Author: Matt Fransen, Chief Investment Officer
The multifamily apartment sector continues to be the darling sector of the real estate asset class.
The stability of the sector’s performance, the burgeoning signs of inflation and the continuance of highly-liquid debt and equity markets should keep demand and values high for the foreseeable future. We continue to fine-tune our strategy to deliver attractive risk-adjusted returns in today’s unique multifamily apartment marketplace. Timberland Partners believes the coming years will remain strong for the multifamily apartment sector – particularly within the company’s target markets for a variety of reasons set forth below, including:
- Apartment acquisitions made in 2022 will likely increase in value over the next few years as rents and construction costs increase;
- Apartments acquired in 2022 will benefit from a strong rental market – occupancy nationally is over 97.5% for professionally managed communities; and[1]
- Properties financed with fixed-rate debt are ideally positioned in inflationary periods like the one we have now entered.
Overall, multifamily real estate should fare exceptionally well in the near-term, inflationary period we have now entered. In the past, our focus was primarily a value-added strategy that relied on driving appreciation in assets through capital improvements and repositioning. In addition to this strategy, we believe today that acquiring high-quality properties, in markets with strong fundamentals, while allowing inflation and market growth to take effect will oftentimes provide an equivalent risk-return profile.
Regardless of asset vintage or location, we always conduct extensive due diligence to understand the target acquisition and the unique demographic and employment drivers in the area. We will continue to utilize long-term, fixed-rate financing at attractive interest rates whenever possible. In this competitive market, we will lean increasingly on our relationships and reputation to source and close deals, as well as our extensive geographic presence to assess submarkets and most accurately underwrite potential acquisitions.
Both market growth and inflation will put upward pressure on rents, and thus, top-line revenue for the properties.
Multifamily apartments, as a sector within the real estate asset class, are well positioned to benefit from the effects of inflation as leases are shorter-term when compared to office, retail, industrial, medical office, etc. and, therefore, reset to market rates more frequently. Further, when financing can be obtained at fixed interest rates with attractive leverage – as current agency financing through Fannie Mae and Freddie Mac affords – both returns on equity and cash yields are accelerated in an inflationary period.
Rental property values also generally benefit from rising prices in for-sale housing (the alternative to renting). In the year ending October 2021, home prices increased nationally 18% year-over-year, the highest single-year increase in the 45-year history of CoreLogic Home Price Index (HPI).[2] Additionally, the housing shortage gap (the difference between supply and demand) has only increased in recent years, with the gap most pronounced in entry-level housing.
The ongoing housing shortage is large and rising, in part due to the effects of the COVID-19 pandemic. Our estimates suggest that the shortage has increased 52% from 2.5 million in 2018 to 3.8 million in 2020. And given the low mortgage rate environment, the high demand and the need for more space, we expect this shortage to continue into the near future. The share of entry-level homes in overall construction declined 40% in the early 1980s to around 7% in 2019.[3]
With interest rates expected to climb over the coming year, the monthly price of homeownership will rise as mortgage costs increase, further deterring first-time buyers.
Thus, overall, we view the macro environment very favorably for near-term value increases in multifamily real estate.
Supply of housing, both for-sale and rental, remains chronically deficient, and demand – driven by new household formation and a growing economy – should continue to rise. At the same time, ongoing inflation will increase property net operating incomes (and, thus, values) while simultaneously deterring new construction and some material and labor-intensive value-add strategies.
Notwithstanding the foregoing, a healthy market in no way guarantees the success of every apartment investment. As always, the devil – and success – is in the details. Timberland Partners will continue our exhaustive due diligence on target properties and their submarkets to ensure the most accurate underwriting possible. We will lean heavily into our relationships with brokers to source off-market opportunities, while at the same time creatively searching out new opportunities by contacting owners directly in our target markets. We will solicit and utilize the opinion of our local management teams when considering new acquisitions. In short, we will continue to focus on the fundamentals that have made Timberland Partners an exceptional investment firm over the past three decades. This is truly an exciting time to be a multifamily investor.
[1] https://www.bloomberg.com/news/articles/2022-01-06/why-aren-t-there-any-vacant-apartments?srnd=premium&sr ef=BWWcUIXI
[2] https://www.corelogic.com/press-releases/us-annual-home-price-growth-at-a-record-18-in-october-corelogic-reports/
[3] http://www.freddiemac.com/research/insight/20210507_housing_supply.page
