exactly right. That has not been rising nearly as fast as it is for the class A.

Henry:
Okay, so class A vacancy is going up because we just keep adding new supply, but the people in the good old faithful B and C, they’re just locked in, and so you’re seeing lower rates there. Is that what I’m hearing?

Kim:
Yeah, those rates are pretty tight. They’re not moving much, and so that creates a lack of that affordable housing for a lot of folks because people just aren’t moving out if it’s a rent that they can afford.

Dave:
Kim, as we talk about rent trends and what’s going on right now, can we talk a little bit about what you’re expecting for the future? Do you expect this softness of rent to continue as we work through the lag? And how long might this softness continue?

Kim:
Yeah, that’s the million-dollar question everybody asks. Yeah. No, I mean, we are expecting that rank growth will be subdued again. This coming year in 2024. Might improve slightly because we are expecting job growth to be a little bit better than what we had originally been expecting. So, right now we think job growth will be about 1% this year. And we, in the multifamily sector, we tie very much the performance of the sector to job growth. And that’s because, again, a lot of jobs, you start a new job, especially if you’re a young person, you start a job, you tend to form a household when you start that job. Now, it could be with roommates, it doesn’t matter, but you form a household. Then, as the job growth continues, then what might happen is you get a better-paying job and then maybe you don’t live with roommates, you get out on your own.
So, we’re always taking a look at job growth because that forms that household, that first household. Usually a first household people don’t run out and buy a house when they get their first job, they tend to rent. So, we do focus on that. So, that’s been where we expect to see this type of demand. And so, therefore, we’re expecting that rent growth will be a little bit better in 2024 than we did see in 2023, despite the fact that we have a lot of this new supply still coming online. So, that’s the plan, but it’s not great. We’re still thinking 1%, maybe 1.5%, but it’s probably going to be closer to 1% this year, very close to what we saw last year. Now, that said, come 2025, as we start to see that this new supply has been delivered, we’re not adding that much more new supply, then we’ll start to see that rent growth start to pick up.
So, we do expect it to be a little higher in 2025, and then by 2026, it could really start to see some momentum because we’re not putting online all this new supply, and we still have the demographics that I’ve been talking about, the gen Zers, they’re still going to be in that sweet spot of renting that age for rental, and now all of a sudden we don’t have a lot of new supply coming online. So, as that supply that came online last year and this year gets absorbed by 2026 in a lot of places, we could start to really see rents get pushed because there’s not enough supply.

Henry:
Yeah, we’ve talked a lot about the supply and demand and rent growth taking a slight dip, but just because rent growth has come down a little bit, that doesn’t necessarily mean that people can afford the rents of the places that they are. Where are you seeing affordability in terms of these rent declines?

Kim:
Yeah. No, that’s a very good point. And like I was talking about earlier about the class B and C, even though their rent growth has declined, their incomes have not necessarily grown, especially from the rent growth that we saw in 2021. So, we saw that that rent growth really escalated in 2021, and it was still elevated in 2022. And even though wages have increased, we’re still playing catch up, right? Inflation was up and rents were up 10% or higher in a lot of places. I don’t know anybody who got a 10% increase in wages. So, people are still playing catch up. And then remember that we’ve also had inflation. So, it’s not like they’re not just paying more rent, they’re paying more for food and other costs. So, there is still this pressure, especially on that class B and C component, because the wage growth, while positive is not enough to offset the increases we’ve seen over the past few years.

Dave:
But in theory, if rent growth stays where it is, then affordability should come back a little bit given the pace of wage growth right now, right?

Kim:
It should, but again, we’re expecting that because of the supply that we’re probably only going to have another year of this subdued rent growth. And I’m not sure that the wage increases are still going to be enough to offset that increase that we have had in ’21 and ’22. But again, it does depend where you are.

Dave:
Yeah, all this with the caveat that this is regionally variant, but I do think that’s really important for investors to note that they’re just expecting rent growth to slow down for a year. I think everyone’s wondering where valuations and multifamily might go because cap rates are starting to go up, but the one thing that could offset cap rates going up is if rents and NOIs start to increase over the next couple of years. So, I think there’s maybe a bunch of multifamily investors here hoping that you’re correct there, Kim.

Kim:
No, I totally understand that. And I would say most of the data we get from our vendors and lots of other multifamily economists are seeing the same trends. So, we’re actually a little more conservative. I know that some are expecting rent growth to really sort of pop later this year and next year. We’re taking a more conservative view. And it’s because of that tying of demographics, that job growth, and then that household formation. I always think of that as the three legs of the multifamily stool in terms of demand.

Dave:
Got it. And before we get out of here, Kim, is there anything else in your research or team’s work about multifamily, specifically from the investor perspective that you think our audience should know?

Kim:
Yeah. No, if you put on your investor hat, as you were talking about earlier about cap rates and valuations, I would say trading has been very thin when you look at the data. So, price discovery is still sort of… We don’t really have price discovery for multifamily just yet. I do think that if we start to see interest rates come down, that that might spur some of the folks on the sidelines to say, “Okay, at this interest rate, at this cap rate, I can make that work.” But one of the big reasons that I’m not concerned too much about the multifamily sector overall is because of the power of demographics.
We have these people, we have the age group that rents apartments. And so, this is just a timing in terms of new supply and where it’s located. But overall, you cannot deny the power of demographics. And as long as we continue to have positive job growth that leads to those household formations, we’re going to start to need more multifamily supply over the longer term. And that is actually my bigger concern, that we are not going to have that necessary supply, and it’s going to be here sooner than we think.

Dave:
Well, thank you, Kim. We appreciate that long-term perspective. It’s super helpful for those of us who try to invest and make our financial decisions on a longer timeframe. For everyone who wants to learn more about Kim’s amazing research, you should definitely check this out if you’re in multifamily. We will put a link to it in the show notes and the show description below. Kim, thank you so much for joining us. We appreciate your time.

Kim:
Sure. No, it was great. Thank you so much.

Henry:
And if you’re listening to this conversation and wondering what does this mean for me? How should this impact the deals I’m going after? Stick around. Dave and I are about to break that down right after the break.
Welcome back, investors. We just wrapped up a heck of a conversation with multifamily expert Kim Betancourt, and we are about to break down what this means for you.

Dave:
Another big thanks for Kim for joining us today. Before we get out of here, I just wanted to sort of help contextualize and make sense of what we’re talking about here. Hopefully, everyone listening understands that rent growth and vacancies are super important to anyone who’s buying multifamily and holding onto real estate over the long term because that impacts your cashflow and your operations. But what we were talking about at the end was really about multifamily valuations and growth. If you’re familiar with multifamily at all, you know that one of the more popular ways to evaluate the value of a multifamily property is using something called cap rate.
So, the way you do that is you take the net operating income, which is basically all of your income minus your operating expenses, and you divide that by the cap rate, and that gives you your valuation. And the reason this is so important is because the way that NOI grows, one of the two important factors of how you grow the value of multifamily is from rent growth. And so, that is one of the reasons why multifamily was growing so quickly over the last couple of years is because rent growth was exploding and that was pushing up the value of multifamily. Now that it’s slowing down, we’re seeing NOIs flatline. And at the same time we’re seeing cap rate goes up, which not to get into it, that pushes down the valuation of multifamily, which is why a lot of people are talking about multifamily crash and how risky multifamily is right now.
And so, if you sort of zoom out a little bit about what Kim just said, she was basically saying she expects this to continue, that NOIs are probably not going to grow much over the next year, but she thinks after that they might start growing again, which is probably good news for multifamily investors, many of which are trying to weather a difficult storm right now with high interest rates, rising cap rates, stagnating rent. So, just wanted to make sure everyone sort of understands what this means for prices in the multifamily market.

Henry:
It’s also great information for prospective multifamily buyers who are looking to jump into the market and potentially buy some of these B and C class properties that are going to become available, especially with the new A class coming on board. But if you’re going to try to get a bank to underwrite your deal, you’re going to have to forecast, hopefully, long-term and be conservative with that. So, understanding or having an idea of where you think rent growth is going to go, or I should say a more realistic idea of where you think rent growth is going to go, will help you have more conservative underwriting and hopefully keep you out of trouble if you get into a property and it’s not producing the results that you need in a short-term fashion.

Dave:
Very well-said. Well, thank you all so much for listening. We appreciate it. Hopefully, you learn something from this episode. We’re going to be trying to bring on more and more of these experts to help you understand some of the more actionable recent trends going on in the real estate market. So, hopefully, this information from Kim was helpful. Henry Washington, as always, it’s always fun doing shows with you. Thank you for being here. And thank you all again for listening. We’ll see you for another episode of the BiggerPockets Podcast very soon.