Gray Report Market Summary and Highlights: Week of August 5, 2022

The apartment market has proven its resilience and remains stable, but in the broader economy, volatility and uncertainty persist. In the face of these mounting anxieties, several reports were published this week that analyze the long-term and short-term risks for the multifamily market, from consumer sentiment, to apartment performance during a recession, to the prospect of lower population growth. Against these and other potential headwinds, the multifamily market is well-positioned, and even in the case of declining population growth, the size of our current housing supply deficit is such that apartment assets will continue to perform well with strong demand from renters through 2022 and through the next decade.

Moody’s: “What Would a Recession Mean to the Multifamily Market?” – https://cre.moodysanalytics.com/insights/research/what-would-a-recession-mean-to-the-multifamily-market/

• “As we face a potential new recession, here are 5 factors to guide us through how the multifamily market may fare compared to the previous recessions: 
  • 1. A Slower rate of new construction
  • 2. A transfer of demand to the multifamily market but watch for possible aftershocks: The figure five chart here is convincing: The price-to-rent ratio, historically, has been much lower than it is right now—the cost of a house is much more expensive now than it has been historically. 
    • This could suggest that we have more room for rent growth, but also, it’s a big sign here that multifamily does well, relatively speaking, during a recession. It’s a good choice.
  • 3. Change in the labor market and real disposable income – Less money means bad. This is not a case where would-be homeowners with less money become renters as much as it would be a case where homeowners and renters have less money and they run into a hard ceiling on what they are able to pay. This is one reason why you see high demand and low vacancy rates for Class C properties and workforce housing: The demand is there, but the money is not there that could pay for rent increases.
  • 4. Bigger swings in the “white-hot Tier 2 markets” that have seen such a run-up in multifamily rent growth in the past two years. Those markets “may be quicker to cool with bigger rent corrections.”
  • 5. “A more regulated financial environment could be a blessing.” What they’re referring to specifically is the sub-prime mortgage crisis. When the last financial crisis had so much to do with the housing market, and they did some meaningful regulatory work to prevent that situation from happening again, that offers some protection from its impacts in the future.
• As they summarize: While many single family markets will likely see small to moderate prices decline in this situation, multifamily’s positive performance should hold up relatively longer, as in previous downturns. Overall, in a mild recessionary environment we would expect only a moderate vacancy rate increase and rent growth to simply decelerate. A slight and short lived dip into negative territory towards the end of the recession is possible, but a free fall is highly unlikely. 

The National Law Review: “New Bill Will Tax Real Estate “Promote” as Carried Interest Subject to Three-Year Holding Period” – https://www.natlawreview.com/article/new-bill-will-tax-real-estate-promote-carried-interest-subject-to-three-year-holding

• As a little bit of background, in 2017, as part of the Tax Cut and Jobs Act, they added section 1061 to the tax code, which extends the holding period for certain carried interests from 1 year to 3 years in order to qualify for a lower tax rate (the long-term capital gains rate). At the time, real estate investments didn’t have this three-year holding period requirement. The new bill would loop real estate investment into this three-year requirement.
• What does this mean?
  • Firstly, what does this mean, like, what the heck is going on here?
    • Here’s my understanding for how this applies to multifamily syndication: Carried interest is the returns on investment that flow back to the syndicator or General Partner of an investment.
    • My understanding then, is that, if this extension goes into effect, real estate investors would pay a larger tax rate for the first 3 years, and all the years thereafter would get taxed at the lower rate.
  • Will this result in the collapse of real estate investments?
  • Will this eliminate the tax advantages of real estate investing altogether, or does it simply defer them? In other words, are you losing out on the earning potential of two years’ deferred taxes if your next real estate investment falls under these changed holding period requirements?
• Here’s what I think might be a more relevant question: Will this even happen?
• I’ll admit, the issue did get my attention, but then Spencer reminded me that this is kindof an ongoing thing: We heard about this when different versions of the “Build Back Better” bill were being debated, and these changes to the tax code never seemed to stick.
• I do think it’s worth considering what could happen if there were changes to the ways that real estate investors are taxed, but it’s not quite time to worry about it.

Apartment List: “National Rent Report, August 2022” – https://www.apartmentlist.com/research/national-rent-data

• Rents up 1.1% month-over-month and 12.3% year-over-year.
• “Don’t Call It a Cooldown” is the name of my sassy pop music single about multifamily rent growth in 2022.
• There’s a line graph here that is one of the more useful visualizations of what I mean here, (not about my pop music career)
  • There are lines on this graph that represent the rent growth in 2018, 2019, 2020, 2021, and this year.
  • The line for 2021 is, of course, the highest. It was at 17.6% rent growth by the end of the year, but in July 2021, it was about 12% rent growth year to date.
  • The line for 2020 is the lowest, actually dipping into the negative with minus 1.5% year-over-year rent growth by year’s end, and around negative 0.5% year to date in July 2020.
  • The other two lines are for 2018 and 2019, and they are much closer to historical averages, with 3.4 and 2.3% year-over-year rent growth by the end of the year, and about 4.5 and 3.5% year to date rent growth in July of 2018 and 2019, respectively.
  • 6.7% is higher than 4.5%. 6.7% is higher than 3.5%. Rent growth is well above historical averages looking at the numbers.
  • If you look at the lines on the graph, you get the idea without even reading the numbers: The 2022 rent growth line is gliding up and away from the 2018, 2019, and 2020 lines. Yes, the 2021 growth line is a dang rocketship in comparison, but rockets are risky! I’m going to go out on a limb here and say that looking for rocketship growth is not a sustainable mindset for investing, whether it’s real estate investing or investing in the stock market.
• The data on apartment demand is arguably more compelling than the rent growth data, which, again, is strong, stable, and elevated. “Don’t Call It a Cooldown”

National Apartment Association/NMHC: “U.S. Apartment Demand through 2035” – https://www.naahq.org/us-apartment-demand-through-2035

• This report is one of the ones that I was most interested in discussing with you today. 
• This study has much more depth and breadth than I can give justice to here, and I encourage anyone interested in the multifamily market to read it. It leans a little more toward the dry side, but the data here is valuable. It’s not often where you see an outlook on the long-term prospects of the apartment market that’s backed up by the numbers like this and isn’t just broad speculation. It’s a little easier to read articles that just speculate without clear evidence, but reports like this one are rare.
• We’ve actually covered some longer-term outlooks for the apartment market with similar conclusions as this one, and then as now, I’m a little bit chastened by the picture they’re painting: Unless we see some dramatic changes, apartment demand and housing demand could decline over the next decade.
• This decline is due to “a confluence of factors at the national level,” the most apparent being slower population growth. The report cites the slowdown in population growth during the pandemic, but I think that this issue is bigger than what’s happened in the last 2 years.
  • That being said, population growth in 2021 was insanely low. It was at 1% in 2020, and it was at .1% in 2021.
  • That dropoff obscures a far more dramatic and meaningful decline in population growth since 1992. In that year, population growth was at 1.4%, but it has gone down steadily since then, sometimes bumping up a little, but consistently trending downward.
  • 2020’s 1% population growth was a huge spike UP from the previous years. From 2016 to 2019, population growth slowed consistently from .7% to .6%, .5%, and .45% before shooting up in 2020.
  • These tenths of a percent are a big deal for population growth. But also, just thinking that we could be at half the population growth that we had just a few years ago is a sobering thought.
  • Here’s a full quote with a little more detail on population growth and how household growth is supposed to grow more than the population: 
    • “From the end of 2021 through the end of 2035, the population should grow in total by 5.5%, but the household growth rate over that same period is 10.6%, as the household size declines. This is an annual compounded growth rate, in our base case, of 0.4% in population increase and 0.7% in household increases. Note that this is a slower pace than recent historical trends when population increased by 0.9% annually on average from 2000 to 2010 and by 0.6% from 2010 to 2020. Household growth stayed a little more stable over time as household size shrank, averaging 1.0% per year from 2000 to 2010 and 0.8% from 2010 to 2020.”
• Households and population growth may not be very strong, but the size of the housing supply crisis is very big.
• To backtrack a little bit, they go through the possibility of an immigration and renter environment that would be more beneficial for the apartment industry. The baseline amount of new units needed, they predict, is 266,000 per year through 2035. In their high-apartment-demand scenario, with more renters and more immigration in the United States, we could need 344,000 units per year. The low-end scenario would call for 175,000 new units per need.
• Okay, so those are the estimates, but then they account for the current deficit in housing, as evidenced by the currently very high levels of housing demand and very low vacancies.
  • With this in mind: an additional inventory of 447,000 to 747,000 units or an average of approximately 600,000 units would be needed to return the market to vacancy levels that allow a more frictionless transaction market with more moderate rental rate increases.
  • So, tack on an extra 50-100,000 new units needed to bring demand back to normal.
• I’ve been thinking a whole lot about population growth, and as incredibly huge as that is, the housing supply issues could very well be just as big right now.

NAHB: “Buyers’ Expectations of Housing Availability Improve” – https://eyeonhousing.org/2022/08/buyers-expectations-of-housing-availability-improve/

• “For the first time since 2020, prospective buyers expect housing availability to improve”
• Is it getting easier to buy a house? “[T]he share expecting the home search to get easier in the months ahead grew from 17% to 22% between the first and second quarters of 2022.”
• This data comes from a survey of “prospective home buyers’ perceptions,” and the consistent perception here is pessimism. Even in the pre-pandemic year of 2018 people were thinking that it was getting harder to buy a home.
• Perceptions, however, are not as concretely meaningful as actual behavior, but the trends associated with homebuyers’ expectations are interesting and perhaps more valid than the absolute number: I mean, at least 60% of homebuyers are pessimistic that homebuying will be harder in the coming months, but if that perception were reality, I think we’d see a lot more people that give up on homebuying altogether. We’ve seen a small amount of that, but not in any amount commensurate with their reported perceptions here.
• But again, the trends are interesting. If you kindof zero-out that baseline of pessimism, then that 5% increase in positive feelings about the homebuying market is more meaningful. Equally interesting is the comparison between different regions in America and their attitudes toward the home buying market.
  • For the Northeast, the South, and the West, positive attitudes spiked in Q1 2021, sank after that high point, and have trended upward in the past quarter.
  • The Midwest is a clear outlier here. Homebuyers here are consistently pessimistic. Their positive feelings about buying a home went down slightly as the other 3 regions went up in Q1 2021, and instead of going up this past quarter, Midwestern home buyers are more pessimistic about buying a home.
• It’s hard to pin down a feeling, but you could argue that a tighter housing market in the Midwest could be the reason that people are not expecting housing availability to improve. Could this also mean that people in the Midwest are more likely to spend more on a home because they don’t want to be caught in a worse situation?

RealPage: “How Will Declining Consumer Sentiment Impact Rental Housing?” – https://www.realpage.com/analytics/will-declining-consumer-sentiment-impact-rental-housing/

• This captures a lot of my feelings about feelings, my sentiments about consumer sentiments: They’re a little bit confusing, but they make some sense.
• People are worried about high prices, but they are still spending. At first, you’d think, “well if you’re worried about high prices, then why are you still spending?” but that’s not a paradox. That’s more like how inflation works: You’re scared that prices are going to be even higher, so you, reluctantly, shell out money now. 
• “We’re seeing some dire outlooks circulated, but our baseline view remains that rents grow materially (though below recent peaks) even as demand moderates – in line with our outlook going into 2022. History tells us that rent growth remains elevated during periods of inflation – which occurred in the 1970s and early 1980s, even amidst three separate periods of economic contraction.”