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
Reinforcements, however, are on their way. After months of legislative inaction, the 2021 Consolidated Appropriations Act passed both congressional chambers on December 21 and became law on December 27. The newly approved spending earmarks $900 billion for additional COVID-19 relief aid, including a partial reinstatement of the disaster unemployment benefits and a $25 billion Emergency Rental Assistance program. While the rental assistance program is undoubtedly a welcome sign to struggling renters and landlords alike, a RealPage analysis of the program indicates that the $25 billion is likely not enough to address all concerns. Moreover, the analysis suggests the allocation process is not well-aligned with state and local needs.
According to Chandan Economics, small multifamily asset pricing has recovered from the early spring — a positive symptom of the market’s deep pool of liquidity. While cap rates remain exceptionally low by historical standards, they did jump by their widest quarterly margin since 2009. All else equal, the ongoing pressures created by the pandemic and continuing recession are not overly affecting the small asset subsector compared to the rest of the multifamily market, and targeted agency support has, to date, been effective in avoiding worst-case scenarios.
Buyers pulled back in second-quarter 2020, with multifamily transaction volume for the quarter falling 67% from the year prior, according to Real Capital Analytics. While buyers have started to return in recent months, the pace of recovery remains slow. The prospect of finding distressed deals has kept many would-be buyers on the sideline.
Lenders, meanwhile, have remained active. The availability of refinancing capital has meant that property owners with expiring mortgages, or simply those that want to access their accrued equity, are not disposing of their assets from a disadvantaged position. Refinancing activity as a share of total small multifamily lending ranged from 61.2% to 66.7% between first-quarter 2019 and first-quarter 2020. Since the onset of the pandemic, the refinancing share has soared, reaching a new high of 78.5% in the fourth quarter (Chart 5).
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 risk-free interest rate is embedded within the yield structure of all other market returns, including cap rates. Investors require additional compensation when accepting additional risk. We can infer this risk premium in small multifamily by looking at the difference between asset cap rates and 10-Year Treasurys.
Despite increased concerns over property-level operations during the pandemic, 10-year Treasurys rates sank to new lows. As both occurred in tandem, small multifamily cap rates moved like a rope in a game of tug of war. On net, falling Treasury rates won out, and cap rates ticked down in the second and third quarters. In the fourth quarter, growing optimism about the economic recovery in the year ahead led Treasury yields to do the unthinkable: rise (albeit marginally). Treasury yields averaged 0.86% in the fourth quarter — a 21 bps rise from the previous quarter.
With small multifamily cap rates rising by less than Treasurys in the fourth quarter, the risk premium narrowed to 452 bps (Chart 10). The spread is down by 21 bps from its recent high of 473 bps set in second-quarter 2020. The risk premium measured between small multifamily and the rest of the multifamily sector recovered slightly in the fourth quarter, doubling from 21 bps to 42 bps (Chart 11). Moreover, the fourth-quarter average brings the spread directly in line with the average set over the 12-months ending March 2020.
Loan-to-value ratios (LTVs) on small multifamily loans continued their vertical descent in the fourth quarter, averaging 65.2%. After topping out at 70.6% in first-quarter 2020, LTVs proceeded to fall by 237 bps in the second quarter, 71 bps in the third quarter, and 232 bps in the fourth quarter (Chart 12).
Across the rest of the sector, LTVs resumed a sliding trajectory in the fourth quarter as well. Average LTVs for all multifamily properties dropped by a substantial 346 bps from the previous quarter, reaching 66.5%. From the high point reached in the fourth quarter, LTVs for all multifamily properties are down 614 bps. According to Chandan Economics’ initial fourth-quarter estimates, the LTV spread between small multifamily all multifamily stood at 131 bps, nearly half of the 246-bps spread measured in the previous quarter.
Debt yields — the ratio of net operating income (NOI) and loan balance — for small multifamily loans jumped by 53 bps to 8.2% in the fourth quarter of 2020, the highest level seen since third-quarter 2019 (Chart 13). The trend was similar for all multifamily properties, where debt yields rose by an appreciable 88 bps to 7.5%.
The spread between small multifamily and all multifamily debt yields fell to 64 bps in the fourth quarter, the lowest level on record (Chart 14). Debt per dollar of NOI, the inverse of debt yields, fell for both small multifamily and all multifamily loans in the fourth quarter. Small multifamily borrowers are securing an average of $12.24 in new debt for every $1 of property NOI, down 84 cents from the prior quarter and 6 cents from last year (Chart 15).
Reaching herd immunity is the single most important factor for a sustained recovery, and the continued vaccination rollout credibly brings that reality within sight. The most recent McKinsey projection (as of November 2020) forecasts that the U.S. will hit herd immunity and a return to somewhat “normal” life around the third or fourth quarter of 2021. While there is hope on the horizon, the labor market may see further deterioration in the months ahead. After months of slow progress, more jobs were lost than added in December, and a reprieve may not come until the spring. As long as there is a labor market in crisis, the financial wellbeing of renters will remain a concern. Still, according to NMHC, renters have, with some local exception, successfully prioritized their monthly rent obligations so far during the pandemic.
The success of small multifamily operators in 2021 will likely be increasingly sensitive to local factors. One of the biggest open questions heading into the new year is whether or not the outflowing pour of residents from high-priced markets into less expensive metro areas and suburbs will continue at such a robust pace. All else equal, there is little evidence to suggest that the small asset subsector nationally is underperforming the market for larger properties. Moreover, small multifamily renters are often less transient and are less likely to transition into homeownership, preserving short-term apartment demand. The small multifamily sector outperformed downside projections from the early spring, and its penchant for stability does not appear at risk, even as 2021 may prove to be a bit darker before the dawn.
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