Gray Report Market Summary and Highlights: Week of August 11, 2022

Last week’s jobs numbers revealed a stronger-than-expected labor market, and the just-released CPI report shows that inflation has levelled off and could be heading down. The economic anxieties of 2022, however, will not be so easily dispelled. Wage growth from the strong jobs market has the potential to re-ignite the rising prices of previous months, and apartment rents are becoming an increasingly powerful driver of inflation. The recent reports on employment and inflation are clearly good news, and for multifamily market specifically, its historic resilience during inflationary periods, along with recent projections of consistent elevated rent growth for the next several years, are positive signs for apartment investors.

Inflation and the Economy

Slate: “Inflation Reduction Act Breakdown” – https://slate.com/news-and-politics/2022/08/inflat

• Inflation reduction is a nice name and is very of the moment, but I have noticed more people talking about the climate provisions in the bill than any kind of aggressive approach to inflation.
• “To a first approximation, the bill amounts to a $370 billion climate investment paid for by prescription drug savings and tax changes. The bill’s three baskets can be analyzed separately, but the baskets are so tightly woven together that any normative assessment of the legislation must account for all three.”
• Tax credits for nuclear power, electric vehicles, and other lower-carbon endeavors, expansions to Medicare and Medicaid, and in the revenue portion 
  • “a new 15 percent minimum tax on the “book income” of large corporations. “Book income” refers to the earnings that corporations report to investors under generally accepted accounting principles. If large corporations pay less than 15 percent of their accounting profits under normal tax rules, then the 15 percent minimum tax potentially kicks in.”
• What was not in the bill but was being considered was any changes to the way that carried interest is taxed.

Bureau of Labor and Statistics: “Consumer Price Index, July 2022” – https://www.bls.gov/news.release/cpi.nr0.htm

• No change in the CPI numbers. Is inflation leveling off, or is this wishful thinking? The core CPI went up a little, and there’s some pretty clear indications that a good portion of these CPI numbers are due to falling gas prices.
• The core CPI does not include food and energy prices, and it’s seen as maybe a little more stable reading of inflation that is less subject to things like oil price volatility. The thing is, energy and food prices are things that people spend money on and are some of the primary contributors to the inflation that people viscerally feel every day.
• Shelter, which is a specifically relevant category that includes rental housing as a sub-category, went up, but it went up .5% slightly less this month than last month’s .6%. Rental housing of a primary residence increased by .7%, which is slightly less than last month’s .8%, but it is still within the same range as the previous few months. You take 12 months of .7% price increases, and you get 8.4% increase in rent prices if these inflation numbers for rental housing stay the same.
  • This is the momentum of the housing supply crisis being felt. We will see continued rent growth here, and even in my drive over here, the news anchors were calling out shelter inflation as something that everyone is watching. It could really start to rise and become a more significant driver of inflation than it already is.
• The numbers are flat, though, and thus far, the markets are pretty happy about it. We reported on some hopeful projections about inflation possibly cooling off, and there is a lot of hope out there still.
• I’m not ready to stop worrying about inflation. The jobs numbers were so good, and there still is so much anxiety in this economy, that it does not seem very wise to expect that inflation could still start ticking up again.
• For multifamily investors and apartment syndicators, lower inflation numbers are a good sign and a reason to—perhaps—hope against hope that the Federal Reserve will not raise interest rates significantly in the near future. High interest rates cut into investment returns and make it difficult for deals to work out.

Bloomberg: “Fed Rate-Hike Forecasts Raised on Strong Jobs Report” – https://www.bloomberg.com/news/articles/2022-08-08/jpmorgan-evercore-raise-fed-hike-forecast-on-strong-jobs-report

• The inflation numbers are relevant as a predictor of potential rate increases from the Federal Reserve, and these interest rate increases have a powerful impact on the state of the multifamily market. Berkadia leads off their mid-year multifamily report with employment figures, and for good reason.
  • I might need to change this as the CPI numbers come in, but last week’s jobs report is at least as compelling as any movement that we’ve seen in inflation numbers.
  • Employment rose far higher than was expected. So many people were expecting lower jobs numbers, and yes, there is still a very good chance that the next report will show lower jobs number, but the low unemployment rate measured for last month goes against so many of the anecdotes about company layoffs and tech slowdowns and recession. To me, that’s news, and there’s a lot of implications for the multifamily market and the economy at large.
• But looking at this article, it sure seems like nothing good can ever happen. A weak jobs report? That clinches it; we’re in a recession. A strong jobs report? Well, now we’re going to get crushed by inflation.
• In terms of the Fed “land the plane” metaphor, I don’t think there’s anywhere to land at all. We can’t find a runway, and we’re looking for an empty field to land this thing, and it’s going to be bumpy no matter what.
• This latest jobs report also brought with it proclamations that jobs are—finally—back to pre-pandemic levels.
  • Actually, you can get close to an answer on the question of job growth and an over-heated economy if you look at what exactly those pre-pandemic unemployment levels were.
  • The way that phrase is being used, “back to pre-pandemic levels” seems like it could mean “back to normal,” like we’re getting back to the typical levels of employment that you could expect any time outside a recession.
  • But there is no typical level of employment, even outside of a recession. (unemployment numbers since 1948).
  • The unemployment rate in January and February 2020 was 3.5%. The last time the unemployment rate was this low was in 1968 and 1969. Other than that period in the late 60s, the only other time that the unemployment rate was as low or lower than it is now was in the early 50s, from 1951-1953.
  • So, instead of saying something like “unemployment is finally back to where it was before the pandemic” we should say “unemployment is down to the exceptionally low levels we were seeing in the months before the pandemic”
  • Given this context and the fact that, aside from a couple of months right before the pandemic, unemployment is the lowest it’s been in more than 50 years, there’s a good case to be made that we’re at full employment, that we’re at the point in the Phillips curve where turning up employment really starts to disproportionately fuel inflation.
• Returning from history back to the present, the Bloomberg article focuses on the immediate effects that will come from the Fed, rather than the implications that low unemployment has for inflation.
• JP Morgan Chase predicts that the Fed will raise interest rates by .75% in September, Citigroup predicts a 1% rate hike.
• Now, as I write this, I’m waiting for the real CPI numbers in the morning, but the article ends with predictions of lower inflation.
• If we do see lower inflation, and unemployment stays at current levels, I don’t think anyone is going to be breathing a sigh of relief. Low unemployment should turn into wage growth, especially as a response to current inflation numbers. Just as the high rents for newly leased apartments are slowing being felt by existing residents renewing their leases, there could be a lag between the combined jump in inflation and employment and the subsequent wage growth that comes as a response to a more competitive labor market and higher cost of living demands.

Inflation Leads to Rates, Rates Lead to Suffering

CBRE: “Commercial Mortgage Markets, Q2 2022” – https://www.cbre.com/insights/figures/q2-2022-us-lending-figures

• Usually Yoda mixes up his grammar when he speaks, but he’s pretty straightforward when he says that “fear leads to anger, anger leads to hate, and hate leads to suffering.” It’s inflation now, inflation leads to rates, and rates lead to suffering, at least they lead to a less favorable environment for leverage. 
• LTV (Loan To Value) numbers: for commercial properties the average is 58.7%, and multifamily is at 61.7%. So multifamily gets a little more wiggle room compared to other property types.
• The loan underwriting measures are particularly interesting.
  • According to CBRE, average LTV has gone down, from 61.7 in Q1 to 60% in Q2, and the pre-pandemic average was 65.3%.
  • And there are different standards listed here, interestingly, and I may be reading this wrong here, the standards for cap rates are not moving in the same way as the others.

Multifamily Market Updates

Berkadia: “Mid-Year 2022 National Multifamily Report” – https://base.berkadia.com/wp-content/uploads/2022/08/Berkadia-Mid-Year-2022-Report-National.pdf

• This concise report begins with a take on employment: According to the Federal Reserve Bank of Atlanta, wages grew 5.3% annually through mid-2022, up from a 3.4% increase during the prior year. The strongest gains have been among low-skilled workers, contributing to more individuals returning to the workforce as the national unemployment rate tightened 230 basis points year over year to 3.6% by June 2022. Class C apartments have showed slightly lower rent growth in the past compared to Class Band Class A properties, and an increase in wage growth for low-skilled workers could strengthen the conditions for these assets.
• On the supply side, we’re going to see a whole lot of deliveries in 2023. 
• Berkadia’s projections for rent growth are markedly positive through 2026, which is the end of the period they project here. No cooldown here, at least in the longterm. Sure they factor in potential seasonal dips here and there, but the growth in the next few years looks a lot stronger than the growth pre-pandemic. Similarly, they have occupancy oscillating around 95 and 96%.
• No cooldown, no implosion, no collapse, no apocalypse. Just steady, strong growth.

RealPage: “As Expected, Apartment Rent Growth Moderates Slightly in July” – https://www.realpage.com/analytics/expected-apartment-rent-growth-moderately-slightly-july/

• As RealPage’s graph so clearly shows, if you take out last year’s incredible rent growth, the rent growth of 2022 is stronger than any other year in the past decade.
• Rent to income rates support further rent growth, and the numbers for rent growth would be incredible if it weren’t for the easy comparison of 2021. Again, don’t call it a cooldown.
  • Year-over-year asking rent was up 12.2% in July. For new leases, the year-over-year rent growth number was 17.2%. For renewals, the number was 11%.
  • Those are huge, high numbers. 11% rent growth just for renewals? Woah.
• As another piece of supporting evidence for the strength of the apartment market in 2022, this is a solid, worthwhile article.
• There is a twist at the end of the article, and it resonates with what I was thinking last week when we covered the long-term projections for the multifamily market: What is going to happen when building new apartments gets easier? Thinking that the pandemic is going to suppress supply chain efficiency forever… I don’t want to think about that dystopia.
  • At the end of the article, Jay Parsons leaves us with some provocative food for thought: “[Reduced apartment demand is] not especially concerning for now given ultra-low vacancy but could become concerning if sustained through 2023 – when apartment supply levels will soar to 40-year highs.”
  • APARTMENT SUPPLY LEVELS AT 40-YEAR HIGHS
  • Now, I actually think that the level of housing and apartment demand is such that this increased supply is going to be absorbed by renters without completely imploding the apartment market, but statements like that make me stand up and take notice.
  • RealPage does a great job reporting on permits, starts, and completions in the multifamily industry, and this prediction for 2023 should motivate apartment investors to take a look at how much supply they can expect in the markets where they typically invest. This increase in supply is not going to be uniform.
  • There are multiple reports that show the new supply coming into the market as a percentage of current inventory, and we will be sure to continue covering these reports.
  • My expectation is that we are going to see more supply in the hot, in-demand markets that grew so much in the past two years. That being said, I’m going to be paying close attention to permits and starts. Supply may not be perfectly even across all markets, but I am not going to make any assumptions without data to back them up.

Housing and Single-Family Homes

Fannie Mae: “Housing Sentiment” – https://www.fanniemae.com/research-and-insights/surveys-indices/national-housing-survey

https://www.fanniemae.com/media/44396/display

• We covered this last month, and it is still worth covering this month, even though the trend is the same. The news is that the trend is the same. It’s no surprise that housing sentiment is down, but the size of it is worth taking account of: We’re very close to the super-low levels of housing sentiment seen in the immediate wake of the COVID-19 outbreak.
• I wish I had the master key to the sentiments of humanity, but I don’t, and I can’t jimmy the door. That’s not to say that these sentiments are invalid, just illogical.
• Inflation, higher interest rates, and still-high home prices are hitting homebuyers hard. Sure, you can tell people that interest rates were never this low at any point before the great housing crisis, but that’s not going to make them feel better. More likely, people are looking at the high rates now, they’re thinking about the super-low rates that are still in recent memory, and they feel pretty awful that it costs so much now to buy a home.
• Home sales have gone down, but I don’t think that home prices have gone down to a level that is commensurate with the increase in mortgage rates.
• To bring this back to the multifamily, the atmosphere and sentiment within the single-family home market could continue the long-reported trend of would-be homebuyers becoming discouraged by the cost of buying a home, remaining renters, and sustaining demand within the apartment market.
• If interest rates continue to increase, that would make it even more difficult to buy a home, which could lead to sustained low housing sentiment even if home prices decline slightly.

NAHB: “Single-Family Homes Started in 2021” – https://eyeonhousing.org/2022/08/single-family-homes-started-in-2021/

• We’ve built a heck of a lot of homes this year. Despite all of this low sentiment, we have built a LOT.
• “Nationally, 1,133,145 new single-family units were started in 2021, 14% higher than the units started in 2020. It marked the fastest growth rate since 2013 and the highest count of starts since the Great Recession.”
• But still, not enough. We’re not getting out of the housing affordability crisis any time soon. We still need to build more homes.