What the Construction Lull Means for the Apartment Sector

This year sees a marked decline in new apartment construction, attributed to elevated interest rates, reduced rents, and overbuilding worries in select regions.

Higher Rates and Falling Rents Spark a Decline in New Apartment Developments

Construction of new apartments has experienced a significant decline this year due to higher interest rates, declining rents, and concerns about overbuilding in some areas.

By the numbers: According to the Census Bureau, apartment building starts fell by 41% in August, compared to the same month the previous year, reaching a seasonally adjusted annual rate of 334K units. This decline, only seen once since the subprime housing crisis, is expected to result in approximately two years of reduced building, as Greg Willett, first vice president at Institutional Property Advisors, predicted.

Construction pause: The market is expecting a surge in rental building openings for the next two years, the highest since the 1980s. This influx of new supply has caused apartment vacancies to rise and rent growth to flatten or decline in several areas. As a result, apartment builders are pausing construction in order to assess the profitability of their projects compared to safer investments, as well as to evaluate the impact of existing buildings in the market.

Financing freeze: The cost and scarcity of construction financing have become significant obstacles for builders. Banks, now holding increased reserves to support troubled property loans, are lending less frequently and tightening standards. Interest rates for construction loans have doubled, climbing from 4–8%. This financing crunch has made it difficult for developers to raise equity from investors uncertain about the future value of completed projects.

Regional impacts: The decline in multifamily starts is most evident in areas that experienced substantial construction during the pandemic. Denver, for example, saw a 66% drop in starts for new apartments in 2Q23 compared to the quarterly average since 2021. This drop in new construction is attributed to stagnant asking rents and the uncertain potential for rent inflation before completion. Additionally, developers in the Dallas metro area have scaled back in untested neighborhoods.

➥ THE TAKEAWAY

Slowly slowing down: The future of apartment buildings heavily depends on interest rate fluctuations. If rates stabilize or fall more in coming quarters, developers and lenders will likely gain confidence and resume stalled construction plans. Another factor favoring the apartment building market is the continuous increase in the price of for-sale homes. This rising affordability gap should drive demand towards rentals for the foreseeable future.

Source: What the Construction Lull Means for the Apartment Sector

https://www.creconsult.net/market-trends/what-the-construction-lull-means-for-the-apartment-sector/

Is Preferred E`quity Multifamily's Savior?

Capital scarcity in multifamily is leading developers and operators to explore alternative funding, with preferred equity gaining popularity due to its higher-than-average returns.

Preferred Equity Steps in to Save Stalled Deals and Boost Returns in Multifamily

Preferred equity, a financing tool in the multifamily sector that had once been sidelined, is witnessing a resurgence due to the scarcity of capital in the sector, prompting developers to explore alternate and niche funding sources.

Shifts in financing: Conventional lenders are becoming increasingly cautious, limiting their funds due to factors like surging interest rates, regulatory pressures, and heightened risk perception. This has led to substantial financing gaps. Companies like Canyon Partners Real Estate and other operators have recognized the benefits of preferred equity investments, attributing its allure to its debt-like qualities, such as fixed terms and priority repayments, while occasionally allowing for profit participation.

New players in town: The preferred equity market has evolved significantly in the past year. New entrants, including REITs, family offices, and foreign investors, are now participating. Chinmay Bhatt of Berkadia highlighted the market's fragmentation and changing interest rate environment as challenges, pointing out the need to consult a broader range of groups to get optimal solutions. Despite these challenges, certain deals remain appealing, especially those that can offer higher current pay rates to the preferred equity.

Source: Federal Deposit Insurance Corp.

Comparison to other funding methods: While preferred equity is gaining traction, it still faces stiff competition from other funding options, especially mezzanine debt. Both fill similar roles in the capital stack, sitting between mortgage debt and common equity. However, preferred equity has an advantage as many mortgage lenders disallow subordinate debts like mezzanine but permit preferred equity. This growth in interest around preferred equity also means investors in this space can be more selective about credit choices, maximizing their investment potential.

➥ THE TAKEAWAY

Multifamily’s lifeboat? Multifamily's traditionally robust performance is facing challenges, pushing sponsors to reconsider preferred equity despite past reservations. In the face of rising interest rates and potential rent reductions in certain markets, experts anticipate an even more prominent role for preferred equity, especially with over $250 billion in multifamily maturities expected in 2024. As the need for refinancing grows, preferred equity is proving essential in bridging the financial gap many owners face.

 

Source: Is Preferred Equity Multifamily’s Savior?

https://www.creconsult.net/market-trends/is-preferred-equity-multifamilys-savior/

The World’s Mega-Rich Are Betting Big on American Renters

A rising number of the super-rich are placing their bets on the US rental market as falling prices in the apartment sector make it increasingly attractive.

Global Tycoons Turn to US Multifamily Buildings in Billion-Dollar Bets

A rising number of the super-rich are placing their bets on the US rental market as falling prices in the apartment sector make it increasingly attractive.

Shifting market: Over the last decade, investments by the ultra-wealthy in multifamily housing have surged. Why is that? The enduring appeal is partly due to their attractive return rates and promising rent increase prospects, stemming from an ongoing supply shortage in the housing market. This trend marks a strategic shift from pre-pandemic times when investments were predominantly focused on office properties, offering stable income through long-term leases.

Billionaire bets: A prime example of this trend is Chicago’s luxurious 727 West Madison tower, which has a new owner, billionaire Amancio Ortega, founder of Zara, who purchased the property for $232 million. This deal follows similar investments, such as Israeli billionaire Eyal Ofer’s acquisition of a 57-unit building near Manhattan’s Gramercy Park. Additionally, wealthy families from Latin America and firms backed by global investors like David Rubenstein are also exploring opportunities in the multifamily building sector, seeking to capitalize on the current real estate market dislocations.

Rental housing > office spaces: The shift towards remote work and a rise in office vacancies post-pandemic have prompted wealthy investors to pivot from office properties to rental housing. This move has been accelerated by a commercial property downturn, marked by a 57% YoY drop in global investment to $142 billion in Q2. While institutional players are cautious due to heightened borrowing costs and falling values, wealthy investors are seizing opportunities with the capability to leverage cash payments or secure financing through strong banking relationships.

Attractive gap: Amidst the rise of remote work and office vacancies, wealthy investors are shifting from office properties to rental housing. A 57% YoY drop in global property investment in Q2 further accelerated this shift. While some institutions are cautious due to heightened borrowing costs and falling values, affluent cash-rich investors see opportunity, especially with sustained housing demand that boosted median rents significantly in recent years.

➥ THE TAKEAWAY

Shaping the future: The convergence of falling apartment prices and increasing rental demands is painting a lucrative picture for the world’s richest to strategically bolster their real estate portfolios. This shift in investment preference signals a newfound confidence in the long-term profitability of the multifamily housing sector amidst the ongoing commercial property slowdown. Moreover, the broadening of rental-housing deals globally hints at the unfolding of a multifaceted investment landscape, potentially redefining wealth accumulation strategies for the mega-rich in the coming years.

Source: The World’s Mega-Rich Are Betting Big on American Renters

https://www.creconsult.net/market-trends/the-worlds-mega-rich-are-betting-big-on-american-renters/

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Five Key CRE Investment Themes for Uncertain Times

The CRE industry is navigating challenging waters with higher interest rates, limited financing options, and a slowing economy. Yet, promising developments ("green shoots") suggest potential growth opportunities.

Five CRE Investment Themes for Turbulent Times

While the CRE industry is navigating turbulent waters, there are promising indicators on the horizon. Here are five investment themes worth following.

Extend to the end: In the throes of the 2007-2012 Great Recession, CRE lenders adopted the "extend and pretend" strategy to mitigate further loan defaults. The present-day mantra is "extend to the end," pointing to the cessation of the Federal Reserve's interest rate hikes. It's predicted that after one more .25% hike, the Fed will hold steady, eventually decreasing rates by the first half of 2024, setting the stage for a CRE investment surge.

Anticipating a CRE boom in 2024: Once the Fed reduces interest rates in 2024, the CRE sector is set to flourish. Investors will find ripe opportunities to seize distressed assets like office spaces, retail hubs, and senior housing properties. The possibility to procure defaulted CRE property notes will emerge, supported by a still-thriving job market.

Seize distressed investment opportunities: It's crucial for CRE investment entities to amass capital for distressed funds now. Ready capital will position them to exploit defaults and discounted properties in the imminent years. Around $150 billion is already allocated for distressed assets, with high-crime Gateway city office properties presenting discounts of up to 50% from their pre-pandemic values.

Target suburban Midwest apartments: While the national apartment scene remains strong, suburban Midwest apartments stand out for their lucrative cap rates between 6.0% to 8.0%. Contrasting with the Coastal and Sunbelt areas, Midwest rentals witnessed a moderate rent increase of around 3.0% over the past half-decade, offering them at appealing risk-adjusted cap rates.

➥ THE TAKEAWAY

Prepare the war chest: Despite current challenges in the CRE industry, 2024 will present key investment opportunities, especially in distressed assets and specific regions. The anticipated Federal Reserve rate changes will drive these prospects, underscoring the importance of timely, strategic investments.

Source: Five Key CRE Investment Themes for Uncertain Times

https://www.creconsult.net/market-trends/five-key-cre-investment-themes-for-uncertain-times/

Why Rents in U.S. Suburbs Aren't Falling as Fast as Cities

Once an escape from city prices, suburbs now present a challenging financial landscape for renters.

Why Rents in U.S. Suburbs Aren't Falling as Fast as Cities

For years, renting in the suburbs meant shelling out less than city rents. However, recent data indicates that this traditional disparity is lessening, leading many to wonder why.

From cities to suburbs: The pandemic saw many professionals with remote work opportunities move from city apartments to the suburbs. Driven by factors like high mortgage rates, increased home prices, and urban concerns such as crime, there's been a noticeable preference for extended renting in suburban areas. Consequently, while city rents rose by 20%, suburban rents surged by 27% since March 2020.

Suburban rents outpacing urban growth: Certain suburbs of cities like Atlanta, Detroit, and Seattle experienced rent jumps ranging from 15% to 21%. Over the pandemic's duration, suburban rent growth surpassed city rent growth by approximately 8 percentage points, marking an unprecedented peak. Although suburban rents remain lower on average, the difference has dwindled from 12% in 2019 to just 5.8% in 2022.

The impact of rising home prices: Skyrocketing home prices also play a crucial role in the altered rental landscape. With median home prices exceeding $400,000 and mortgage rates increasing, the typical American finds homeownership less attainable. Consequently, many opt for longer rental durations, reducing the available apartments for newcomers.

Rental construction lags behind demand: Another critical factor is the significant rental unit shortage that predates the pandemic. While the U.S. faced a deficit of approximately 6.8 million affordable rentals in early 2020, construction has since attempted to bridge this gap. Data from 2023 indicates that nearly a million new apartment complexes are underway, aiming to alleviate the shortage over the next couple of years.

➥ THE TAKEAWAY

Why it matters: The traditional gap in rental prices between city centers and suburbs is shrinking. Factors like pandemic-driven migration, soaring home prices, and a shortage of rental units play pivotal roles in this transformation. As new constructions progress, experts anticipate a cooling down of rent hikes, but the changing face of rental economics hints at a more balanced urban-suburban rental landscape in the future.

Source: Why Rents in U.S. Suburbs Aren’t Falling as Fast as Cities

https://www.creconsult.net/market-trends/why-rents-in-u-s-suburbs-arent-falling-as-fast-as-cities/