By the end of 2015, the multifamily industry was closing out five years of an unprecedented run of success: rent growth was spectacular, demand was up and those factors spurred construction to hit pre-recession highs. During this period of strength, experts repeatedly predicted that each coming year would be the year of slowing down. Is 2016 the year?
In the first half of this year, multifamily fundamentals are moderating, but demand remains strong and we predict growth will continue, although at reduced, more sustainable, levels.
As increased levels of new supply entered the market, multifamily fundamentals began to taper a bit at the end of last year and into the first half of this year, but favorable demographic trends continued to produce significant demand so that conditions are not meaningfully impacted. Construction slowed in the first five months of 2016, indicating the market has found the appropriate level of construction for the demand at hand.
Multifamily property prices increased again in first quarter 2016, but at a slower rate than in the prior few years. As the rate of increase in rental income slows, property price appreciation can be expected to follow.
Job growth, while volatile, remains healthy but is starting to slow from the pace seen in the last few years. All wage tiers have felt the slowdown in employment gains. Growth in high-wage sectors has slowed more than the other wage tiers, to some extent because of the slowdown in hiring in the energy industry, which typically offers higher-paying jobs.
The number of households increased by 1.9 million last year, including 1.6 million new renter households. Overall, homeownership declined to 63.1 percent of households at the end of second quarter 2016. Further homeownership declines are expected based on demographics, affordability constraints, and a growing diversification in the type of renting households, such as seniors, millennials leaving the nest, and increases in minorities and multigenerational households.
The multifamily market continued its above-average performance in the first half of 2016, albeit at lower levels than in the prior few years. After all, the performance at 2014 and 2015 levels, when some markets experienced rent growth in the double digits, was not expected to continue over the long term.
Much of this year’s moderation is due to increased supply outpacing demand as it comes online in some markets. Multifamily completions are expected to peak this year and demand will not absorb all of the new supply immediately. Vacancy rates will increase in some markets, causing landlords to consider easing rent growth. As a result, gross income growth, which accounts for rent growth and vacancies, will slow down in 2016 but should remain in line with the long-run historical average of around 3.4 percent.
We believe multifamily construction will remain slightly above the pre-recession average for the long term. Rather than a sign of the industry overproducing, the elevated construction level is a response to the changing demand for multifamily units, which will take up the new supply over time.
Treasury rates have declined this year, despite the Federal Reserve’s increase in interest rates in December 2015. Cap rates decreased to 5.7 percent in the first quarter and are unlikely to be affected by short-term movement in the 10-year Treasury.
Following 2015’s higher-than-anticipated multifamily origination volume, which was up by 34 percent, expectations are for volume growth to continue in 2016 but at a slower pace, ending the year up seven percent, to around $280 billion.
Many of the same factors from 2015 are still in play: increasing property prices, elevated construction pipeline, high number of maturities, and low interest rates. Growth in subsequent years is expected to increase by three to five percent.
For the remainder of 2016, as more supply is delivered, multifamily property performance will be strong but will not match the spectacular performance of 2015.
Deceleration in the multifamily market is expected and needed so that the market is not driven to becoming over-inflated However, the underlying demand fundamentals remain strong and occupancies are tight, by historical standards.
Fundamentals will rebound in 2017 as we move past the wave of new supply working its way into the market. Dispersion across individual markets will continue, but increased supply or economic headwinds in some markets will not derail multifamily growth at the national level.
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