By Chris Bruen, Senior Director, Research, NMHC
The pendulum swung hard for the multifamily market in 2022. An extremely tight market in the first quarter of 2022— characterized by the highest annual rent growth and lowest vacancy rate on record for apartments—loosened rather significantly in the latter part of the year as inflation, interest rate hikes and economic uncertainty dampened household demand.
The combination of moderating rent growth and an increasing cost of capital caused apartment transaction volume to fall off, cap rates to edge up and investment returns to turn negative as the year progressed.
Amid the changing conditions, multifamily firms moved to reposition their portfolios. REITs and cross-border funds ended up net sellers in 2022, while institutional investors, private owners and other unknown entities were net buyers. This investment activity led to a few changes to this year’s NMHC 50 rankings, even as the lists still include many of the company names people have come to expect through the years.
Time will tell how these strategies will move companies towards their fiscal goals. For now, the outlook for 2023 remains fairly challenged despite long-term fundamentals remaining largely positive. Recessionary fears are meeting expectations of more market softening for multifamily as record levels of new product begin to hit the market. This temporary bulge in new supply is likely to put negative pressure on rents and trigger a pullback in multifamily construction activity, further exacerbating the industry’s stubborn affordability challenges.
Inflation and Rising Rates Cause Historic Rent Growth to Cool
The start of 2022 saw effective asking rents for professionally managed apartments tracked by RealPage grow 15.3 percent year over year in the first quarter—marking the highest rate since their records began in 2000—while the vacancy rate fell to a record low 2.5 percent. However, even as the vacancy rate proceeded to increase 70 basis points (bps) in the second quarter, rents continued to climb at a breakneck annual rate of 14.5 percent (the second-highest rate on record).
But rent was hardly the only thing that became more expensive in early 2022. Overall inflation grew to a more than 40-year high in June 2022, with overall prices for goods and services rising 9.0 percent from the previous year. To combat this persistent inflationary pressure, at the start of 2022, the Federal Reserve announced it would begin raising its target federal funds rate aggressively.
This series of interest rate hikes created an uncertain economic environment for American consumers, particularly since inflation was also eroding their purchasing power, and fueled concerns over a possible recession going into 2023. Subsequently, rents fell for four consecutive months beginning in September, while the vacancy rate for professionally managed apartments rose to 4.1 percent in 3Q 2022 and 4.9 percent in 4Q 2022.
A Rising Cost of Capital Slows Transactions
Higher interest rates also translated to both a higher cost and lower availability of debt in the apartment market. Respondents to the NMHC Quarterly Survey of Apartment Market Conditions reported worsening conditions for debt financing in January, April, July and October 2022 (and again in January 2023). With a higher cost of debt, investors began to demand a higher rate of return on equity, as Quarterly Survey respondents reported a decreasing availability of equity financing for four consecutive quarters beginning in April 2022.
Potential sellers on the other hand—many of whom are locked into low mortgage rates—have been reluctant to offer significant discounts, leading to a widening bid-ask spread and declining transaction volumes in the latter part of the year. Apartment transaction volume fell 19.5 percent in 3Q 2022 from the previous quarter and then an additional 33.3 percent in 4Q 2022 to $51.7 billion. For the full year of 2022, deal flow declined 16.3 percent to $296.0 billion. Yet, because 2021 was such a record year for sales volume, 2022 still marked the second-highest year for transactions since records began in 2001. Private owners once again accounted for the majority of both acquisitions (65.3 percent) and dispositions (63.7 percent) by volume in 2022, while institutional/equity funds made up the second-highest share (24.5 percent of acquisitions and 21.3 percent of dispositions). REITs were the largest net sellers of apartment properties in 2022 (-$17.2 billion), followed by cross-border funds (-$5.3 billion). The year’s largest net buyers, meanwhile, consisted of institutional/equity funds (+$9.3 billion), other or unknown entities (+$8.7 billion) and private owners (+$4.6 billion).
Rising Rates Cause Outsized Investment Returns to Moderate
From mid-2021 to mid-2022, historic levels of market tightness and rent growth for apartments generated outsized returns for investors in the sector.
Unlevered, annualized apartment returns peaked at 30.2 percent in 4Q 2021, according to data from the National Council of Real Estate Investment Fiduciaries (NCREIF). They then moderated to 22.7 percent in 1Q 2022, 16.4 percent in 2Q 2022 and 4.9 percent in 3Q 2022. In the fourth quarter of last year, annualized returns finally turned negative (-12.2 percent), while the cap rate in the apartment transaction market tracked by Real Capital Analytics increased from 4.7 percent to 4.9 percent.
Although price discovery has become more difficult in this rising interest rate environment, there is no doubt that valuations have started to come down.
Multifamily Construction Continues to Accelerate, While Completions Lag
Multifamily construction activity accelerated considerably over the past two years. The number of multifamily permits (5+ units) issued rose 27.9 percent in 2021 and another 10.3 percent in 2022, reaching the highest annual total since 1986. Similarly, multifamily starts rose 22.6 percent in 2021 and 15.4 percent in 2022, again reaching the highest annual total since 1986.
Single-family, build-to-rent (BTR) activity also swelled last year. The number of BTR starts jumped 31.7 percent in 2022 to 79,000, accounting for 7.9 percent of all single-family starts. This marks the highest share of single-family starts being built for rent since records began in 1974.
While this ramped-up construction activity is resulting in a lot of deliveries on the build-to-rent side of the market—BTR completions grew 28.8 percent to 67,000 units in 2022, accounting for 6.6 percent of all single-family completions—much of this construction activity has yet to fully make its way through the pipeline on the multifamily side.
Just 359,900 multifamily units were completed in 2022, 1.0 percent fewer than in 2021 and 1.3 percent fewer than in 2020. The NMHC Construction Quarterly Survey found that the gross majority of multifamily construction and development firms (between 84 percent to 97 percent of respondents across four rounds of the survey) experienced construction delays during 2022.
However, many of these multifamily units under construction are likely to be completed in the coming year, which could exacerbate softening conditions in the apartment market in the short term. Yet, the combination of higher interest rates and lower/negative rent growth may inhibit new multifamily construction going forward.
Newsworthy Deals & Changes in the Rankings
Despite the market challenges, there were a few industry growth stories and strategic plays coming out of 2022. MAA ascended to the No. 1 spot on this year’s list of top owners, reporting a portfolio of nearly 100,000 units (99,676), followed by Greystar Real Estate Partners at No. 2 (formerly No. 5) with 98,860 units and Morgan Properties at No. 3 with 93,594 units owned.
Blackstone Funds acquired American Campus Communities, Inc. (ACC) for $12.8 billion in August 2022. ACC, which was the last remaining public REIT for purpose-built student housing, was the 33rd largest apartment owner and 36th largest manager in last year’s NMHC 50. The private equity firm also completed a $5.8 billion acquisition of Preferred Apartment Communities, Inc. in 2022. GVA Management more than doubled the size of its portfolio in 2022 (+103 percent), earning a spot on the NMHC 50 for the first time as the 41st largest owner. GVA’s growth was fueled by acquisitions throughout 2022, including the $458 million purchase of a 2,899-unit portfolio from Cedar Grove Capital spanning the Carolinas to Oklahoma and a $380 million purchase (in partnership with Leste Real Estate U.S.) of 1,670 multifamily units in five communities located in South Carolina, Tennessee and Texas.
Looking Ahead for Signs of Improvement
The economic recovery following the COVID-19 outbreak in 2020 translated to historic apartment demand, overwhelming the available housing supply and yielding above average rent growth and returns for investors in the latter part of 2021 and first half of 2022. But the boon proved to be short lived, as the economic picture darkened and housing demand pulled back.
Multifamily’s hope and wish is that the pendulum soon swings back, reversing the industry’s current trajectory. Stronger demand and rent growth will bring back confidence to the capital markets and balance out the market’s wave of new supply. While the expectation is that these headwinds will be only temporary, multifamily faces longer-term challenges even as its fundamentals remain solid. Chief among them is a worsening affordability problem that can only be solved by building more rental homes. To sustain a higher level of multifamily construction over a longer horizon, the industry needs to push to reduce onerous regulatory barriers to new supply and oppose policies that ultimately exacerbate the nation’s growing affordability problem.