Supply is likely to outstrip demand in 2023

December 2, 2022 3 Minute Listen

Overall demand to hold steady

The U.S. multifamily sector is expected to perform above average in 2023 despite economic headwinds and ongoing capital markets disruptions. Strong housing fundamentals should keep occupancy rates above 95% and drive 4% rent growth, although less than the sub-3% vacancy rates and double-digit rent growth of the past two years.

It appears 2022 will be a turning point for multifamily fundamentals. Leasing activity was unseasonably slow in the summer when demand is typically at its strongest. This coincided with a steady pace of new deliveries, causing the overall vacancy rate to rise by 150 bps in Q2 and Q3 2022, pressuring rents.

Supply-side pressures are elevated, but manageable. Of the 796,000 units currently under construction in the 69 markets tracked by CBRE, 450,000 units are expected to deliver in 2023, adding 2.6% to the total inventory. Construction debt is less available and costlier, causing a slowdown in much-needed new starts. With the for-sale market already supply-constrained, CBRE projects that nearly 3.5 million new market-rate multifamily units will be needed by 2035 to keep pace with demand. In the near term, however, as households grapple with economic uncertainty, household formation and new renter demand will struggle to keep pace with supply. Vacancy rates will continue rising, albeit at a slower pace, and drift toward the 20-year average of 5%.

Figure 17: Multifamily Rent Growth & Vacancy Rate

Sources: CBRE Research, CBRE Econometric Advisors, Q3 2022.

Overall housing demand remains strong

More renters are grappling with whether to renew their leases as they reduce spending due to high inflation. Although net new leasing stalled, overall housing demand and occupancy rates remained strong.

The challenging for-sale market is propping up demand for multifamily rentals, as home prices and mortgage rates have skyrocketed. CBRE calculates that the average house payment for a newly purchased home in Q3 2022 was 57% more expensive than the average monthly apartment rent, the widest cost gap on record. The premium averaged just 8.5% before the pandemic. Even if home values continue to fall and mortgage rates drop next year, the relatively lower cost of renting will support multifamily demand.

Figure 18: Cost of Ownership vs. Cost of Renting

Note: The monthly payment for a newly purchased home assumes 30-year mortgage with a 10% down payment (in line with historical trends for first time buyers from the National Association of Realtors), the median listing price according to Realtor.com, as well as a presumed PMI payment of 0.75% and state and local tax payment of 1.8% of purchase price.
Sources: CBRE Research, CBRE Econometric Advisors, Freddie Mac, Census Bureau, National Association of Realtors, Q3 2022.

Investors waiting for market to stabilize

The post-summer instability in the capital markets and rapidly rising interest rates have significantly lessened multifamily investment activity. Higher commercial mortgage rates are sending some buyers to the sidelines. However, private buyers’ relatively greater tolerance for volatility is buoying investment activity. As rates stabilize, the return of many institutional investors will provide a further tailwind to the multifamily investment market in 2023.

In addition to multifamily’s strong underlying fundamentals and an average annual total return of 9.3% over the past decade, the sector also benefits from Fannie Mae and Freddie Mac—debt sources that are not available to other sectors. As the market stabilizes in 2023, more investors and lenders will deploy capital in one of the best asset classes for hedging inflation concerns.

Pricing is still adjusting to higher interest rates. Cap rates have increased by at least 75 to 100 bps this year and CBRE expects additional cap rate expansion in 2023. For now, smaller, high-quality and well-located assets are the most likely to sell. While some markets will be more impacted than others by the looming recession, additional price adjustments are likely in 2023, offering attractive buying opportunities.

Trends to Watch

Affordable Housing

Affordable housing program support of approximately 640,000 units nationwide is scheduled to expire over the next eight years. This is in addition to an estimated shortage of 7 million low-income units needed to meet demand. These expirations present a unique investment opportunity to maintain the affordable housing designation or to rehab and convert them to market-rate units. Affordable housing investment is particularly attractive because of strong and stable fundamentals, growing demand and access to more favorable lending terms, such as longer loan terms, higher loan-to-value ratios and longer amortization periods.

Figure 19: Multifamily Units With Affordable Housing Program Support Expiring Through 2030

Sources: Public & Affordable Housing Research Corp., National Low Income Housing Coalition, National Housing Preservation Database.

Expiring Tenant Protections

Many pandemic-era tenant protections like eviction moratoriums and rent freezes are due to expire in 2023. This will create both headwinds and tailwinds for multifamily fundamentals. For example, some landlords will play catch-up as they raise rents to match market values, which could support stronger average rent growth in 2023. On the other hand, landlords exercising their right to evict tenants will at least temporarily increase vacancy.

Overall demand to hold steady

The U.S. multifamily sector is expected to perform above average in 2023 despite economic headwinds and ongoing capital markets disruptions. Strong housing fundamentals should keep occupancy rates above 95% and drive 4% rent growth, although less than the sub-3% vacancy rates and double-digit rent growth of the past two years.

It appears 2022 will be a turning point for multifamily fundamentals. Leasing activity was unseasonably slow in the summer when demand is typically at its strongest. This coincided with a steady pace of new deliveries, causing the overall vacancy rate to rise by 150 bps in Q2 and Q3 2022, pressuring rents.

Supply-side pressures are elevated, but manageable. Of the 796,000 units currently under construction in the 69 markets tracked by CBRE, 450,000 units are expected to deliver in 2023, adding 2.6% to the total inventory. Construction debt is less available and costlier, causing a slowdown in much-needed new starts. With the for-sale market already supply-constrained, CBRE projects that nearly 3.5 million new market-rate multifamily units will be needed by 2035 to keep pace with demand. In the near term, however, as households grapple with economic uncertainty, household formation and new renter demand will struggle to keep pace with supply. Vacancy rates will continue rising, albeit at a slower pace, and drift toward the 20-year average of 5%.

Figure 17: Multifamily Rent Growth & Vacancy Rate

Sources: CBRE Research, CBRE Econometric Advisors, Q3 2022.

Overall housing demand remains strong

More renters are grappling with whether to renew their leases as they reduce spending due to high inflation. Although net new leasing stalled, overall housing demand and occupancy rates remained strong.

The challenging for-sale market is propping up demand for multifamily rentals, as home prices and mortgage rates have skyrocketed. CBRE calculates that the average house payment for a newly purchased home in Q3 2022 was 57% more expensive than the average monthly apartment rent, the widest cost gap on record. The premium averaged just 8.5% before the pandemic. Even if home values continue to fall and mortgage rates drop next year, the relatively lower cost of renting will support multifamily demand.

Figure 18: Cost of Ownership vs. Cost of Renting

Note: The monthly payment for a newly purchased home assumes 30-year mortgage with a 10% down payment (in line with historical trends for first time buyers from the National Association of Realtors), the median listing price according to Realtor.com, as well as a presumed PMI payment of 0.75% and state and local tax payment of 1.8% of purchase price.
Sources: CBRE Research, CBRE Econometric Advisors, Freddie Mac, Census Bureau, National Association of Realtors, Q3 2022.

Investors waiting for market to stabilize

The post-summer instability in the capital markets and rapidly rising interest rates have significantly lessened multifamily investment activity. Higher commercial mortgage rates are sending some buyers to the sidelines. However, private buyers’ relatively greater tolerance for volatility is buoying investment activity. As rates stabilize, the return of many institutional investors will provide a further tailwind to the multifamily investment market in 2023.

In addition to multifamily’s strong underlying fundamentals and an average annual total return of 9.3% over the past decade, the sector also benefits from Fannie Mae and Freddie Mac—debt sources that are not available to other sectors. As the market stabilizes in 2023, more investors and lenders will deploy capital in one of the best asset classes for hedging inflation concerns.

Pricing is still adjusting to higher interest rates. Cap rates have increased by at least 75 to 100 bps this year and CBRE expects additional cap rate expansion in 2023. For now, smaller, high-quality and well-located assets are the most likely to sell. While some markets will be more impacted than others by the looming recession, additional price adjustments are likely in 2023, offering attractive buying opportunities.

Trends to Watch

Affordable Housing

Affordable housing program support of approximately 640,000 units nationwide is scheduled to expire over the next eight years. This is in addition to an estimated shortage of 7 million low-income units needed to meet demand. These expirations present a unique investment opportunity to maintain the affordable housing designation or to rehab and convert them to market-rate units. Affordable housing investment is particularly attractive because of strong and stable fundamentals, growing demand and access to more favorable lending terms, such as longer loan terms, higher loan-to-value ratios and longer amortization periods.

Figure 19: Multifamily Units With Affordable Housing Program Support Expiring Through 2030

Source: Public & Affordable Housing Research Corp., National Low Income Housing Coalition, National Housing Preservation Database.

Expiring Tenant Protections

Many pandemic-era tenant protections like eviction moratoriums and rent freezes are due to expire in 2023. This will create both headwinds and tailwinds for multifamily fundamentals. For example, some landlords will play catch-up as they raise rents to match market values, which could support stronger average rent growth in 2023. On the other hand, landlords exercising their right to evict tenants will at least temporarily increase vacancy.

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