Multifamily’s Complicated Supply Issue

The multifamily sector faces a complex supply challenge, with abundant ongoing development and varied implications across different locations and property types.

Multifamily's Complicated Supply Issue

The multifamily sector faces a complex supply challenge, with abundant ongoing development and varied implications across different locations and property types.

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Good morning. The multifamily housing sector is wrestling with a perceived supply problem. Against all odds, office landlords outperformed the S&P 500 in Q3 for the first time since 2020. The US industrial market saw an uptick in vacancy rates in Q3. Meanwhile, suburban apartment rents continue to rise as populations surge.

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Market Snapshot

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*Data as of 10/09/2023 market close.


A Glut in Growth: Inside the Oversupply Problem in Multifamily Housing

The multifamily sector is experiencing a supply challenge, with an abundance of development in progress. However, this issue might not be as simplistic as it appears, with different implications based on location and property type.

Market segments: The impact of supply is not uniform, varying across low- to middle-income neighborhoods and wealthier suburban areas. Notably, affordable housing remains stable due to its long-term horizon and resilience against short-term market fluctuations. Rochelle Mills from Innovative Housing Opportunities indicates that public funds lend stability to this segment, with occupancy rates being consistently high.

Historical context: Jay Lybic of CoStar Group emphasizes that the current supply issue differs significantly from previous ones, particularly in terms of which market segments feel the impact. Unlike scenarios in the late 1990s, the present situation sees the “pain” of oversupply being mostly felt at the top end of the market, safeguarding the middle market to some extent due to a substantial price difference.

The demand: Despite high deliveries, long-term projections by institutions like the National Multifamily Housing Council estimate a requirement of 3.5 million new multifamily units over the next decade. Paul Fiorilla from Yardi Matrix notes that while the number of units under construction is substantial, rising rents — up 22% combined in 2021 and 2022 — indicate robust demand, as the market seeks to compensate for under-building following the global financial crisis.

Regional insights: The geographical aspect is pivotal in understanding supply and demand dynamics. While the Sunbelt is grappling with an oversupply, other areas, especially in the Midwest and Northeast, show stability or even a surge in their markets. The supply tends to be concentrated in rapidly growing markets like Austin and Phoenix, where population and job growth seek to balance the increasing housing units.


Big picture: Although oversupply poses short-term challenges, several experts predict the market will stabilize in the long run, as new units are gradually absorbed and demand stabilizes. Consequently, the forthcoming 12-18 months may be balanced as the market navigates through rent growth and stable investment options. Industry insiders like Jay Parsons suggest that a strategy centered around long-term views and patience will likely be rewarded, pointing to a potential equilibrium around 2025 when supply catches up.


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Office Landlords Outpaces the S&P 500 for the First Time Since 2020, But Challenges Loom

What continues to be seen as commercial real estate's weakest link, office landlords have made a striking comeback in Q3, achieving its first quarterly outperformance against the S&P 500 Index since 2020. However, there's a hint of vulnerability in the air.

Surprising outperformance: Defying odds, office real estate saw only a 2.8% slip in Q3, standing strong against the S&P 500's 3.7% tumble. This rebound is commendable given the sector's struggles since the pandemic's onset. However, the office sector remains susceptible to the looming threat of rising rates, especially after a recent surge in hiring.

Outperforming peers: The strong jobs report caused a sharp drop in real estate stocks last week, particularly office REITs, which hit a low not seen since 2009. Despite this setback, office REITs still had their best quarter since the pandemic began, with office landlords outperforming other real estate categories, only slightly trailing behind data centers in losses, shedding just 1.5% in Q3.

Relief rally: SL Green's sale of a 49.9% stake in 245 Park Avenue catalyzed a sector-wide uplift for office owners. The move renewed investor confidence in the office market, evident by Hudson Pacific Properties rebounding with a 58% rise this quarter. New York giants, Vornado Realty Trust and SL Green followed suit with gains of 25% and 24%.


The long game: Even the beat-down San Francisco office market shows signs of recovery with a slight uptick in tenant activity. The number of tenants increased from 137 to 180, and their space requirements nearly doubled. However, with many of these tenancies being short-term, CRE investors need to be patient and prepared for market cycles over the long run.


📖 Read: The Supreme Court's decision to deny a challenge to NY's Rent Stabilization Law has significant implications for multifamily investors in the Big Apple, potentially affecting millions of residents.

🎧 Listen: In this episode of Bisnow Reports, CBRE's Global Chief Economist and Global Head of Research, Richard Barkham, discusses the firm's forecast for an economic recession.


Industrial Slowdown Continues Amidst Record Construction Deliveries

US industrial market continues to slow as record amount of construction delivers

An uptick in vacancy in the U.S. industrial market is being fueled by a wave of new construction. (The Business Journals)

The US industrial market saw an uptick in vacancy rates in Q3, primarily due to a record amount of new construction.

Rising vacancies: According to Cushman & Wakefield (CWK), the industrial vacancy rate increased to 4.7% in Q3, up from 4% in Q2. The surge in vacancy is primarily attributed to a wave of new construction entering the market. Despite an increase in sublease availability and a record-high total of 139 MSF in Q3, the overall vacancy rate in the industrial market remains healthy. Additionally, industrial construction starts have dropped significantly, down 68% YoY.

Shifting dynamics: The vacancy rate is expected to rise above 5% due to a slowdown in industrial construction starts. However, rental rates are still expected to continue growing, although at a slower pace than before. Developers would rather offer concessions like tenant improvement allowances or free rent to attract tenants than let a building sit vacant. Most markets are transitioning from extremely tight vacancy rates of 1–3% to a still-constrained range of 3–5%, with rental rates likely to remain stable or grow due to ongoing new construction.

Move to manufacturing: Despite recent legislation, the return of manufacturing to the US remains a slow and labor-intensive process, with no significant uptick in deal activity yet. Advanced manufacturing facilities, such as semiconductor fabs or battery plants, are crucial but require careful consideration of labor and resource availability for their location. High-ceiling logistics facilities catering to third-party logistics and e-commerce tenants remain the primary driver of demand.


Balancing act: While the industrial market is experiencing an uptick in vacancy rates, experts anticipate that the slowdown in construction starts will provide time for the market to absorb new developments. The shift is expected to lead to a more sustainable vacancy rate, and rental rates are unlikely to drop significantly. While vacancies may be rising, it may be a return to normal rather than a cause for alarm.


Suburban Apartment Rents Soar as Population Surges

The pandemic-induced migration to the suburbs has not only resulted in substantial population growth but has also led to increased demand for apartments and rising rents, particularly in suburban areas.

Pandemic pivot: Before the pandemic, metropolitan areas offering high walkability levels commanded premium prices in the housing market. However, the advent of the pandemic in 2020 drastically altered these trends. Suddenly, homes in least-walkable areas, often located farther from core metropolitan zones, began to experience accelerated price growth, a phenomenon mirrored in the rental markets of these regions as well.

Top growth markets: According to CoStar, from late 2019 to 2023, the places with the most significant rent increases are Jacksonville (NC), Naples (FL), Valdosta (GA), Bloomington (IL), and New Bern (NC). Conversely, metropolitan regions like San Jose and San Francisco have witnessed stagnant or even decreasing rents. Among the 390 markets studied by CoStar, major cities like NYC, LA, and Chicago have had slower rent growth compared to their suburban counterparts.

Population gains in US driven by suburbs

Urban vs. suburban: Rent increases in the largest U.S. cities have gradually increased more than their suburban peers. In NYC, rents per unit rose by 10.59% in Q3 2019 compared to Q4 2019. Los Angeles experienced a 9.46% increase, and Chicago saw a 15.18% uptick in rents during the same period.


Suburban surge: The pandemic-induced shift in housing preferences towards suburban areas has significantly increased apartment rents, outpacing the rent growth in major US cities. This period of adjustment invites a unique opportunity to innovate housing and urban planning policies, to balance growth, sustainability, and affordability in both urban and suburban landscapes.


  • Lease lifeline: WeWork (WE) is urgently renegotiating its leases with landlords to avoid bankruptcy and retain control, as it faces substantial rent obligations totaling over $2.2B.

  • Junk status: S&P Global Ratings is considering downgrading Brookfield Property Partners to junk due to the need to refi significant debt despite rising rates and declining values.

  • Space for lease: DFW has 76 MSF of office space available, driven by a surge in sublease offerings and a decrease in demand, with the most located in older, less desirable buildings.

  • Condo partnership: Property Markets Group and Lndmrk Development acquired a 1.1-acre site in Wynwood Norte for $20M with plans to develop condos.

  • Power struggle: A group of disgruntled shareholders has sent an open letter to Pennsylvania Real Estate Investment Trust (PREIT) demanding the appointment of a replacement for Temple University acting President JoAnne Epps.

  • Commission overhaul: The parent company of Coldwell Banker has agreed to pay $83.5M to settle class-action lawsuits and change its commission policies.

  • Ransom payment: Decades-old reciprocal easement agreements (REAs) in mall anchor tenant leases are losing their power as owners seek redevelopment flexibility and tenants prioritize long-term viability.

  • Texas titan: Two Houston-based firms, Concourse Development and the US arm of Mexico-based Maquina Holdings, have merged to create a new company called Ember with the aim of developing large projects across Texas.

  • Unwanted guest: A woman who rented an Airbnb (ABNB) guesthouse in Brentwood has not paid rent for over 540 days and refuses to leave, leading to legal disputes with the landlord over rent control and occupancy issues.

  • CRE impact: The September jobs report indicates stronger-than-expected payroll employment growth, potentially leading to further interest rate hikes, which could impact CRE.

  • Midtown markdown: The sale of a century-old office building in Midtown South to Sovereign Partners for $125M represents a 50% discount from the $230M purchase price a decade ago.

  • Demand for data: Data centers are becoming increasingly popular among CRE investors, with private equity investments in the sector reaching record highs in 2022 and 2023.

  • Financing frustration: Mark Franceski, Managing Director of Zelman & Associates, says obtaining financing in the current market is the most challenging it has been since 2012, with multifamily being the preferred asset class for investors.

  • Bridging the gap: PGIM Real Estate has provided $143.5M in bridge financing to LaTerra Development for two multifamily projects in LA, allowing LaTerra to replace construction loans and stabilize while securing longer-term permanent debt.


Overall Leasing Demand Turns Negative

The CRE industry is bracing for the impact of higher interest rates, which could lead to underwriting higher vacancies, longer lease-up times, and muted rent growth due to increased borrowing costs for buyers and limited expansion capabilities for existing tenants, with recent data showing a negative net absorption and weaker demand.

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