Multifamily Highlights, 9/30/2022: Housing Problems and Multifamily Solutions for Q4 2022

Apartment rents are trending toward a seasonal slowdown in line with pre-pandemic trends, and while home values are falling, housing affordability remains a problem. Despite these headwinds, the multifamily market is on solid footing, supported by consistent high demand, and in the context of the volatility and uncertainty in the broader economy, the historic stability of apartment assets and the longer hold period for these investments continue to draw attention from investors looking for an attractive risk-return profile in the current economic environment.

The New York Times: “Inflation Has Hit Tenants Hard. What About Their Landlords?” – https://www.nytimes.com/2022/09/27/business/economy/landlords-rent-inflation.html

• The subtitle re-frames this issue as one in which larger corporate owners are profiting but smaller ones are not.
  • One of the “smaller” landlords “manages 6,000 apartments in the Houston area.”
  • Firstly, 6,000 is a pretty decent number, and secondly, I looked up the company, and the vast majority of these apartments are in the Houston area, which may or may not be representative of the whole of America.
• My initial question is, what are these larger landlords doing that the smaller landlords do not or cannot do?
  • The article provides more anecdotal evidence than hard data, but it does speculate on some of these things:
  • “Rising expenses have weighed more heavily on their bottom lines.” which is a little bit vague
  • They also gesture towards the idea that “the business of acquiring, renovating and building apartments” may be more attractive to smaller, “midsize landlords” than larger ones, and in this inflationary and high-interest environment, these value-add projects won’t be as profitable due to labor and materials costs
  • Deferred maintenance and putting off nonessential repairs was also speculated as a cause for smaller operators’ lack of success
  • And more pointedly than the above reasons, “[m]ore recently, smaller landlords have been asking for lower-than-market-rent increases.”
    • The little testimonial from the company managing 6,000 units described a situation where the company tried to raise rents but people left in droves. What if that company is using a rent management software and the software told them to do the wrong thing?
    • I do wonder how much of this could be related to the market of Houston, but it’s not hard to imagine a situation where you are hemmed in by comparable properties with competitive rents, even though you’ve just sunk in some money improving the property.
•  The comment section cites inflation outpacing wages as well as rising taxes, some wholly expected diatribes against horrible landlords, a tragically-uncited claim that rents have risen faster than wages for the past 40 years (which should be a conversation associated with affordable housing, but I digress), some people who don’t like housing as a commodity, some thoughts about how stocks have taken a hit too as well, and that’s a fairly representative sample of the comments
• I’ll be honest, I love reading the comments. I never comment, but I sure do love wading into the comments. It’s like a turgid swamp, teeming with life! Sometimes there’s just the same opinions that you expect, sometimes you’ll have an outlier opinion arguing with whatever the mainstream opinion is, and everytime… every time you’ll come away with a feeling that there’s just no convincing some people, and that’s okay. The important thing is that you should never write in the comments section if you’re trying to convince anyone else other than yourself.

The Manhattan Institute: “How to Fight Housing Price InflationPolicy Menus for Stopping Government-Induced Housing Woes from Spreading Beyond the Coasts” – https://www.manhattan-institute.org/how-to-fight-housing-price-inflation

• How to solve all of these problems listed in the NYT article? The Manhattan Institute has a forcefully pointed answer. Very pointed. This article is pointy. Direct.
• The article starts out with information about the housing crisis in general, and in this case the housing crisis refers to the lack of affordable housing.
  • Just to take a step back here. We’re still getting articles on how housing is too expensive and how we don’t have enough of it.
  • For people dialed into every movement of the housing market, right now seems like an anxious time as single-family home values are slowly decreasing while mortgage payments for new homebuyers are steadily high due to increasing mortgage rates.
  • The size of the housing affordability crisis is larger than the short or medium-term movements we’ve seen in the past few months or years or expect in the future.
  • At the very least, it is going to be incredibly difficult to shift the perception of high home prices. 
    • You mentioned this last episode, but it’s worth repeating: People that want to sell their homes are holding on to them instead of selling them at a lower price. Sellers think that if they wait, the price will go up. In a world of declining housing sentiment, that counts as hope.
    • If we get to a place where sellers think that if they wait, the price will go down, then that’s a stronger signal that this housing price correction has some staying power.
    • Right now, though, we’ve got people waiting for higher prices to come back. If home listings start to tick up and sellers scramble into the market thinking, “well, I’d better sell today before the price goes down tomorrow,” that’s bad. That’s the bad scenario.
• So yeah, the Manhattan Institute lays out the problems and lack of housing supply, high housing prices, and trends in which housing costs are growing faster than wages.
• I wasn’t too far into the article when I noticed that, hey, this article has a point. It’s one of those articles that’s making a point!
  • Right after they lay out the housing crisis problem in its many facets, they point to five different kinds of “artificial” restrictions to housing growth. And when they point to these five points, they use bullet points. Because naturally.
    • Bans on housing types through zoning or preservation regulations
    • Mandates on lot size, density, parking, design, and more
    • Discretionary review, which empowers politicians and bureaucrats to dictate terms on specific projects
    • Urban growth boundaries, which aim at killing suburbs
    • Building codes, which set standards for construction 
  • Building codes is probably the most commonly-encountered hindrance to new development if I had to guess, mostly because I bet that developers know that if they have to deal with any of these other issues, they’re going to try to build somewhere else. And I don’t think that building codes in themselves are a problem as much as the constant change in building codes. I said this in an earlier episode of the Gray Report, I don’t want someone to be able to build a new building that messes up the water table and floods my basement, and I’m guessing that there are regulations in place to prevent that from happening. Likewise, I think that a lot of housing regulations make it safe for renters to live somewhere without having to inspect every square inch of the property and its history to ensure that it’s structurally sound. But at the same time, there’s some well-meaning changes to building codes that are put in place every year, and as well-intentioned as they are, a lot of builders do not like them.
  • The authors of the article group the first three things—bans on housing types, mandates on lot size and density, and discretionary review—as zoning-related issues, writing that “[z]oning is the most consistent—and, arguably, greatest—barrier to Americans’ housing freedom.”
    • What a great point there! I give this article one more point for using the words “housing freedom,” which is a phrase I have not yet encountered in discussions of the housing affordability crisis.
    • More seriously, though, the inconsistency of these zoning rules is certainly frustrating.
      • Now, to be fair, I can see this inconsistency as a product of local government decisions. Maybe a city in the North has regulations about snow removal that are unnecessary in the Southwest.
      • But just as likely is that some of these zoning regulations are not as much tied to local geography as much as NIMBY-ism and resistance to change.
      • The idea of discretionary review is what makes me tense up and clench my teeth.
        • It’s not even the cases of clear corruption that I’m thinking about here, like if a local authority approves his business partner’s lousy development and rejects obviously better ideas.
        • What I’m thinking of is a well-meaning review board rejects a modest but very sound and workable development plan in the interest of, you name it, safety, the character of the neighborhood, aesthetic appeal, traffic, etc.
        • Then, a week or a month later, the board meets to review a far more elaborate plan that is almost insulting in how it goes against this review board’s values. So the board rejects it. But the company involved in the more elaborate plan has the money and the patience to keep coming back to the review board, to keep arguing its case, and to hire a team of experts to make their case. Ultimately, the review board is worn down, and the community is dramatically changed.
        • Again, these are well-meaning people, but an over-reliance on discretionary review could lead to these situations where it’s actually the little guy who gets the short shrift, when I’m sure the intent is to protect the little guy.
• Here’s a little cleanser quote from the article: “The aim for reform is for communities to have the freedom to flourish, for states to keep their promise of opportunity for hardworking families, and for property owners to have the right to live where and how they’d like.”
  • I am going to find a snippet of fife and drum music, and I’m going to edit that into the background of that quote.
  • This article is a little bit strange because they have moments like these where it sounds like a portion of a political stump speech, but then there actually is like, a breakdown of specific ideas that you can sink your teeth into better than the airy language about the “promise of opportunity for hardworking families.”
  • Why is always the hardworking families that people are trying to help? I’ll come out and say it: I like hardworking families, I like regular working families, and I even like lazy families.
• But yes, they do get to the point, and they’ve got some clear solutions, broken down into three groups or “policy menus” as they call them, one is Restoring property rights, the second is Making housing pay off, and the third is Streamlining local government. I won’t judge them as a whole, but there are a lot of ideas here that make a whole lot of sense.
• Starting with restoring property rights, their idea of a homeowner’s bill of rights is solid. It’s not like it totally abandons the interests of the government or community either. I could be missing some huge opportunity for exploitation in this homeowner’s bill of rights, but it is at least a positive example of a consistent set of rules as opposed to a less-predictable discretionary review
• Another interesting idea that I both love and could see going terribly wrong is a permit shot clock, where the government has 60 days to approve or deny a permit or else it is automatically approved.
  • Government delays and backlogs are not so easily conjured away by deadlines, so this might not work so well.
• Some of their ideas about zoning are very interesting, but it’s easy for me to see how a community would be opposed to some of these deregulatory moves like removing parking requirements.
• But if some of these neighborhoods get tax breaks, or “housing dividend[s]” as this article calls it, when new housing comes into the area, that could balance these interests at least a little bit.
• I need to stop with this article for now, but suffice to say, there is so, so much more here for people to chew on. This article comes from a right-leaning think tank, but their ideas should be interesting to lefties and righties. You may not agree with all or any of them, but they’ll surely set you thinking about the compromises, common grounds, and balance of interests between those who want to create new homes and local governments and neighborhood authorities acting in the interest of existing homeowners.

The Federal Reserve Bank of San Francisco: “Remote Work and Housing Demand” – https://www.frbsf.org/economic-research/publications/economic-letter/2022/september/remote-work-and-housing-demand/

• This is a significant piece of research. It’s not like, overwhelming my Google News feed, but it has been cited in a couple of the more interesting articles I read this week.
• Look, we all guessed at this, but until someone actually does the work with empirical data, it’s speculation.
• The San Francisco Fed crunched the numbers, and guess what, remote work increases housing demand.
• The real stakes of this conclusion lie in the fact that remote work has not by any means gone away and is not expected to do so, which would suggest that whatever effect remote work has on housing demand is also going to continue.
• “After adjusting for the role of migration, our estimates show that 1 percentage point more remote work causes house prices to increase by about 0.9 percentage point.” That’s not nothing!
• In their conclusion, they see remote work as tied to a full 15% increase in home price growth. Also, to repeat, it’s not really going away.

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

• Rent growth is down 0.2% month-over-month on average, up 7.6% year-over-year, and up 6.8% since the beginning of the year. This is the first time that Apartment List has recorded a monthly drop in rents since December of last year.
• In September of 2021, rents were still flying high at nearly 2% MoM, which shrunk to under 1% by October, nearly zero growth in November, and around -0.2% that December.
• Rather than September of 2021, this month looks more like September of 2018, closer to a pre-pandemic norm.
• Agh. Okay, even without looking at the current economic situation with inflation and interest rates driving down housing prices, it wouldn’t be a bad prediction to say that every action has an equal and opposite reaction, we saw a mountain of rent growth in 2021, and we could see a valley coming up this winter.
  • I do not think Newton’s 3rd Law applies here completely because housing demand is more powerful than physics at this point, but I would be a little inclined to factor in this balancing and correction when looking at rent performance in the coming months.
• Rents are going to flatten out these next few months if they haven’t already, and they could go down slightly month-over-month. But, if the trend line holds, we could still be at 5.3% rent growth by the end of the year, which is well above the pre-pandemic rent growth of 3.5% .

Berkadia: “Class-A Performance” – https://base.berkadia.com/wp-content/uploads/2022/09/Berkadia-Class-A-Performance-September-2022.pdf

• Class-A apartments have outperformed B and C-class apartments, with the report’s authors arguing that remote work and higher mortgage rates are driving would-be homebuyers into Class-A apartments specifically. I’ll need a study on that to make sure that speculation has legs, but I think that this is just as likely a product of the varied employment and economic success of renters at different income levels.
• We see this mentioned in places like the New York Times and other mainstream takes on the housing market–the higher-income renters are doing fine and can support paying rent, but the lower-income renters are getting squeezed. 
  • An increase in food and gas prices is a bigger proportion of the budgets of lower-income renters vs. higher-income renters.
• What’s really interesting is that the Class-C and Class-B apartments have higher occupancy rates overall than Class-A, even though they’re lagging in rent growth. It’s hard not to see this as a hard limit to rent growth.
• The list of markets with the highest Class-A rent growth is actually a varied mix of popular markets along with some in the Midwest and some that you don’t see as much as others. It’s not like we’re seeing the poor performers suddenly on top here, but there could be some opportunities in some of these markets that are more under-the-radar than others.

RealPage (Jay Parsons): “Rental Market Tracker, August 2022” – https://www.linkedin.com/posts/jay-parsons-a7a6656_rentals-housing-sfr-activity-6980515869546217472-SWif?utm_source=share&utm_medium=member_desktop

• “Inflation, rising rates and plummeting consumer confidence appears to be having a freezing effect on demand for all types of housing. . . . To be clear: The market isn’t collapsing (vacancy is still below 5%), but it sure is softening. It’s not just normalization anymore.”
• Low traffic in the summer for new leases has led to a slowdown in demand that may be stronger in the higher-growth markets of last year, but the slowdown is happening throughout the country
• Quote: “Make no mistake: The Fed is having its intended impact — at least on rental demand and rents. Rental demand started hot in Q1, and has been waning since Q2 after the Fed’s first rate hike in the second half of March. Month-over-month rent increases have followed suit, coming in far below the record hikes seen in 2021. Anyone suggesting otherwise is looking at lagging data. Rents are no longer a major driver of inflation.”
  • Jay Parsons commented on this “lagging data” angle in a separate LinkedIN post, but it’s worth a little contextual information here: Essentially, the CPI measurement of inflation, which, for better or for worse, is the most prominent indicator of inflation that we have, is demonstrably like, one of the most lagging measurements of rent inflation out there.
  • This means that we probably will see rents as a driver of inflation AS MEASURED BY THE CPI, but Jay Parsons argues here that we’re past that now. The CPI is a snapshot of too far into the past, too far removed from the now-fully-moderated rents of today.