As we approach the midpoint of 2025, the supply and demand fundamentals of the multifamily housing market are becoming increasingly favorable. Apartment demand remains strong, as evidenced by near record absorption in the first quarter. And further, supply will continue to tighten as deliveries and new starts for multifamily housing continue to fall.
Multifamily Development Headwinds
The sharp decline in new multifamily development is mainly due to economic headwinds, making projects financial unfeasible in many cases. Simply put, most projects today don’t pencil out.
Development projects require equity capital, and those investors seek returns that commensurate with the additional risks associated with ground-up development. Ground-up development typically includes risks far greater than those of acquiring stabilized, income-producing assets with fixed-rate financing. Key risks include:
- Interest Rate Risk: Construction loans typically have floating rates, exposing borrowers to increased debt service costs if interest rates rise.
- Construction Risk: Contractors may face cost overruns, delays, or even bankruptcy. Even with guaranteed maximum price (GMP) contracts, these can derail budgets and timelines.
- Lease-Up Risk: If market conditions soften and consumer confidence declines, properties may take longer than expected to stabilize and generate forecasted income.
- Capital Markets Risk: Most construction loans mature in 3-5 years, which may force developers to finance or sell into an unfavorable market, potentially at a lower valuation.
The most critical metric to development today is the untrended return on cost (ROC), or the projected year-one net operating income (NOI) as a percentage of total development cost, assuming the property was built and stabilized today.
This return is comparable to the “going-in” cap rate on an acquisition, but it must exceed market cap rates to justify the additional risk of development. Today, development equity sources typically require a 100 to 150 basis point (1.0% to 1.5%) premium over market cap rates.
For example, if newly built, stabilized multifamily assets trade at a 5.5% cap rate, a developer needs to demonstrate an untrended ROC of at least 6.5% to 7.0%. This implies a 15% or greater discount to market value on a cost basis. In today’s market conditions, it is extremely challenging to build an equivalent product for 15% less than it cost two or three years ago. In fact, costs have increased across most categories.
Development feasibility could be restored if cap rates decline or if rent growth outperforms. If cap rates compress, the value of stabilized assets would rise, improving development economics. However, this scenario is unlikely in the near term given the Federal Reserve’s hesitation to cut short-term rates and elevated long-term yields. If rent growth drives NOI higher and construction costs moderate, untrended ROC could once again exceed market cap rates. This scenario is also unlikely in the near term as overall project costs are expected to rise, especially due to shortages in construction labor.
The current tariff and policy uncertainty has further increased risk for developers. Some firms have chosen to accelerate projects ahead of potential tariff setbacks, while others are expected to hit pause until future conditions are more certain. Timberland Partners’ key markets saw some of the deepest cuts in multifamily permits for the year ending February 2025. Minneapolis-St. Paul-Bloomington, MN saw a 47.9% decrease in units permitted, while Nashville-Davidson-Murfreesboro-Franklin, TN saw a 37.8% cut.
Nationally, 576,700 units were delivered in the 1st quarter of 2025, down slightly from the all-time peak of 585,200 units the previous quarter. Delivery volumes are expected to fall for the next few years as developers complete the current pipeline of previously entitled and financed projects. Both permits and starts for multifamily product have been declining for the past few years and are well below 2021 and 2022 highs. Around 370,000 multifamily units started construction in the year-ending February, 6.6% lower than the previous year, and well below the annual peaks over 600,000 units seen in 2021 and 2022.
Demand Factors
Against the backdrop of falling supply, demand for housing is quite strong. Apartment occupancy enjoyed a steady climb throughout the early months of 2025, somewhat moderating in May. The Midwest posted the nation’s strongest annual rent growth at 3.4%, benefiting from more modest supply pipelines compared to other regions, high renter retention rates, and sustained pricing power. These dynamics are consistent with Midwest apartment performance over time, offering stability compared to more boom-and-bust markets.
Renter demand continued to outpace deliveries across the country. Net absorption was measured at 100,600 units in Q1 according to CBRE, a 77% year-over-year increase and the highest Q1 absorption since 2000. Economic conditions have remained stable. Education and health services sectors were notable contributors to U.S. job growth, while sectors like manufacturing and government continued to experience job losses. The high cost of for-sale homes and elevated interest rates continue to push more individuals and families toward renting. In most markets, it is at least 50% more expensive to purchase a home compared to renting. Additionally, income growth has outpaced rent growth for multiple years, and consumer balance sheets are generally strong. Barring an unforeseen and severe economic shock, renter demand should continue and support normal or above-trend rent growth in the near term.
Sources
CBRE. “Q1 2025 U.S. Multifamily Figures.” CBRE, 2025.
Newmark. United States Multifamily Capital Markets Report. Newmark, n.d.
RealPage. “Apartment Supply Peak: 1st Quarter 2025.” RealPage Analytics, 2025.
RealPage. “February 2025 Metro Permit Update.” RealPage Analytics, 2025.
RealPage. “May 2025 U.S. Employment Update.” RealPage Analytics, 2025.
Yardi Matrix. Matrix Multifamily National Report—May 2025. Yardi Matrix, May 2025.
