Notes: Gray Report Newsletter, June 15 2022

Every week, The Gray Report publishes a video and podcast that covers the latest news, research, and reports from the multifamily industry, commercial real estate markets, and the economy. Below are some of the notes used in the production of this show. These notes may be rougher and more conversational compared to other blog posts and publications from Gray Capital, but they provide additional insight into our ongoing discussion of the most important news and research for apartment investors.

Reason: Does Affordable Housing Make the Surrounding Neighborhood Less Affordable?

• Urban Institute Study Cited in the Article
• Reason is a libertarian magazine that covers a number of political, social, and economic topics through the lens of this smaller-government, more-individual-rights perspective. It’s a magazine that you know what you’re getting. It doesn’t pretend that it’s presenting the unbiased and objectively correct opinion. It wears its influences on its sleeve, and I love it for that.
• A blow to the NIMBYs out there worried about home prices plummeting when affordable housing is built in the area. And this NIMBY-motivated claim, I think, is used even against market rate apartments. This study only covers affordable housing, but I think the results at least imply that denser, multifamily housing in general may not lower homeowners property values much, if at all.
• Worth noting is that the study that this Reason article covers, the study was limited to the city of Alexandria, Virginia, but still, there’s some very interesting conclusions here.
• When affordable housing went up in a neighborhood with households below median income level, home prices increased by 0.17%. For areas above the median income, home prices went up by 0.06%.
  • These are, well, one or two thousandths of the price of a home, but the fact that prices did not go down is powerful enough on its own.
• I’m glad Reason also brought up the kind of conflicting aims here between affordable housing and rising home prices. If your goal is for individuals to be able to pay for housing, you don’t want your affordable housing to make other housing un-affordable.
• Reason adds that “Those with incomes too high to qualify for the affordable housing units are left paying higher prices to live in the same neighborhood.” The Reason article has a pretty compelling explanation for this that is left out of the study from the Urban Institute:
  • “One possible explanation for why affordable housing projects would increase home prices in the first place: They consume land that could have been used for totally market-rate projects.
  • Those new market-rate units would both increase supply and absorb demand from higher-income renters or homebuyers. Because an affordable housing development’s income restrictions end up excluding them, those higher-income renters and buyers instead bid up the prices of nearby homes.
  • That could plausibly explain why affordable housing developments raised prices even more when market-rate developments with set-aside affordable units were excluded from the Urban Institute’s analysis. The presence of the market-rate units in those projects absorbed the market-rate demand, thus suppressing adjacent property value increases.”
• Now, the Urban Institute study explains the property value increases as the effect of “high design requirements for these projects [that] make the buildings desirable, aesthetically-pleasing neighborhood features.” In the words of one of the study’s authors “It increases the amenity effect. People like living next to nice things.”
• The Reason author, Christian Britschgi, also expands on the costs of the redistributive aims of affordable housing:
  • The income-restricted affordable units give some lower-income people housing in desirable neighborhoods at below-market rates. But by limiting the supply of land that could go to market-rate projects, they are raising housing costs for middle- and higher-income residents.
  • Depending on where they’re built, they could be raising housing costs for lower-income residents as well who don’t end up winning places in the new building. As mentioned, the Urban Institute brief notes that Alexandria’s affordable housing developments raised home prices the most in lower-income census tracts.
  • That’s a trade-off to keep in mind as lawmakers at the state and federal levels consider increasing subsidies for affordable housing construction.
• Unintended consequences as a result of government policy? Does that really happen?

NAHB/NMHC: Regulations Account for Over 40% of the Cost of Multifamily Development

• 40.6 percent to be exact!
• That is… a lot. And when it comes to regulations, there are a lot, and they can differ depending on your location, municipality, jurisdiction, etc.
• Another important thing to note: Some of these regulations are important and help ensure the safety of a building and the surrounding area.
  • I would hate to live next to an apartment building that didn’t need to follow drainage regulations, for example.
• So, when it comes to the effect of regulations as a whole, this study breaks down that 40.6% on construction costs.
  • 3.2% = Cost of applying for zoning approval
  • 8.5% = Costs when site work begins (fees required, studies, etc.)
    • What is “etc.”? That sounds important. Is “etc.” roofs that don’t leak? I would like to know if that includes the cost of roofs that don’t leak!
  • 5.4% = Development requirements (layout, mats, etc.) beyond the ordinary.
  • 2.4% = Cost of land dedicated to the govt. or left unbuilt
  • 4.4% = Fees charged when building construction is authorized
  • 2.7% = Costs of affordability mandates
  • 11.1% = Changes to building codes over the past 10 years
  • 2.6% = Complying with OSHA/other labor regulations
  • 0.5% = Pure cost of delay (if regulation imposed no other cost)
• Yes, some regulations are helpful, but many regulations are not helpful. Additionally, what this breakdown reveals, is that the WAY that regulations operate is not helpful either, the fees involved, the studies required, and the changes in regulations make it more costly for developers.
• I think that the most salient point in this study is that “some of these regulatory mandates can discourage developers from building in the very marketplaces that have the greatest need for more housing.”
  • 47.9% of developers avoid jurisdictions with inclusionary zoning
  • 87.5% of developers avoid places with rent control
• One brief digression in this study is particularly relevant for our discussion today, even though it did not fit the subject of government regulation: 
  • “NIMBY opposition to multifamily development adds an average of 5.6 percent to total development costs and delays the delivery of new housing by an average of 7.4 months.”
  • They nominally separate NIMBY opposition from government regulations, but I can think of many regulations that are very much dictated by the sentiment of a neighborhood
• There is a similar breakdown in costs on page five of the report, and they do a pretty good job of showing how widespread an impact certain regulations have.
  • For instance, they separate out the effects of the cost of land dedicated to the government and the cost of affordability mandates because not all places have those regulations.
  • Additionally, they note the prevalence of other regulations like zoning approval:  “93.9 percent of the respondents indicat[ed] that they must dedicate resources to rezone the land to allow multifamily construction”
• I am particularly curious about the section on costs when site work begins, which has an 8.5% impact on the cost of development.
  • They include fees here along with studies, and I am curious where the lines are drawn here, or if this distinction is worth making.
• Some of the fees, I imagine, are to pay for paperwork costs that were created by the regulations themselves.
• Out of this list, I can pull out the 3.2% cost for zoning approval, the 4.4% cost for fees when construction is authorized, and the 11.1% cost of building code changes as a particularly pernicious group.
  • Now, it is almost a cliche to describe those instances of corruption in which a policymaker is influenced by a 3rd party and crafts a regulation that ultimately benefits that 3rd party. Oh? You have to buy energy efficient windows from this one specific company, and it just so happens that it’s a company that loves to take policymakers out for nice steak dinners?—I know it’s not always steak dinners and window regulations, but you get the idea.
  • Now this may be hard to believe, but a lot of regulations are created by well-meaning policymakers with specific safety or other issues in mind.
  • My cynicism about regulations in general isn’t because they might come from a corrupt official or they come from policymakers who are too focused on safety issues at the expense of practicality.
  • I think there’s a natural tendency toward bureaucratic expansion that’s in play here.
    • Let’s say there’s a guy who writes regulations. He wrote some really great ones last year. That’s his job, writing regulations. Is he going to just stop writing regulations all of a sudden when he thinks there are too many? My guess is that he’s going to keep writing them; his job depends on it.
    • There is a large group of people whose jobs are tied into the regulatory regime, and they are going to do what they can to make sure that they still have a job and that they still have work to do. They may not get any kickbacks from fatcats, but they are not going to deregulate themselves out of their jobs.

Moody’s Analytics: Entering the Danger Zone: The Outlook for CRE and Housing

• The language of “the Danger Zone” is concerning, but any worries about the multifamily market are eliminated right in the first part of their executive summary.
  • Multifamily (and industrial) rents and vacancies are not too far off the very positive trends of 2021 and are still “posting impressive results”
  • Continuing the summary, tightening monetary policy has increased risk somewhat, and cap rates are projected to increase “for the remainder of  2022 through 2023.”
  • Finally, they show some clear skepticism that there is a housing bubble that will burst, even though higher mortgage rates have begun to impact home prices.
• Moody’s, in their assessment of CRE conditions, notes “The Seemingly Endless Ocean of Optimism for Multifamily and Industrial.”
  • For once, there is not mention of “inevitable cooling” in rent growth, but numbers speak for themselves: at 2.5% rent growth for Q1 2022, we’re looking at a really great year for multifamily.

Redfin: May 2022 Rent Report

• I included this report because it shows an upswing in year-over-year rent growth. Rents are jerking upward for May!
• The peak, for this study, was in March, when year-over-year rent growth was at 17%. Then it went down in April but has remained stable or slightly higher in May. The words in the report say that April’s rent growth was the same as May’s but the chart of rent growth shows a very clear upward trend. 
  • How much of a trend? What does this chart really say? Frustratingly, Redfin does not give us exact numbers here, but with this chart in hand, I think I might be able to help.
  • First, I looked at last month’s rent report and found out that they actually had more specific numbers than this month. In March, rent growth was at 16.7 and in April it was 15.1%. So now we know that rent growth is more than 15.1% in May, but HOW much Spencer, HOW MUCH?
  • To answer this question, I needed a protractor. I also needed to figure out how I was going to use it.
    • LOOK: The 1.6% decrease from March to April measured out to a -53 degrees on the protractor.
    • ALSO LOOK: The positive angle from April to May measured out to 9 full degrees. 9 degrees!
    • 1.6 divided by 53 = 0.0302. So every one degree difference in this chart is equivalent to 0.0302% difference in year-over-year rent growth.
    • So, if you multiply that by nine, those nine full degrees, we get 0.2718 percent difference.
    • Well, I just found out that they did list the specific rent growth number for May and I skimmed over it, rendering this entire exercise pointless.
• The potential reason for this uptick in rent growth, according to the report’s author Tim Ellis, is the rising mortgage rates driving people to rent rather than buy, which we’ve explained more than a few times on the Gray Report, and another reason is due to shifts in household formation such that more individuals are choosing to live alone. This second point is something that we’ve covered recently as it relates to Gen Z renting preferences, but it has not received as much attention as the connection between higher mortgage rates and people choosing to rent rather than buy a home. That being said, there is likely more hard data that’s been gathered about household formation trends (seen in this May publication from the Federal Reserve last month) than there is about the shift in homebuying and renting attitudes in 2022.
• Just to finish out the report, their information on specific markets has Austin, TX at the top at, oh dang, 48% year-over-year rent growth. The 3-way tie for second place includes Nashville, TN; Seattle, WA; and a notable Midwestern breakout, Cincinnati, OH all posting 32% rent growth year-over-year last month. Great job, Cincinnati!

RealPage: The Secret of Good Multifamily Forecasts? Don’t Do These 10 Things.

• Use the same model for Austin, TX as you do for Chicago, IL.
  • Clearly true. No problem with this one.
• Overweight the impact of new supply coming into the market.
  • Yes, but don’t ignore it. This could go either way. It’s pretty dang important to pay attention to supply. I mean, supply, demand, that’s all we’ve got!
• Assume that a strong single family home sales mean that there’s going to be weak demand for rental housing.
  • Super true. I like this one.
• Don’t account for the specific income range of the area you’re forecasting.
  • I think this actually gets at a good principle that they don’t include in this list: Whether it’s income stats or rent growth, try to drill down on the specific location, the specific sub-market or neighborhood where you’re looking.
  • The rule is still a good one: You want to find the income levels that match the kind of apartment you are interested in investing in. A fancy apartment may not seem like a great move in a lower income area, and workforce housing may not be the best fit in a high-income sub-market. …but maybe you can renovate that workforce housing to appeal to the broader makeup of the area? JUST A THOUGHT!
• Trust your model implicitly without considering anything else.
  • I agree with this one, and I’ll also add that motivated reasoning belongs here too. You don’t want to tweak your model just because you have a hunch. Be open to new information, and don’t take it personally if your model is making you sad or if you think that maybe your model is missing something.
• Never change your model.
  • Having been through the past two years, I really hope that this isn’t a problem. BUT, this is WAY trickier to pull off than one might think.
• Use creative metrics like “jobs per unit of demand” instead of absorption
  • I’m not 100% clear on the point for this one. I think that job growth is an important metric to follow when projecting housing demand. I wouldn’t place all the weight of a model on job growth, but matching it should definitely be a factor.
• Needless appeal to the reversion to the mean.
  • Yeah I agree and I can’t put it any better than the author “PICK A SIDE.” That’s what forecasts are for, trying to uncover insights about the future that you can exploit in your investments.
• Limiting possibilities based on time or assumptions
  • This doesn’t seem wrong but it does seem a little vague.
• Never learn from your mistakes.
  • This may be vague, but it hits hard. It’s incredibly difficult to take your ego out of the equation when you’ve worked so hard on your analysis. I think here is where having a team is really invaluable. Whether you’re buying a duplex or a 300-unit apartment tower, working with other people and testing your ideas against someone with another perspective is going to help you. You may not agree with them, but they could see something that you don’t.

Marcus & Millichap: Are We in a Housing Bubble?

• I don’t think we’re in a bubble either, John Chang. We don’t have enough homes, and there is pent-up demand.
• I do like the graphs of months of available supply and apartment vacancy at 1:58, especially the months of available supply graph. You can see how the norm before the pandemic was 4 or 5 months of available supply, and then by 2021 the norm is around 2 months of available supply.
• A previous graph at 1:39 showed single family and multifamily completions alongside household growth, and here the great financial crisis is the clear inflection point. After a low point in 2011, as completions and household formation rose through that whole decade, we have built increasingly more multifamily properties as a share of all housing units built in this country. I’d love to know an explanation for this trend that’s backed up by data. I can speculate on declining homebuying habits, affordability, and homebuilder incentives, but I’d love to know the real information behind these trends.
• Home buyers are balking at mortgage rates for a very good reason: They are higher than they’ve been in 6+ years as you can see in the graph at 3:34
• The most compelling graph here though for multifamily professionals and investors is at 3:59 and shows the expanding—rapidly expanding—gap between rent and home payments. I think that curtailed home sales and damped enthusiasm in the market will bring down home price growth slightly, but rents growth should stay strong if this gap persists.