Accepting the Multifamily Market's New Normal

By David Brickman, Chief Executive Officer

Multifamily lending has largely stalled, with the $264 billion originated in 2023 falling well short of the nearly $500 billion annually that might be reasonably expected in a healthy, stable market based on historical growth and financing patterns. Much of this lack of activity stems from price dislocation that has significantly reduced new acquisitions as well as a precipitous slowdown in voluntary refinances among borrowers who expect—or at least hope—that a drop in interest rates is just around the corner. This is understandable, not only because of slowing economic growth and the inverted yield curve, but also because the Federal Reserve has provided repeated assurances that such a move is forthcoming.

But what if it’s not? Given the tenacity of inflation, the earliest such a rate cut might happen is probably the end of the third quarter, and even that is far from certain. Inflation, like prices in general, are sticky. We could be talking about the possibility of lowering rates, in the absence of truly lower rates, for a lot longer. And, of course, while the Fed may lower short-term rates, and long-term rates may follow suit, such decreases would almost certainly be quite modest compared with the increases experienced in 2022 and 2023.

Mindful of this uncertain future, I have to wonder if perhaps it is time to stop wishing for a drop in interest rates that may or may not arrive anytime soon (but would be welcome) and instead consider that the current environment may be our new normal. That is, maybe the market uncertainty we have experienced is actually market recalibration to a new rate environment.

There is certainly a reasonable case to be made to reconsider multifamily investment in the current climate. First of all, property prices are markedly lower (and cap rates higher) than they have been in the past few years. And even with higher interest rates, the cost of debt remains significantly less than equity, whose returns are solidly in the teens. Investors can still use leverage as an effective way to both amplify returns and scale their investments. While no one wants lower returns or negative leverage in the short run, the medium to long-term outlook is solid and reflects the resiliency of multifamily as an asset class and the unmet demand for rental housing.

Additionally—as we have seen throughout many cycles—multifamily is a very stable asset class. Yes, there is an alarming rise in the cost of insurance premiums. Nevertheless, the rental market writ large is relatively healthy, even if some geographies are experiencing a bit of indigestion from the elevated level of recent deliveries. And although we are no longer seeing the pandemic era’s steep rent increases, rent levels generally remain firm. Rent growth was positive in 83 of the 100 largest cities in April, with year-over-year declines concentrated in those Sun Belt cities that are simultaneously rich with completions and also replete with long-term growth prospects.

Further, there is unaddressed rental demand waiting in the wings. Though completions surged in 2023 and have continued at an elevated rate to date in 2024, new deliveries are expected to peak this year or in early 2025. Permits have steadily dropped since 2022, with seasonally adjusted annual rates falling from 608,000 to 485,000 just in the past year. And this drop does not fully reflect the significant reduction in the availability of construction capital to developers that presages a drop in new development. Crucially, this slowdown comes even as demographic trends signal continued strong rental demand. The nation’s population growth rate accelerated to 0.49% from 2022 to 2023 (driven largely by immigration), up from 0.37% a year earlier, and an essentially flat rate the year prior to that. And most other economic measures of rental housing demand growth, including job and wage growth, remain solid.

For as long as there has been a multifamily market, there has been a debt market to support it. That is not likely to change anytime soon. Even as I write this, there is more than $2.1 trillion in multifamily debt outstanding. Assuming that debt needs to, on average, turn over every five to seven years (and that is on top of the pent-up demand for financing from the cohort of 2023 maturities that have already been extended) and that hundreds of thousands of new completions that come online in the next year will need to be financed, we are looking at a baseline financing volume of approximately $400 billion to $500 billion. And, that is before factoring in any significant effect from an uptick in investment sales, which should kick back into gear soon.

No, the returns on multifamily investments are not what they were prior to the pandemic. However, as an asset class, multifamily is healthy, and the industry will recover. Investment and financing activity will slowly resume, with or without rate cuts. Cap rates and pricing will stabilize, sponsors will deploy capital, and lenders will lend. We just need to hope that the “animal spirits” driving the current market will, like the broods of cicadas underground in the Midwest and Southeast, emerge in force to propel the market to its new normal, whatever that may be.