Unless an 11th-hour agreement is reached, an impasse will trigger the first U.S. government shutdown since 2019. Starting December 21, 2024, many non-essential federal government operations will be limited or suspended, but most multifamily financing activities will not be disrupted.
With home prices nearing all-time highs, single-family rental (SFR) housing is uniquely positioned to capture an even larger slice of the for-sale market. As structured capital markets rebound, SFR will benefit from a set of tailwinds that include robust levels of new construction and favorable trends in cap rates and debt yields. Arbor’s Single-Family Rental Investment Trends Report, developed in partnership with Chandan Economics, shows why this sector’s prospects are so strong.
Building on an organizational commitment to the inclusion of individuals from all backgrounds, Arbor — in partnership with the Real Estate Pride Council and Dr. Sam Chandan, Founder of Chandan Economics, Founding Director, NYU Stern School of Business C.H. Chen Institute for Global Real Estate Finance, and Co-Chair of the Real Estate Pride Council — hosted a speed networking event in Manhattan on November 20 for local LGBTQIA+ students and commercial real estate mentors.
Small multifamily continued to moderate through the midpoint of 2024, amid strong demand despite an elevated interest rate environment and rising property-level yields.
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%.
Key Findings
Noteworthy optimists in March 2020 had predicted that the domestic battle against the pandemic was going to see meaningful improvement in April. To their credit, they never specified in April of which year.
Progress on the public health front continues to gain momentum, boosting the near-term economic outlook. Through mid-April, more than half of all U.S. adults had received at least one dose of a COVID-19 vaccine, and daily deaths have fallen to nearly 700 nationally. We may remain far off from a non-socially distanced ticker-tape parade declaring the end of the pandemic, but guarded optimism is surely in order.
Market watchers are increasingly hopeful about the domestic recovery as economic tailwinds are starting to sync up. If anything, the biggest debate in policy circles right now is if the U.S. economy may actually overheat in the years ahead. Real GDP grew at an annualized rate of 6.4% for the first quarter of 2021, slightly below estimates but still a positive read. Through March 2021, the civilian unemployment rate dropped to 6.0% — an improvement of 8.8% from April 2020’s high (Chart 1).
Within small multifamily1, the start of the new year brought a reversal of some COVID-induced trends. Notably, loan-to-value ratios (LTVs) and debt yields, two metrics that saw hyper-variability due to increased risk aversion, have started to trend back toward their pre-pandemic levels. Despite the positive progress made thus far, there are still some challenges ahead for the small multifamily market.
While the amended 2020 Appropriations Bill and the passage of the American Rescue Plan Act earmark more than $50 billion in Federal aid for rental assistance programs, several industry groups like the National Multifamily Housing Council and Mortgage Bankers Association noted in a letter addressed to Treasury Secretary Janet Yellen that this assistance contains several shortcomings. The letter highlights the ineligibility of some low-income renters and “burdensome documentation requirements” that are “drastically slowing down the distribution of funding” as significant problem areas.
All else equal, small multifamily remains resilient heading into 2021’s warm weather months. According to Chandan Economics, small multifamily asset valuations are up an estimated 5.5% year over year, and cap rates are down to just 5.3%. Originations have started to recover, and the share of new lending volume going toward acquisitions increased for the first time in six quarters. Challenges are still a daily reality, but the balance of macroeconomic and small multifamily-specific tailwinds are finally starting to outnumber the headwinds.
1Chandan Economics defines small multifamily properties as those with 5 to 50 units and primary mortgages of $1.0 million to $7.5 million.
Refinancing activity made up the bulk of new lending activity as buyers and sellers were far apart in their opinions of ‘fair value’ through much of last year. The refinancing share of small multifamily lending increased for five consecutive quarters, reaching a high of 78.5% in the fourth quarter of 2020 (Chart 4).
With the economic horizon starting to look less cloudy and an abundance of opportunistic capital seeking deployment, trades are starting to become more common. In first-quarter 2021, the refinancing share of small multifamily lending fell to 67.9% — just 90 basis points (bps) above where it stood one year ago and before the onset of pandemic-related financial conditions.
National average cap rates for small multifamily properties shaved off 2 bps in the first quarter of 2021, settling at 5.3% (Chart 7). Since the start of 2011, small multifamily cap rates have followed a long-term trend of compression, falling an average of 20 bps annually. Through first-quarter 2021, small multifamily cap rates are down 34 bps year over year, outpacing the post-Great Recession trajectory.
The small multifamily risk premium, a measure of additional compensation demanded by investors to account for higher levels of risk, is best measured by comparing cap rates to 10-year Treasury yields. The credit quality of the U.S. government is perceived as unmatched, making the price it pays for its debt an approximation for the risk-free interest rate. The small multifamily risk premium averaged 399 bps in first-quarter 2020, as cap rates ticked down, and Treasury yields rose considerably (Chart 8). The risk premium surged to 470 bps in second-quarter 2020 as a global ‘flight to safety’ increased the prices of government bonds and suppressed their yields. The risk premium has fallen since, declining for three consecutive quarters.
The cap rate spread between small multifamily assets and the rest of the multifamily sector, a measure of the idiosyncratic risk of smaller properties, held effectively unchanged in first-quarter 2020, dropping just a single basis point to 38 bps (Chart 9).
The small versus all multifamily cap rate spread hit an all-time high of 121 bps in 2010 and an all-time low of just 19 bps in third-quarter 2020. Over time, the yield structure of small assets has come to look more like the rest of the sector as liquidity has improved and technological adoptions have added operational efficiencies.
As noted in last quarter’s report, reaching herd immunity remains the single-most important factor for a sustained economic recovery. The most recent McKinsey projection (as of March 2021) reflects an improving outlook and now forecasts that the U.S. will hit the critical threshold in third-quarter 2021. Vaccine hesitancy and the potential for variants to cause surges in cases are risk factors worth keeping an eye on, but through mid-April, more than half of U.S. adults have received at least a first dose of a COVID vaccine, fueling near-term optimism.
As the small multifamily sector heads into the middle of 2021, the CDC’s continued national eviction moratorium remains a sizeable roadblock on the hopeful path back to normalcy. While the moratorium is a challenging factor for all multifamily operators, the effects asymmetrically impact mom-and-pop owners. Nonperforming units in smaller apartment buildings make up a more significant percentage of forgone potential income. Even still, the scale of nonperformance has not measured close to initial fears. Opportunistic investors spent the early days of the crisis stockpiling capital to deploy into distressed assets. The relative infrequency of distress and the overabundance of capital are leading to competitive pricing, softening the blow for owners who find themselves in involuntary sales. All else equal, the small multifamily sector remains well positioned to return to health and exit the crisis from as strong of a position as it had entered.
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