By Daniel Brown, Jeff Huther and Sharon Whitaker
ABA DataBank
As scrutiny of commercial real estate continues, some analysts are turning their focus away from office space and examining other subcomponents of CRE for vulnerabilities. Recent articles have latched onto some of the headwinds in the multifamily space, concluding that this sector is destined for significant struggles ahead. However, while operating costs have risen significantly for multifamily properties, future rent growth should be able to support the resiliency of these properties in the foreseeable future. In fact, Moody’s Analytics notes that multifamily expense ratios, which is the ratio of operational costs divided by revenue, have remained relatively level throughout the last few years.
The largest headwind for the multifamily space is the sharp increase in operating costs. Between increased costs for materials, labor, insurance, and interest rates, average operating costs have increased almost 50 percent over the last 4 years. For example, figure 1 illustrates the explosion in multifamily insurance premiums, which have more than doubled since the pandemic. While this is a concerning trend, analysis from the Insurance Information Institute in figure 2 estimates that disinflation should occur in multifamily insurance now through 2026, making the situation slightly more manageable.
Labor and material cost increases are yet another notable headwind for multifamily performance. Using data from the Bureau of Labor Statistics, hourly wages for all occupations have increased an average of 19.4 percent from August 2020 to August 2024. However, using the same survey, construction wages are up 20.6 percent during the same period. On the material cost side, while commodity prices have cumulatively increased by 33.5 percent over the last 4 years, commodity prices related to construction have increased 37.67 percent during the same time period. The increases in these operating expenses have coincided with a decline in multifamily valuations. As the Green Street Commercial Property Price Index in figure 3 illustrates, multifamily valuations (the green line labeled “Apartment”) peaked in late 2021 when rates were near zero. However, figure 3 also illustrates that multifamily property valuations are up 3 percent in the last month, which may be related to the recent 50 basis point rate cut and further expected easing.
Analysts critical of the multifamily sector have routinely highlighted the fact that rent growth has stalled across the country. Indeed, as figure 4 highlights, average monthly rent peaked in 2022 and has declined slightly since. Regional performance seems to be illustrating a market working towards a new long-term equilibrium. The August 2024 Apartment List National Rent Report notes cities with outsized rent increases during the pandemic like Austin, Phoenix and Raleigh were the cities with the slowest year over year growth in rents over the past year, while cities that struggled during the pandemic, such as Washington, D.C., and Detroit are experiencing the largest increases in rent from August 2023 to August 2024.
However, more forward-looking metrics indicate that this short-term stall in rent price increases may be coming to an end. One indication that rents may soon start to trend upward is the uptick in large multifamily deals closing. In June 2024, one of the largest private equity firms, KKR, completed a $2.1 billion deal for apartment buildings located across the country. Blackstone also recently agreed to pay $10 billion to take private an apartment income REIT that focuses on coastal markets.
Two of the largest factors that should prop up rental prices are rental vacancy rates and a lack of new supply. As figure 5 illustrates, while vacancy rates have increased slightly since 2021, multifamily vacancies are still well below the historical average, suggesting ample cashflows to landlords.
An additional source of concern about the multifamily sector was the surge in apartment buildings under construction in 2022 and 2023. A previous ABA DataBank article emphasized that these projects were predominately in areas seeing population growth, and therefore unlikely to result in an oversupply of rentals. Since then, builders have actually pulled back from the market, and figure 6 highlights that the first two quarters of 2024 as the lowest figures for new apartment units under construction in the past decade. Therefore, any areas of softness in the multifamily market should firm up as a lack of new supply will support rents in the near future.
Despite the increase in operating costs for apartment buildings, the structural undersupply of housing in the United States should lead to sustained resilience of the multifamily space. Looking forward, the market is pricing in a series of rate cuts over the next several months, insurance premium increases should abate, and the lack of new multifamily supply coming online over the next few years should all prove to help sustain and boost rent prices. Therefore, analysts examining bank exposure to the multifamily space should be aware that these forces likely mean continued strong performance of multifamily loans on bank balance sheets.
Dan Brown is a senior director and economist at ABA. Jeff Huther is VP for banking and economic policy research at ABA. Sharon Whitaker is VP for mortgage finance policy at ABA. For additional research and analysis from the ABA’s Office of the Chief Economist, please see the OCE website.
