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%.
Small Multifamily Investment Trends Report Q2 2024
In the first quarter of 2024, the small multifamily subsector continued to fall in line with pre-pandemic norms, resuming patterns frequently seen before the historic multifamily boom years of 2021 and 2022.
Across the multifamily real estate sector, distress has remained limited. According to Trepp, the delinquency rate of multifamily loans in CMBS transactions was 1.8% at the end of the first quarter of 2024, down from 2.6% at the end of the previous quarter. Trends found in small multifamily properties tell a similar story. According to Freddie Mac, 97.8% of its small balance multifamily loans were either current or less than 60 days delinquent through February 2024. There may also be light at the end of the tunnel for asset pricing. Compared to last year, cap rates are higher, and valuations sit lower. However, when measured against the previous quarter, both metrics show improvement, with cap rates falling slightly and asset prices holding steady.
In the quarters ahead, small multifamily is likely to see steady improvement. Lending standards remain conservative, and the market consensus that there will be six rate cuts in 2024 has faded. Although many anticipate more hawkish monetary policy in the months ahead, multifamily’s structural strength has historically helped it withstand heavy headwinds. When the Federal Reserve cuts interest rates, multifamily investment activity is likely
to see a bounce.
Elevated interest rates continued to impact small multifamily lending volume in the first quarter of 2024, as compared with the highs of recent years. The $44.4 billion year-end 2023 estimate of new multifamily lending volume on loans with original balances between $1 million and $9 million1 — including loans for apartment building sales and refinancing — represented a significant deceleration from the record-breaking 2022 total of $90.1 billion (Chart 1).
Thus far in 2024, a rapid bounce back does not appear in the cards — but neither does a further pullback. Through the year’s first quarter, small multifamily originations are on pace to hit $44.7 billion in 2024, a slight increase of 0.6% over last year.
Sustained high interest rates are the primary factor weighing down origination volumes, and they impact the market in several ways.
First, it widens the bid-ask spread (the difference between what a buyer is willing to pay and what a seller is willing to accept). Amid higher capital costs, potential buyers are seeking larger discounts. At the same time, a lack of multifamily sector distress has meant fewer owners have been motivated to sell if they do not receive an offer that meets their perception of fair value. Further, according to Yardi Matrix, loan extensions have been a common feature of the current lending environment, simultaneously suppressing new originations and distress.
Altogether, lower transaction activity, more frequent loan extensions, and reduced incentives for refinancings have all contributed to decreased origination volumes through 2023 and into early 2024.
1 All data, unless otherwise stated, are based on Chandan Economics’ analysis of a limited pool of loans with original balances of $1 million to $9.0 million and loan-to-value ratios above 50%.
A high interest rate environment makes cash-out refinancing less attractive. When interest rates are favorable, borrowers often use accrued equity in their properties to finance subsequent acquisitions. In high interest rate environments, cash-out refinancing may result in a voluntary increase in debt servicing costs.
After the refinancing share of originations reached a high of 75.6% in the third quarter of 2022, it has fallen in three consecutive quarters, landing at a low of 60.5% in the second quarter of 2023 (Chart 2). The refinancing share of originations has been normalizing over the past three-quarters of available data, ranging between 66.8% and 72.7%.
Through the first quarter of 2024, the Arbor Small Multifamily Price Index shows that small multifamily asset valuations were down 4.3% from a year earlier (Chart 3). While annual price growth remains negative, the first-quarter reading marks an improvement from the prior two quarters, where annual price declines reached above 9%. Further, quarter-over-quarter, prices held effectively flat, falling by just 0.2% in the year’s first three months. The first-quarter movement comes as expense growth has narrowly outpaced property-level incomes, which weighed against valuations, even as cap rates ticked down by a few basis points.
Following the small multifamily sector’s peak in the third quarter of 2022, asset prices have declined in six consecutive quarters, dropping 11.8% in aggregate value. Despite recent declines, small multifamily valuations today are still 19.9% higher than before the pandemic.
In the first quarter of 2024, small multifamily cap rates averaged 5.7% — declining quarter-over-quarter for the first time since mid-2022 (Chart 4). The marginal decline of 5 basis points represents a surprising shift in direction. Similar trends have also been reported for prime multifamily properties, an indication that recent patterns in rising cap rates could be reversing sector-wide.
The small multifamily risk premium, best measured by comparing cap rates to the yield on the 10-year Treasury, approximates the additional compensation that investors require to account for higher levels of risk. This risk premium widened by 23 bps in the first quarter of 2024, reaching 156 bps (Chart 5).
The first quarter increase arrives as 10-year Treasury yields averaged 4.2% over the year’s first three months — down from 4.5% in the fourth quarter of 2023. Despite the slight increase, the current risk premium is less than half of the average risk premium of 370 bps observed between 2015 and 2019. Meanwhile, the cap rate spread between small multifamily assets and the rest of the multifamily sector, a measure of the risk unique to smaller properties, narrowed by 10 bps during the first quarter to finish at 28 bps (Chart 6).
Expense ratios, measured as the relationship between underwritten property-level expenses and effective gross income, have remained stable in recent quarters. In the first quarter of 2024, expense ratios in small multifamily properties receiving financing averaged 40.7% — rising slightly from the 39.7% observed during the prior quarter (Chart 7). Expense ratios peaked at 43.2% in the first quarter of 2023, just as property insurance prices sharply increased. However, expense ratios have quickly come back down to a normal range. Over the past four quarters of available data, expense ratios have deviated by less than a percentage point — ranging between 39.7% and 40.9%.
In the first quarter of 2024, small multifamily properties receiving financing had an average occupancy rate of 96.6% (Chart 8). In each of the past two quarters, small multifamily occupancy rates declined, falling 127 bps in total, although they remain slightly higher than where they were a year ago.
Small multifamily properties have a 2% higher occupancy rate than other types of multifamily real estate. This trend is supported by the relationship-driven nature of small multifamily owners. According to a recent report by the Terner Center for Housing Innovation at UC Berkeley, a majority of small multifamily property owners report that at least half of their rental units were leased at below-market-rate rent prices in an effort to retain quality tenants.
Debt underwriting standards remained tight through the first quarter of 2024. Loan-to-value ratios (LTVs) slid by 179 bps from the previous quarter, settling at 57.9% (Chart 9). Small multifamily LTVs have generally declined since the onset of the pandemic. After hitting a record high of 69.2% in the fourth quarter of 2019, they have dropped in 11 of 17 quarters. In that time, average LTVs have decreased by 11.4 percentage points, highlighting that lenders require more substantial equity cushions when trends in valuations are volatile.
Average debt yields for small multifamily loans continued climbing higher in the first quarter of 2024, reaching 9.5% (Chart 10). Small multifamily debt yields have risen in each of the past seven quarters, hitting their highest point in nearly a decade. While cap rates and debt yields are higher than a year ago, debt yields have increased more substantially. In the first quarter of 2024, the spread between debt yields and cap rates widened to 382 bps — the most significant difference since 2013 (Chart 11).
The inverse of debt yields, the debt per dollar of net operating income (NOI), for small multifamily loans fell again in the first quarter of 2024. Small multifamily borrowers secured an average of $10.49 in new debt for every $1.00 of property NOI, a decline of $0.21 from the previous quarter and its lowest level since 2014.
The small multifamily subsector’s stronger-than-average occupancy rates provide a stable foundation that will allow property owners to hold steady through the current high interest rate environment. As evidenced by the recent stabilization of asset prices and cap rates, as well as an uptick in large investor buying activity, there is growing confidence that the sector is rebounding from its cyclical bottom. For the small multifamily sector, interest rate headwinds will likely create a bumpy road to recovery in 2024, but smoother pavement lies ahead.
For more small multifamily research and insights, visit arbor.com/articles
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