A Student of the Real Estate Game

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A ‘Golden Era’ for Apartments?

Feb 7, 2021 | Market News, Multifamily

My recent post, things don’t stay good forever, was intended to serve as a reminder that even when things are good, fundamentals matter. It was not a bearish take on multifamily. In fact, I’m as bullish multifamily real estate today as I’ve ever been. 

Dr. Peter Linneman recently joined Willy Walker to chat about the economy and real estate market. When Dr. Linneman talks, people listen. So when he claimed the next decade is going to be a ‘golden era’ for apartments, the industry took notice.

His thesis is straightforward; in a world starved for yield and awash with money, asset classes such as multifamily which generate consistent cash flow will be in high demand. This will result in asset inflation (compressing cap rates) and strong performance for the sector.  

His logic is sound and I’m witnessing firsthand the run up in multifamily asset pricing. Many light value-add deals across the Southeast we’ve underwritten recently are trading close to replacement cost and newly built properties are trading above replacement cost.  

The most challenging aspect of the market today is that real estate is not cheap by historic standards. The bullish view is driven by the anticipation that multifamily real estate is going to get even more expensive in the future. If cap rates compress, you can stabilize at a lower unlevered yield on cost. Instead of targeting a 7%+ YOC for value-add deals, the target may be 6% or 6.5%. Instead of developing to a 6.5% YOC, you may build to a 5.75%.  

Cap rate compression is one element of investment performance, the other is increasing revenue, NOI, and cash flow. While fundamentals have been challenged over the past 12 months, rents have come roaring back, and fundamentals are quickly improving. Here are some of the fundamentals that will drive multifamily performance:

  • Economists predict a return to full employment by 2023 and for the unemployment rate to drop to 5.5% – 6% by the end of 2021.
  • Consumer confidence is up and retail spending is at record high levels.
  • The Biden Administration’s push for a $15 minimum wage will fuel overall wage growth.
  • More economic stimulus will be directed towards the innocent victims of the government shutdowns and sectors most hard hit by the pandemic.
  • Additional household formation. Today, 34% of young adults (24.9 million) live with their parents. This is 5.1 million above the long-term average. Stimulus, a high savings rate, and growing job market will lead to household formation.

This isn’t to say that multifamily investing isn’t without risks. Compressing cap rates, however, can overshadow a lot of mistakes.

What’s your view on multifamily investing today?