by Brandon Michaels and Chris Adnams
· A recent Yardi Matrix report evidenced a direct correlation between increased employment growth and higher multifamily rent growth from April 2021 to March 2022.
· As employment growth softens, major metros across the US are experiencing weakening rent growth with some even turning negative, per CoStar Analytics.
· As a result, TREPP data shows that special servicing rates for multifamily assets are up to 2.97% from 1.29% a year ago.
· Hiring and quitting rates over the past year and a half have shown a negative trend, a sign that the job market continues to weaken, potentially creating more troubles ahead for the multifamily rental market.
· $8 billion of multifamily loans are set to mature this fall, creating significant concern for this asset class in the wake of softening rents and changes to the job market
As debt conditions tighten, landlords holding assets with floating rate debt or debt coming due may begin to question whether the fundamentals of their properties can withstand the rising debt service requirements. Most experts initially felt the changing debt markets would impact the office sector only, however, new data from Costar shows multifamily rents softening across many major metros with some even starting to decline. While this rent softening comes after a period of incredible rent growth, why has rent growth started to decrease, and will it continue to diminish moving forward?
What’s Driving Demand?
A recent report delivered by Yardi Matrix detailed several drivers to multifamily rent growth. Not the least of which was the impact of job availability and employment growth on the demand for housing across a multitude of primary, secondary, and tertiary markets. In Yardi’s report, employment growth in the first quarter of 2021 was directly correlated with lagging but historically outsized rental growth. In the Los Angeles metro, the Bureau of Labor Statistics report in April of 2021 showed a 10.3% boost in jobs compared to the year earlier. By the first quarter of 2022, just one year later, the metro enjoyed a more than 7% annual increase in rents, according to CoStar Analytics. This effect is even more pronounced in metros with higher job growth. The Miami area saw a 17.73% year-over-year increase in rents after experiencing a more than 18% annual employment growth from a year previous.
Lacking Employment Growth Hurting Rents
This ramp up in employment has petered out, however. While employment is still historically robust, as evidenced by the national unemployment rate, recent data has shown signs of weakness. A report across a variety of markets for May of 2023 showed at best, low single digit percentage increases in employment growth (Washington DC, Seattle, and New York) with some markets in the survey even showing negative growth (Chicago, Los Angeles, and San Francisco). In the same way that outsized employment growth returned outsized rent growth; the opposite effect is also true. US markets across the board have seen significant softening in rent growth as employment growth converges on zero percent. In the Seattle and San Francisco metros, rent growth in the second quarter of 2023 has been at -0.84%. Excluding the period for COVID-19 shutdown, this was the first negative rent growth following the recovery of the 2008 Great Recession. The Miami and Los Angeles metros are not far behind with annual rent growths down to 1.01% and 0.85%, respectively.
Softening Rents vs Rising Rates
Currently, the effects of the rent growth slowdown are minimal. Rents are still above their pre-pandemic averages, however, coupled with the effects of rising interest rates, the softening may prove to be detrimental. In the TREPP Special Servicing Report for June, a report detailing the percentage of CMBS loans transferred to special servicing due to a variety of loan payment challenges, the multifamily special servicing rate stood at 2.97%. While this figure is low relative to other asset classes included in the report, the rate is up from 2.33% six months ago and 1.29% a year earlier.
In a new release from publication The Real Deal, Tides Equities, a prolific purchaser of multifamily assets throughout the Sunbelt states during 2021 and 2022, conveyed challenges meeting their debt service in the face of rising interest rates without further rent growth to support the expense. They reported that roughly 20% of their portfolio could need a cash injection and nine of their multifamily properties have debt service coverage ratios below 1.0.
The United States is in a period of historically low unemployment. Currently, the unemployment rate is 3.6%, but it’s showing signs of letting up. The hiring rate has reduced from its high of 4.6% in November of 2021 to 3.9% as of May 2023, showing that employers are less eager to take on new employees. Furthermore, the quitting rate over the same period reduced from 3.0% to 2.4%, a sign that employees are less confident in their ability to promptly find a new job.
As the employment situation continues to soften, the effect on renters’ ability to pay higher and higher rents will be degraded. With these headwinds ahead for multifamily owners, many will likely face the same debt and cash flow challenges that those in the office sector face. With over $8 billion of loan maturities set to come due this fall, the cost of higher debt coupled with changes in the job markets and the rental landscape could prove problematic for the multifamily market.