Every December, I make my top 20 predictions for multifamily real estate for the coming year. And last year was no different, except that I was making my 2024 predictions in a macroeconomic environment of lingering inflation, wage growth pressure and higher interest rates. The multifamily market sector was affected by all three with declining—and even negative—rent growth, increasing construction and operational costs, and tighter lending conditions.
We faced the new year with a lot of uncertainty. So mid-way through the year, I’m weighing in on my predictions, focusing on areas of the highest impact for multifamily investors. (I also hosted a webinar addressing this topic, which you can watch here.)
Prediction: Interest Rates Will Remain High
When I wrote my 2024 predictions late last year, the Federal Reserve had just announced a decision to hold the Fed Funds rate steady at 5.25% to 5.50%. The markets assumed that rate cuts were on the horizon, and the 10-year Treasury yield ended the year slightly below 4.0%. At the time I made my prediction, I was not joining what I considered premature euphoria about lower lending rates.
Well, nearly halfway through the year, the Fed has not made any of the roughly three rate cuts that were predicted for this year. It’s not expected to make one in June, either. I predicted that this year the Fed would not lower interest rates, leading to slow growth and, eventually, a recession. I expected the 10-year Treasury yield to remain within the 3.5%-to-4.5% range and that it would not drop substantially. So far, that’s generally been the case. I believe that multifamily real estate can do very well in a higher interest rate environment. The challenge has been the doubling of the risk-free rate in a very short period of time.
Fed Funds Effective Rate vs. Inflation Rate
Source: St. Louis Federal Reserve
April’s Consumer Price Index rate came in at 3.4% year over year—that was a bit benign, but the Producer Price Index for the same month wasn’t. I believe inflation will stay at around 3%, and that’s stickier than what the Fed wants. But the multifamily does just fine in a 4.5% interest rate environment. What we need is interest rates that don’t fluctuate so much. I believe we’ll experience a lower-volatility interest rate environment going forward.
Prediction: New Multifamily Development Will Come to a Standstill
As real estate lending shrinks with the rise in interest rates, the threat of default on expiring debt is increasing. New construction starts, declining for the past year and a half, have fallen sharply. In my 2024 prediction, I said it would be at least 12 to 18 months—until mid-year 2025—before new construction regains its footing.
This is playing out: According to economist Jay Parsons, U.S. multifamily completions are outpacing new starts at the widest level since 1975, and he doesn’t expect what he calls a meaningful acceleration before mid-2025, “and more likely in 2026.”
U.S. Multifamily Housing Starts Vs. Completions
Source: St. Louis Federal Reserve
This disparity is one of the many reasons that I believe multifamily fundamentals are strong going forward. We are working through a current glut of supply, but the reality is that for the rest of this decade, the housing shortage will be exacerbated. And renters in those years will encounter higher rents because of the imbalance—in particular, in our growth markets, which have continued to show extraordinary absorption.
Prediction: Elevated Valuations Have Mostly Corrected but Will Fall Lower
I predicted that multifamily market valuations would decline further, and they have. CoStar reported that its value-weighted index of multifamily property prices fell 1.0% month over month in March, the seventh decline in a row. While others in the industry have called a bottom, I’m not willing to declare that. I operate in terms of distributions.
But at this point, I think it’s more probable that values will go up, not down, from here, after peaking in 2022 and declining as the Fed began to increase interest rates. So, I believe that investors should be reallocating back to multifamily because the valuations are much more attractive than they were 12 or 18 months ago. Rent growth, in my opinion, will offset higher cap rates. I think demand remains for housing, partly because of the disparity in the cost to own versus the cost to rent.
U.S. Multifamily Quarterly Index (CCRSI)
Note: The CoStar Commercial Repeat-Sale Indices (CCRSI) measure commercial real estate prices in the U.S.
Source: CoStar Commercial Repeat Sale Indices
In terms of operations costs, I believe we’ve reached the bottom. The type of supply shocks that have increased our expense ratios in the past year and a half aren’t occurring now. That’s true even with insurance rates, which I don’t expect to decrease, but I don’t believe they will continue to increase at their previous rates.
Prediction: More Distressed Assets Will Emerge
I’ll address this prediction anecdotally. We haven’t done more distressed deals at this point because we’ve tended to see lower-quality assets in lower-quality locations that don’t meet our criteria for investment. I believe this distress cycle won’t last very long and will offer short-term opportunities. That’s because the distressed assets were purchased at too high of a price and leveraged with too much cheap variable-rate debt.
But we are starting to see higher-quality deals in the multifamily market. An example: Our Denver office has been in discussions with a group that developed a Class A asset, which is now in lease-up, in a good submarket of a big Western city. The situation has taken a turn, and they are looking for investment dollars. The property has been de-risked, and we’d be getting development-like returns without taking the development risk.
This is an example of what I’m deeming distress 2.0. During distress 1.0, in 2009, we were buying notes from banks and in certain instances those banks were failing. Back then, it wasn’t a distressed real estate situation. The entire economy was experiencing distress. That’s not the market we’re in now. If we do get the deal done, I believe it would be 20% below replacement cost, with flat to slightly positive leverage. That’s more like what distress 2.0 could look like.
Prediction: Multifamily Market Fundamentals Will Strengthen
Our Multilytics℠ Rent Forecast January 2024-January 2025, published late last year, predicted that we would reach the bottom in the rent-correction cycle after flattening and negative rent growth. We expect to start seeing rent increases in many of our markets in the latter half of the year. Then we expect further strengthening in 2025 and ’26. As I said earlier, the wave of multifamily supply caused by 2021’s low interest rate environment is here now. But so is demand.
It’s tough to pin down exactly what this long-term housing shortage will look like, and the environment that potential home buyers will face in coming years. As you can see, there is quite a disparity in the numbers.
Housing Inventory and Cost Comparison
While we could argue about who’s more correct—and I probably trust Freddie Mac the most—the point is that we are underhoused. And it’s only going to get worse.
The disparity between the cost to buy versus rent is extraordinary, but it shouldn’t be surprising. Rents flattened, but the cost to own a home keeps going up because of interest rates, insurance and property tax increases. This is one of the biggest reasons why I believe rental housing as an asset class is so sound, and that the multifamily market remains a solid long-term investment.
For more on this topic, please view the recent webinar, which also includes an informative Q&A period based on questions from viewers.
