As the interest rate outlook brightens, unique opportunities for outsized returns abound, Dr. Sam Chandan, Founding Director of the C.H. Chen Institute for Global Real Estate Finance at the NYU Stern School of Business and the Non-Executive Chairman of Chandan Economics, explains in this top-level overview of Arbor’s latest Special Report.
Continually challenged by low inventory, affordable housing sits at a crossroads following the 2024 election. Incoming leadership plans to introduce market-based principles to an agenda that may also include an expanded Housing Choice Voucher program. Arbor’s Affordable Housing Trends Report Winter 2024/2025, developed in partnership with Chandan Economics, provides insight into a pivotal multifamily sector about to embark in a new direction.
The skies surrounding commercial real estate markets are clearing, suggest the Emerging Trends in Real Estate 2025 (ETRE 2025) findings. As pandemic-related structural changes settle into place, cyclical economic trends, such as interest rates, demand, and construction levels, are now the key drivers to watch.
As more single-family rental (SFR) operators rely on build-to-rent (BTR) development to supply new inventory, construction starts have steadily risen, reaching another record high in the third quarter of 2024. SFR/BTR construction has eclipsed 92,000 units in the last four quarters — an all-time high and an annual increase of 31.4%.
As renters face a national shortage of 7 million low-income rental homes, the U.S. Department of Housing and Urban Development’s (HUD) Low-Income Housing Tax Credit (LIHTC) program is pivotal in helping to close the affordability gap for renters. It is the nation’s most significant resource for affordable apartment housing construction, which gives state and local agencies approximately $10 billion in annual budget authority to issue tax credits for affordable housing development.
The Federal Housing Finance Agency (FHFA) announced a $3 billion boost to Fannie Mae and Freddie Mac’s volume cap for loan purchases in 2025 to $146 billion ($73 billion for each agency). This increase in FHFA loan caps for 2025 aligns with industry expectations, given the anticipation of improving market conditions and lending activity expected in a lower interest rate environment. Next year’s cap for the Government-Sponsored Entities (GSEs) is an increase of approximately 4% from the $140 billion limit set for 2024.
The U.S. multifamily market held steady in a more normalized cycle through the first three quarters of 2024, following its skyrocketing recovery from the pandemic-related contraction. Rental demand remained strong, driven by the continued nationwide housing shortage and strong wage growth, while the high levels of new construction seen over the last two years appears to have peaked.
Small multifamily’s normalization pushed forward last quarter as the Federal Reserve made a long-awaited reduction to the target federal funds rate. Arbor’s Small Multifamily Investment Trends Report Q4 2024, developed in partnership with Chandan Economics, shows signs of stability have multiplied. Robust rental demand, a limited supply of quality affordable housing, and several other promising developments should support the subsector’s strength heading into 2025.
Q: What is the Arbor Small Multifamily Price Index (ASMPI)?
A: The ASMPI estimates the average price appreciation for small multifamily properties on a quarterly basis, by comparing small multifamily cap rates and small multifamily rents.
Q: What is an index?
A: • An index starts with an assigned base, then increases or decreases with the change in value. In the case of the ASMPI, a base value of 100.0 is assigned to Q1 2000.
• For example, if the ASMPI stood at 100, then increased 5.0% during the quarter, the new value would be 105. Likewise, if the index decreased 5.0%, the new value would be 95.
• Other frequently used indices in the real estate industry include the S&P CoreLogic Case-Shiller Home Price Index and the Consumer Price Index.
Q: What is the purpose of the ASMPI?
A: • Given the lack of affordable rental housing supply to meet the robust demand, the index’s quarterly data provides insights on potential investment opportunities in the property sector.
• The index fills an important need in the marketplace for quarterly data analytics focused on small multifamily properties.
Q: How is the ASMPI calculated?
A: The ASMPI is calculated by comparing the historical relationship of cap rates on properties with primary mortgages between $1 million and $7.5 million, and the rental income earned on small multifamily properties (5 to 49 units).
Q: How do you define a “small multifamily property”?
A: For the purposes of the ASMPI, we define small multifamily properties as those which have 5 to 49 units. This is consistent with the distinctions made in the U.S. Census Bureau’s American Community Survey.
Q: How do you define a “primary mortgage” on a property?
A: A primary mortgage means that at least 50% or more of the financing on the property comes from this loan. For the purposes of the ASMPI, we use Chandan Economics’ database of loans with primary mortgages of $1 million to $7.5 million.
Q: What is the formula for calculating the ASMPI?
A: Property Valuation = Net Operating Income / Cap Rate
Q: What is a cap rate?
A: A cap rate is the annual rate of return on a property, also known as the annual yield.
Q: How do you determine the cap rates for the formula?
A: Chandan Economics tracks small multifamily cap rates through its loan database and economic models consisting of small multifamily properties with primary mortgages between $1 million and $7.5 million.
Q: How do you determine the net operating income for the formula?
A: • Operating income is calculated based on Chandan Economics’ models of annual contract rents for multifamily properties with 5 to 49 units, using data published by the U.S. Census Bureau in the American Community Survey.
• Operating income is adjusted for any vacancy losses. Other forms of property income other than direct rental income are not included as part of the model.
• An assumption in the model is that variable operating expenses are passed through to tenants.
Q: What is the methodology for the ASMPI?
A: The Arbor Small Multifamily Price Index is calculated by comparing the historical relationship of cap rates and operating income. Cap rates data are sourced from Chandan Economics’ loan database and data models consisting of properties with primary mortgages between $1 million and $7.5 million. Operating income is estimated by Chandan Economics’ models of annual rents on multifamily properties with 5 to 49 units. Primary sample data used for small multifamily rents model is sourced by the U.S. Census Bureau as part of the American Community Survey.
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