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Single-Family Rental Investment Trends Report Q3 2024

Single-Family Rental Investment Trends Report Q3 2024

SFR Construction Hits Another All-Time High as Structured
Capital Markets Rebound

Key Findings

  • SFR/BTR construction starts surged to another new record high.
  • SFR CMBS activity in 2024 is on pace to triple last year’s total.
  • Cap rates jump to 6.8% amid high-interest rates and healthy levels of rent growth.

Table of Contents

State of the Market
Performance Metrics
Supply & Demand Conditions
Outlook

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State of the Market

As the single-family rental (SFR) sector expands, its structural strengths continue to counterbalance the challenges of a high-interest rate environment. In construction starts and other fundamental areas, clear signals have emerged that it is well-positioned for another growth spurt.

In recent quarters, institutional investors have focused on ground-up, purpose-built development rather than acquisitions of existing properties, resulting in a build-to-rent (BTR) construction surge.

SFR/BTR’s underlying demand fundamentals are robust right now as access to affordable homeownership remains challenging amid high interest rates, limited available supply, and elevated home prices. According to data from the Federal Reserve Bank of Atlanta, buying a house is about 38% less affordable today than in 2020.

While the challenging conditions associated with high interest rates continue to impact cap rates and debt yields, most other gauges of SFR performance have either stabilized or improved. Structured SFR capital markets saw a burst in activity through 2024’s first half, and distress remained minimal within the sector and throughout the broader housing market. Even as inflation pushes the cost of living higher, occupancy rates are stable, rent growth remains healthy, and construction momentum is gaining steam.

As we move through the second half of the year, SFR’s structural strengths give it a solid foundation to grow as economic conditions continue normalizing.

Performance Metrics

CMBS Issuance

Structured SFR capital markets have seen distinct signs of improvement so far this year. SFR CMBS issuance has totaled $4.2 billion through the first half of 2024 — 143% more than the output from the second half of 2023 ($1.7 billion) (Chart 1). If issuance in 2024’s second half matches or exceeds the first six months of the year, total production would at least triple 2023’s mark. While issuance levels have been below the historical highs registered during 2021 and 2022, this year’s pace of activity, if sustained, would be roughly in line with 2020’s tally and more than double 2019’s level, another encouraging sign of a normalization underway.

Originations by Purpose

New acquisition loans have accounted for the lion’s share of SFR originations since 2022 as the interest rate environment has reduced the incentive for refinancings. According to Fannie Mae, new loans intended for purchasing have accounted for 78.2% of SFR lending activity in 2024, the highest share on record going back to 1999 (Chart 2). By contrast, rate-and-term refinancing loans, which accounted for 47.3% of originations just four years ago, accounted for 7.2% of 2024’s lending activity through the first quarter.

The rolling four-quarter dollar volume of rate-and-term refinancings fell by 45.0%, compared to one year ago, an analysis of Fannie Mae data shows (Chart 3). Cash-out refinancings also dropped significantly, declining by 57.7%. However, investor single-family purchases declined less rapidly, sliding by 28.6%. The dip in SFR purchasing activity was in line with the owner-occupant segment of the market, where single-family home purchases by first-time and non-first-time homebuyers retreated at a pace of 24.9% and 23.8%, respectively.

Occupancy

Occupancy rates across all SFR property types averaged 94.6% in the second quarter of 2024, according to U.S. Census Bureau data (Chart 4). The second quarter’s SFR occupancy rate was slightly lower (-10 bps) than the prior quarter’s rate, though it was up 10 bps from the same time last year. DBRS Morningstar, which tracks the performance of 133,664 SFR units within its rated CMBS transactions, reported a similar SFR vacancy rate of 92.4%
through May 2024.

Rent Growth: National

National SFR rent growth continued to increase at a healthy pace. According to Zillow’s Observed Rent Index for single-family rental properties, rents in the sector were up 4.7% from a year earlier through July 2024 (Chart 5). While rent growth retreated from the double-digit growth rates of 2021 and 2022, the current pace of increase remains robust by historical standards. Even though SFR rent growth slid in the past four consecutive months, the current annual growth rate was slightly above the pre-pandemic (2016-2019) average of 4.4%.

DBRS Morningstar’s latest SFR report shows the resumption of seasonal patterns for rent growth, lease renewals, and tenant turnover. Vacant-to-occupied (V2O) rent growth sat at 3.5% through April 2024 — up from 0.7% six months earlier. Renewal rent growth, which generally accounts for 80-85% of the sector’s units, stood higher at 6.0% over the same period. Notably, renewal rent price momentum has re-accelerated over the past four months of data, with the annual growth rate rising by 1.7 percentage points in that time frame.

Rent Growth: Metros

Among the top 20 SFR hotspot markets (defined here as markets with the highest SFR share of rentals across the top 50 metros by population), Indianapolis has been seeing the most robust levels of SFR annual rent growth, with prices rising 7.7% from a year earlier through July 2024 (Chart 6). Closely behind was Kansas City, KS (+7.0%), and Richmond, VA (+6.7%). At the other end of the spectrum are several Sun Belt markets that accelerated most quickly during the post-pandemic boom and cooled afterward, including Phoenix, AZ (+2.0%), Tampa, FL (+2.9%), and Jacksonville, FL (+3.3%).

Cap Rates

SFR cap rates jumped again in the second quarter of 2024, rising 26 bps to 6.8%1 (Chart 7). Cap rates rose in seven of the past 10 quarters, increasing by 149 bps, and have hit their highest point since the first quarter of 2018. With interest rates elevated, investors have been broadly revising their yield requirements. The continued upward movement of cap rates comes as transaction-based measures of home prices slid again in the second quarter of 2024 and property-level incomes rose.

1 Unless otherwise noted, the Chandan Economics data covering single-family rental cap rates and debt yields are based on model estimates and a sample pool of loans. Data are meant to represent conditions at the point of origination.

The spread between SFR cap rates and 10-year Treasury yields approximates the SFR risk premium. In the second quarter of 2024,10-year Treasury notes carried an average yield of 4.5%, jumping from 4.2% in the first quarter. With average Treasury yields and SFR cap rates rising, the SFR risk premium held relatively flat, falling by a negligible three bps to settle at 231 bps in the second quarter (Chart 8). Meanwhile, the spread between SFR and multifamily properties widened slightly by 12 bps, averaging 117 bps.

Pricing

The average valuation of a single-family rental that received a Fannie Mae mortgage in the first quarter of 2024 was $362,343 — up 0.8% from the 2023 average (Chart 9). During the same time frame, average valuations for owner-occupied units are up by a comparable 1.1%, reaching $420,790.

Historically, the average assessed property values on mortgages originated to single-family owner-occupants and single-family investors have been consistently different. Underwriters consider factors in rental properties (such as vacancies, turnover, and management-related expenses) that are not present in owner-occupied units, contributing to generally lower assessed values for rentals. Average property values are also lower because investors are incentivized to target value-add assets rather than paying higher prices for existing value.

While underwritten valuation gains have been marginal, trends this year have been encouraging. After valuations declined for both renter-occupied and owner-occupied single-family homes in 2022, each segment bounced higher in 2023 and has continued to do so thus far in the 2024 data. Notably, these trends contrast with transaction-based price indices, such as the Federal Reserve Bank of St. Louis’ Median Home Sales Price Index, which continued to decline. This divergence reflects current market conditions in which lower-priced homes have a wider pool of buyers and sellers.

Debt Yields

Debt yields, a key measure of credit risk, jumped again during the second quarter of 2024, rising by 31 bps to finish at 11.1% (Chart 10). The increase marked the eighth time debt yields have risen in the past 10 quarters, indicating that lenders have remained cautious in an unsettled investment climate. The rise in debt yields in recent quarters translates to SFR investors securing less debt capital for every $1.00 of property-level net operating income (NOI). Through the second quarter of 2024, SFR debt declined to $9.02 for every $1.00 of NOI, a decrease of $0.26 from the previous quarter and a drop of $0.64 from the same time last year.

Supply & Demand Conditions

Residential Distress

Even with elevated mortgage interest rates, there has been little to no distress across the U.S. housing market. The Federal Reserve Bank of New York’s Q2 2024 Quarterly Report on Household Debt and Credit indicated that only 0.6% of household mortgages were more than 90 days delinquent through the second quarter of 2024, which is half of a percentage point below where default rates were at the start of the pandemic (Chart 11).

 

Within the SFR sector, evidence suggests that distress patterns mirror the broader single-family ecosystem, with delinquency rates dropping considerably. According to DBRS Morningstar, within rated SFR CMBS transactions, 2.4% of loans were delinquent in May 2024 — nearly half the 4.2% rate reported one year earlier (Chart 12).

Build-to-Rent (BTR)

BTR communities have become a defining feature of the SFR sector. Through the second quarter of 2024, BTR development remained robust, with aggregate production and single-family market share both pushing up against all-time highs. Over the past 12 months, BTR accounted for 8.1% of all single-family construction starts, reclaiming the record high for the product type (Chart 13). For comparison, before the SFR sector institutionalized in the aftermath of the 2007-09 recession, the BTR share of single-family construction never eclipsed 3.1%. By unit count, 83,000 BTR construction starts were recorded in the 12 months that ended in the second quarter of 2024 — another new record high. Notably, the rolling annual sum is up by 20.3% when compared to a year ago, demonstrating the sustained surge in BTR development.

Outlook

Investors broadly expect that the Federal Reserve will loosen monetary policy this year, adding momentum to an ongoing normalization of real estate capital markets. Regardless, the SFR sector has not waited to hear the Fed’s starting bell.

With structural tailwinds overmatching cyclical headwinds, BTR construction’s gains this quarter were clear evidence of a sector on the rise. SFR’s short- and long-term prospects continue to be bright due to its long-term demand profile and a strong pipeline, which will limit the need for conversions.

As the math behind rent-versus-buy calculations changes, SFR continues to be an attractive option for many would-be buyers priced out of the housing market. On balance, while risks and challenges remain, SFR is solidly positioned to grow and even outpace its current gains in future quarters.



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Disclaimer
This report is intended for general guidance and information purposes only. This report is under no circumstances intended to be used or considered as financial or investment advice, a recommendation or an offer to sell, or a solicitation of any offer to buy any securities or other form of financial asset. Please note that this is not an offer document. The report is not to be considered as investment research or an objective or independent explanation of the matters contained herein and is not prepared in accordance with the regulation regarding investment analysis. The material in the report is obtained from various sources per dating of the report. We have taken reasonable care to ensure that, and to the best of our knowledge, material information contained herein is in accordance with the facts and contains no omission likely to affect its understanding. That said, all content is provided herein “as is” and neither Arbor Realty Trust, Inc. or Chandan Economics, LLC (“the Companies”) nor their affiliated or related entities, nor any person involved in the creation, production and distribution of the content make any warranties, express or implied. The Companies do not make any representations or warranties, express or implied, as to the reliability, usefulness, completeness, accuracy, currency nor represent that use of any information provided herein would not infringe on other third-party rights. The Companies shall not be liable for any direct, indirect or consequential damages to the reader or a third party arising from the use of the information contained herein. There may have been changes in matters which affect the content contained herein and/or the Companies subsequent to the date of this report. Neither the issue nor delivery of this report shall under any circumstance create any implication that the information contained herein is correct as of any time subsequent to the date hereof or that the affairs of the Companies have not since changed. The Companies do not intend, and do not assume any obligation to update or correct the information included in this report. The contents of this report are not to be construed as legal, business, investment or tax advice. Each recipient should consult with its legal, business, investment and tax advisors as to legal, business, investment and tax advice. The information contained herein may be subject to changes without prior notice. This report is only intended for the recipients, and should not be copied or otherwise distributed, in whole or in part, to any other person.

Small Multifamily Investment Trends Report Q3 2024

Small Multifamily Investment Trends Report Q3 2024

Cap Rates Climb Again as Originations Begin Rebounding

Key Findings

  • Small multifamily originations were on pace for a modest 7.9% annual increase in 2024.
  • Cap rates reversed a first-quarter decline, rising to 6.1%.
  • Credit conditions remained conservative as debt yields rose to 9.9%.

Table of Contents

State of the Market
Lending Volume
Loans by Purpose
Arbor Small Multifamily Price Index
Cap Rates & Spreads
Expense Ratios
Occupancy Rates
Leverage & Debt Yields
Outlook

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State of the Market

Small multifamily continued to moderate through the midpoint of 2024, as strong demand and lending support from government-sponsored enterprises (GSEs) counterbalanced an elevated interest rate environment and rising property-level yields.

 

Although loan activity retreated slightly, distress has remained limited within the small multifamily subsector. According to Freddie Mac, 97.2% of its small balance multifamily loans were current through May 2024 — a decrease of about two percentage points from the end of 2022. The share of the outstanding loan balance that has either reached foreclosure or REO (real estate owned) was just 0.2%, signaling that lenders and borrowers are increasingly working together to cure non-performance.

 

While economic headwinds persist, more signs of a normalization underway have brightened the outlook for 2025 and beyond. The National Multifamily Housing Council’s (NMHC) most recent Quarterly Survey of Apartment Conditions shows a growing share of multifamily practitioners reported higher sales volume and improved borrowing conditions compared to the previous three-month period.

 

Multifamily originations have also recently shown signs of improvement. According to Freddie Mac’s 2024 Midyear Multifamily Outlook, they have now been projected to increase by a little more than 20% in 2024, provided monetary policy is loosened as expected this year. Already, small multifamily originations have seen a modest pickup in the first two quarters of the year, although uneven improvement can be expected for the remainder of 2024. Multifamily completions sit at a five-decade high, while rents increased 2.7% year-over-year through June 2024, signaling momentum is trending positive but has room to grow.

 

With a consensus of opinion building that the Federal Reserve will cut interest rates multiple times by year’s end, a macroeconomic inflection that would accelerate a normalization could be on the horizon.

Lending Volume

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 — decelerated significantly from $83.9 billion in 2022 (Chart 1). 

Thus far in 2024, originations appear to be stabilizing and rebounding modestly. Through the second quarter, small multifamily originations are on an annualized pace to reach $48.0 billion in 2024, an increase of 7.9% over last year’s volume. 

 

Several factors have weighed down origination volumes in 2023 and 2024, including challenges brought on by high interest rates, sellers adjusting to the realities of lower asset valuations, and macroeconomic uncertainties. Additionally, loan extensions, a common feature of the current lending environment, have simultaneously suppressed both new originations and distress.

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 million and loan-to-value ratios above 50%.

Loans by Purpose

High interest rates have been reducing the incentive for investors to pursue cash-out refinancing. After hitting a high of 75.6% in the third quarter of 2022, the refinancing share of originations fell for three consecutive quarters, reaching a low of 60.5% in the second quarter of 2023 (Chart 2). However, the refinancing share of originations, which was 68.9% in the second quarter of 2024, has normalized over the past four quarters, ranging between 66.8% and 72.7%.

Arbor Small Multifamily Price Index

The Arbor Small Multifamily Price Index showed that asset valuations were down 1.5% year-over-year through the second quarter of 2024 and down 11.2% from their 2022 peak (Chart 3). The second-quarter price decline was driven entirely by rising cap rates — as operating incomes, expense ratios, and occupancy rates all improved within the sector. Despite these declines, valuations were about 19.0% higher than pre-pandemic levels.   

Cap Rates & Spreads

In the second quarter of 2024, small multifamily cap rates averaged 6.1%, reversing the previous quarter’s declines (Chart 4) with an increase of 36 basis points (bps). After cap rates in the sector reached an all-time low of 5.0% in the third quarter of 2022, property-level yields increased in six of the following seven quarters, climbing a total of 105 bps during that time. The second quarter mark was the first time since 2018 that cap rates eclipsed 6.0%. Rising cap rates have been a double-edged sword for small multifamily. On the one hand, cap rate increases have negatively impacted asset valuations. At the same time, they have improved the return profile for prospective investors.

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 a marginal seven bps in the second quarter of 2024 to reach 160 bps (Chart 5). The increase arrived as 10-year Treasury yields averaged 4.5% between April and June — up from 4.2% in the first quarter of the year. 

Despite the slight increase, the risk premium remained well below pre-pandemic trends. Between 2015 and 2019, the small multifamily risk premium averaged 370 bps — more than double the current spread. 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, increased by 21 bps during the second quarter to reach 45 bps (Chart 6).

Expense Ratios

Expense ratios, measured as the relationship between underwritten property-level expenses and effective gross income, have remained stable in recent quarters. In the second quarter of 2024, expense ratios in small multifamily properties receiving financing averaged 40.4%, a slight decline from the 40.6% observed during the prior quarter (Chart 7). Expense ratios peaked at 43.0% in the first quarter of 2023, coinciding with a steep rise in property insurance prices. However, expense ratios have quickly normalized. In the past five quarters of available data, expense ratios ranged in a tight window between 39.6% and 40.6%.

Occupancy Rates

Occupancy rates within small multifamily properties that received financing during the second quarter averaged 97.1% (Chart 8). After posting slight declines in the prior two quarters, the average was a notable improvement of 45 bps, putting occupancy rates directly in line with where they were a year ago.

Small multifamily occupancy rates routinely best the rest of the multifamily sector. Occupancy rates in small multifamily properties track about 2% higher than the rest of the sector, an anomaly that may be driven by the interpersonal relationships between many landlords and their tenants. According to a recent report by the Terner Center for Housing Innovation  at UC Berkeley, a majority of small multifamily property owners reported that at least half of their rental units were being leased at below-market-rate rents, primarily to retain quality tenants.

Leverage & Debt Yields

Debt underwriting standards remained tight, as loan-to-value ratios (LTVs) improved by 164 bps from the previous quarter, settling at 59.9% (Chart 9). However, the upward movement in the second quarter only erased declines from the first three months of the year, with average LTVs down 29 bps from year-end 2023. Small multifamily LTVs remain below pre-pandemic levels and down 9.1 percentage points from a peak of 68.9% in 2019.

Average debt yields for small multifamily loans continued to ascend, reaching 9.9% (Chart 10). Small multifamily debt yields have risen in each of the past eight quarters, reaching their highest point in over a decade.

While cap rates and debt yields are both higher than one year ago, debt yields have increased more substantially than cap rates. The spread between debt yields and cap rates remained at 383 bps in the second quarter of 2024, holding at its widest point 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.

Outlook

The small multifamily subsector continues to post gains and show growth amid a challenging macroeconomic environment. Between the liquidity provided by the GSEs, the increasing frequency of loan extensions, and the expectation that financial market conditions will soon improve, the small asset class remains on solid footing and distress should remain contained.

 

In the past decade, there have been 3.5 million more household formations than new housing unit completions. The ongoing housing shortage in the U.S. will result in above-average multifamily demand levels for the foreseeable future. If the Federal Reserve moves to cut interest rates this year, it will further help bridge gaps between buyers and sellers, accelerating the small multifamily sector’s normalization.

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833.578.0312

Disclaimer

This report is intended for general guidance and information purposes only. This report is under no circumstances intended to be used or considered as financial or investment advice, a recommendation or an offer to sell, or a solicitation of any offer to buy any securities or other form of financial asset. Please note that this is not an offer document. The report is not to be considered as investment research or an objective or independent explanation of the matters contained herein and is not prepared in accordance with the regulation regarding investment analysis. The material in the report is obtained from various sources per dating of the report. We have taken reasonable care to ensure that, and to the best of our knowledge, material information contained herein is in accordance with the facts and contains no omission likely to affect its understanding. That said, all content is provided herein “as is” and neither Arbor Realty Trust, Inc. or Chandan Economics, LLC (“the Companies”) nor their affiliated or related entities, nor any person involved in the creation, production and distribution of the content make any warranties, express or implied. The Companies do not make any representations or warranties, express or implied, as to the reliability, usefulness, completeness, accuracy, currency nor represent that use of any information provided herein would not infringe on other third-party rights. The Companies shall not be liable for any direct, indirect or consequential damages to the reader or a third party arising from the use of the information contained herein. There may have been changes in matters which affect the content contained herein and/or the Companies subsequent to the date of this report. Neither the issue nor delivery of this report shall under any circumstance create any implication that the information contained herein is correct as of any time subsequent to the date hereof or that the affairs of the Companies have not since changed. The Companies do not intend, and do not assume any obligation to update or correct the information included in this report. The contents of this report are not to be construed as legal, business, investment or tax advice. Each recipient should consult with its legal, business, investment and tax advisors as to legal, business, investment and tax advice. The information contained herein may be subject to changes without prior notice. This report is only intended for the recipients, and should not be copied or otherwise distributed, in whole or in part, to any other person.

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 million and loan-to-value ratios above 50%.

Single-Family Rental Investment Trends Report Q2 2024

Single-Family Rental Investment Trends Report Q2 2024

SFR Construction Soars as Rent Growth Remains Robust

Key Findings

  • SFR/BTR construction starts surged to another new record high.
  • CMBS activity jumped, signaling improvements in structured capital markets.
  • Cap rates climbed to 6.6% amid high interest rates and robust rent growth.

Table of Contents

State of the Market
Performance Metrics
Supply & Demand Conditions
Outlook

PDF link below

State of the Market

Despite ongoing challenges in the capital markets environment, the strength of the single-family rental (SFR) sector has become fully apparent. As it reaches new highs quarter after quarter and build-to-rent (BTR) construction surges, optimism is building in SFR’s long-term prospects.

 

SFR construction has shown considerable gains since homeownership became substantially less affordable after interest rates started rising in March 2022. According to data from the Atlanta Federal Reserve Bank, buying a home is about 29% less affordable today than at the onset of the pandemic. As a result, BTR communities have attracted the attention of tenants and investors, driving the number of SFR/BTR construction starts to an all-time high.

 

While the interest rates have presented real challenges, the SFR sector’s favorable balance of tailwinds is unmistakable. Occupancy rates are stable, rent growth remains robust, and construction momentum has never been stronger. As 2024’s midpoint approaches, SFR’s structural strengths continue to outweigh cyclical headwinds.

Performance Metrics

CMBS Issuance

Structured SFR capital markets registered high levels of activity to start the year. According to Finsight, SFR CMBS issuance totaled $1.9 billion in the first quarter of 2024 — more than doubling the output of $713 million in the fourth quarter of 2023 (Chart 1). Additionally, issuance in the first quarter reached its highest quarterly total since the middle of 2022. If SFR CMBS issuance were to sustain its first-quarter pace through the balance of the year, the annual total would reach $7.7 billion, a 45% increase from its 2015-2019 average of $5.3 billion.

Originations by Purpose

With elevated interest rates reducing the incentive for refinancing, new acquisition loans have accounted for the lion’s share of SFR originations over the past two years. According to Fannie Mae, new loans intended for purchasing accounted for 78.0% of SFR lending activity in 2023 — the highest share on record going back to 1999 (Chart 2). Simultaneously, rate-and-term refinancing loans, which accounted for nearly 50% of originations as recently as 2020, were 5.8% of 2023’s lending activity.

In 2023, the dollar volume of rate-and-term refinancings fell by 74.5% from the previous year, according to an analysis of Fannie Mae data (Chart 3). Cash-out refinancings dropped similarly, decreasing 74.2%. However, investor pullback in single-family purchases was only 38.6%, about half as severe as the decline was for refinancings. The recent slide in SFR purchasing activity has been comparable to trends in other commercial real estate sectors. For example, single-family home purchases by first-time and non-first-time homebuyers fell by 30.0% and 27.0%, respectively.

Occupancy

SFR occupancy rates remained strong through the first three months of the year and continued to support the sector’s structural health. Occupancy rates across all SFR property types averaged 94.7% in the first quarter of 2024, according to U.S. Census Bureau data (Chart 4). The first quarter average SFR occupancy rate was an improvement of 30 bps over the prior quarter and an increase of 30 bps over the same time last year. DBRS Morningstar, which tracks the performance of 128,350 SFR units within its rated CMBS transactions, reported a similarly healthy SFR occupancy rate of 92.9% through February 2024, another sign that renter interest in SFR continues to be high.

Rent Growth: National

National SFR rent growth climbed at a healthy pace through 2024’s first quarter mark. According to Zillow’s Observed Rent Index (ZORI) for single-family rental properties, rents in the sector were up 5.0% from a year earlier through March 2024 (Chart 5). While rent growth slowed from the lofty, unsustainable double-digit growth rates seen in 2021 and 2022, the pace of increase remained robust by historical standards. The first quarter’s growth rate sits well above the pre-pandemic (2016-2019) average of 4.4% for the sector.

Data from DBRS Morningstar helps to shed light on the difference in rent growth trends between renewing leases and properties that have turned over with a new set of tenants. According to the company’s latest report, vacant-to-occupied (V2O) rent growth resumed seasonal patterns, where rent growth peaks in the spring and bottoms out in the fall, with current V2O growth sitting at 2.0% through January 2024. Rent growth for renewals, which generally accounts for more than 80% of the sector’s leased units, stood higher at 4.7%.

Rent Growth: Metros

Of the top 20 SFR hotspot markets — those with the highest SFR share of rentals among the 50 most populous metros — Richmond, VA, had the most robust levels of SFR rent growth through March 2024, with prices rising 8.1% from a year earlier (Chart 6). Following closely behind was St. Louis, MO, with an increase of 7.7% and Birmingham, AL, which saw 7.5% growth. At the other end of the spectrum are a few markets where rent growth accelerated most quickly during the post-pandemic boom and has since cooled, including Phoenix, AZ (+2.5%), Las Vegas, NV (+3.4%), and Memphis, TN (+3.4%).

Cap Rates

SFR cap rates ascended again in the first quarter of 2024, climbing 11 bps to 6.6% (Chart 7).1 Cap rates have now risen in six of the past nine quarters, increasing by a total of 132 bps to hit their highest point since the second quarter of 2018. In today’s elevated interest rate environment, investors have broadly revised their yield requirements. The ongoing upward movement of cap rates comes as home prices slid slightly nationally in the first quarter of 2024 and resilient rent growth continues to support rising property-level incomes.

Another key measure of the health of the SFR market is the spread between SFR cap rates and 10-year Treasury yields that approximates the SFR risk premium. In the first quarter, 10-year Treasury notes carried an average yield of 4.2%, falling from 4.5% during the fourth quarter of 2023. As average Treasury yields fell and SFR cap rates rose, the SFR risk premium climbed 243 bps in the first quarter (Chart 8). At the same time, the spread between SFR and multifamily properties widened slightly by 5 bps, averaging 116 bps.

Pricing

There are consistent differences between the average assessed property values on mortgages originated to single-family owner-occupants versus single-family investors. Underwriters consider factors, such as vacancies, turnover, and management-related expenses, not present in owner-occupied units, that contribute to generally lower assessed values for rental units. Additionally, SFR investors often target value-added assets instead of paying premium prices for properties with higher existing value.

 

The average valuation of a single-family rental property that received a Fannie Mae mortgage in 2023 was $344,761 — down 2.8% from the 2022 average (Chart 9). During the same time period, average valuations for owner-occupied units increased 3.3%, reaching $415,575. Subsequently, the average underwritten valuation gap between the two groups of properties increased to 17.0% — its widest point since 2012.

The drop-off in SFR valuations on properties with Fannie Mae mortgages in 2023 reflects heightened caution among buyers. Investors want to have a high degree of confidence that their assets will appreciate over the short term to justify making a purchase. In a housing market with recent price instability and a dearth of transaction activity, many investors require higher yields and lower prices to execute an acquisition.

Debt Yields

Debt yields, a key measure of credit risk, jumped again during the first quarter of 2024, rising by 23 bps to land at 10.9% (Chart 10). The increase marked the seventh time debt yields have risen in the past nine quarters, highlighting that lenders have remained diligent in an unsettled investment climate. The rise in debt yields in recent quarters translated to SFR investors securing less debt capital for every dollar of property-level net operating income (NOI). Through the first quarter of 2024, SFR debt declined to $9.16 for every dollar of NOI, a decrease of $0.20 from the previous quarter and a drop of $0.78 from the same time last year.

Supply & Demand Conditions

Residential Distress

Even with mortgage rates remaining above 7%, there has been little to no distress across the U.S. housing market. Most homeowners have locked-in rates that are well below prevailing market norms, resulting in a shrinking of available housing inventory, and home valuations pressing all-time highs. Meanwhile, underwriting standards have tightened for borrowers who are applying for mortgages. According to the Federal Reserve Bank of New York’s Q1 2024 Quarterly Report on Household Debt and Credit, the share of new borrowers with a credit score above 760 has risen in four consecutive quarters and currently sits at 70.5%.

 

The New York Fed’s report indicated that only 0.9% of household mortgages are more than 90 days delinquent, slightly below where default rates were at the start of the pandemic (Chart 11). Mortgage performance trends differ from other types of household debt that are more sensitive to variable interest rates, such as credit cards. In the past year, the share of mortgages that are more than 90 days delinquent rose by 16 bps. Meanwhile, the share of credit card debt that is seriously delinquent rose 245 bps. These two disparate trends underscore that although some of the conditions necessary for distress are present, the unique contours of the mortgage market have thus far insulated the housing sector from interest-rate-driven defaults.

Within the SFR sector, newly released data suggests that distress patterns mirror the broader single-family ecosystem. According to DBRS Morningstar, within rated SFR CMBS transactions, only 2.9% of loans were delinquent in February 2024 — nearly half the 5.4% rate reported one year earlier (Chart 12).

Build-to-Rent

BTR communities have become a defining feature of the SFR sector. Through the first quarter of 2024, BTR production was robust. Over the past 12 months, BTR accounted for 8.0% of all single-family construction starts, remaining near its record high (Chart 13). For comparison, before the 2007-2009 recession ended, the BTR share of single-family construction never eclipsed 3.1%. By unit count, there were 80,000 BTR construction starts in the 12 months ending in the first quarter of 2024 — also a new record high. Compared to a year ago, the rolling annual sum is up by 15.9%, demonstrating a sustained surge in development.

Outlook

Even as the impact of persistently high interest rates is readily apparent, the structural strengths of the SFR sector are impossible to ignore. The continued surge in BTR construction shows undeterred optimism in SFR’s long-term prospects. Its strengthening pipeline continues to reduce the need for converting existing single-family homes into rental units. Property-level yields remain heavily influenced by movements in the broader interest rate environment. With barriers to ownership increasing for would-be homebuyers, single-family rental homes continue to absorb an increasing share of housing demand generated by Generation Z, lifestyle renters, and even downsizing Baby Boomers. Strengthened by sound fundamentals, SFR is surging and has room to grow within the multifamily real estate sector.

1 Unless otherwise noted, the Chandan Economics data covering single-family rental cap rates and debt yields are based on model estimates and a sample pool of loans. Data are meant to represent conditions at the point of origination.

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Disclaimer All content is provided herein “as is” and neither Arbor Realty Trust, Inc. or Chandan Economics, LLC (“the Companies”) nor their affiliated or related entities, nor any person involved in the creation, production and distribution of the content make any warranties, express or implied. The Companies do not make any representations regarding the reliability, usefulness, completeness, accuracy, currency nor represent that use of any information provided herein would not infringe on other third party rights. The Companies shall not be liable for any direct, indirect or consequential damages to the reader or a third party arising from the use of the information contained herein.

Small Multifamily Investment Trends Report Q2 2024

Small Multifamily Investment Trends Report Q2 2024

Valuations and Cap Rates Stabilize as Fundamentals Support Growth

Key Findings

  • Small multifamily valuations held steady over the last quarter.
  • Cap rates fell for the first time in nearly two years, sliding 5 bps.
  • Credit conditions remain conservative as debt yields rose to 9.5%.

Table of Contents

State of the Market
Lending Volume
Loans by Purpose
Arbor Small Multifamily Price Index
Cap Rates & Spreads
Expense Ratios
Occupancy Rates
Leverage & Debt Yields
Outlook

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State of the Market

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.

Lending Volume

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%.

Loans by Purpose

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%.

Arbor Small Multifamily Price Index

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.

Cap Rates & Spreads

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

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%.

Occupancy Rates

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.

Leverage & Debt Yields

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.

Outlook

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.

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Disclaimer
All content is provided herein “as is” and neither Arbor Realty Trust, Inc. or Chandan Economics, LLC (“the Companies”) nor their affiliated or related entities, nor any person involved in the creation, production and distribution of the content make any warranties, express or implied. The Companies do not make any representations regarding the reliability, usefulness, completeness, accuracy, currency nor represent that use of any information provided herein would not infringe on other third party rights. The Companies shall not be liable for any direct, indirect or consequential damages to the reader or a third party arising from the use of the information contained herein.

Affordable Housing Trends – Spring 2024

Affordable Housing

Trends Report

Spring 2024

About This Report

The Arbor Realty Trust Affordable Housing Trends Report, developed in partnership with Chandan Economics, offers a wide-ranging view into the complex, yet critically important affordable and workforce housing sectors.

 

This report series is a comprehensive primer to help industry stakeholders understand the major trends shaping the affordable housing market. It addresses the significant changes observed both in terms of policy decisions and market dynamics and describes opportunities for investment and financing in the space.

 

Focused primarily on affordable housing supported by government spending, subsidies, or tax incentives, including the Low-Income Housing Tax Credit (LIHTC), Housing Choice Vouchers (HCV), and Project-Based Section 8, these reports also cover the Naturally Occurring Affordable Housing (NOAH) segment and the utilization of rent control.

Key Takeaways

  • Approximately half of all rental households in the U.S. are now classified as moderately or severely cost-constrained.
  • Critical affordable housing programs received funding expansions in the recently passed FY 2024 federal spending package.
  • Up-zoning is being utilized more frequently to encourage affordable housing creation by allowing development in higher-density areas.

Table of Contents

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State of the Market

As the cost of homeownership climbs ever higher, the affordability crisis has become one of the nation’s most intractable issues. The number of renters that are either moderately or severely housing cost-constrained reached an all-time high of 22.5 million households in 2022, accounting for roughly half (49.8%) of all rentals (Chart 1)1, according to a Chandan Economics analysis of U.S. Census Bureau data. While the number of non-cost-burdened rental households has remained effectively flat (-0.05%) over the past five years, cost-burdened rentals have swelled by 10%.

 

The National Low Income Housing Coalition’s (NLIHC) March 2024 report The Gap notes that the shortage of affordable rental housing widened between 2019 and 2022, expanding by 480,000 units. The NLIHC estimated that the U.S. currently needs 7.3 million more affordable housing units to meet current demand.

As affordable housing advocates continued to pressure lawmakers, the federal government’s 2024 budget offered some welcomed news. It included an $8.3 billion increase in funding for the U.S. Department of Housing and Urban Development’s affordable housing programs. At the same time, state and local governments are utilizing policy initiatives, including tax credits for new construction and targeted amendments to zoning codes, to encourage development. With more funding on the way, policymakers and private market advocates are pressing ahead with plans to add units to an increasingly tight housing market.

LIHTC

The Low-Income Housing Tax Credit (LIHTC) program is the nation’s single-largest supply-side affordable housing resource. LIHTCs come in two forms: a 9% tax credit to incentivize new development and a 4% tax credit for rehabilitating and preserving existing properties. According to the National Housing Preservation Database, LIHTCs supported approximately 2.6 million rental units in 2023. In recent years, developer funding gaps have limited the use of the 9% LIHTC. Construction costs have soared while the 9% LIHTC tax credit, which developers can sell to finance their projects, has declined in value. Following the 2016 election, LIHTC equity prices dropped in value by about 10% as investors anticipated (and eventually received) a decrease in tax liabilities (Chart 2). Since 2021, 9% LIHTC equity prices have stabilized between $0.87 and $0.89 per credit, according to CohnReznick’s Housing Tax Credit Monitor.

Meanwhile, the rehabilitation tax credit became more appealing after the December 2020 passage of the Consolidated Appropriations Act established a minimum 4% floor on the applicable federal tax credit rate for tax-exempt multifamily housing private activity bonds (PABs). The minimum floor made the 4% tax credit more valuable and increased how much funding developers can raise to finance construction. As a result, the 4% LIHTC tax credit for rehabilitation became more attractive compared to the ground-up development 9% credit, leading to a greater share of rehabilitation activity. In 2023, the 4% credit accounted for 59.5% of newly HUD-insured LIHTC mortgages — a new high.

 

In 2023, the dollar volume of investor equity closed into housing tax credit funds reached another record high of $26.3 billion — an increase of 6.6% year-over-year, according to CohnReznick (Chart 3). In its Housing Tax Credit Monitor Report, CohnReznick notes that two factors were largely responsible for the volume increase: increased use of the 4% tax credit and the Community Reinvestment Act (CRA). Amended in October 2023, the CRA encourages banks to help meet the credit needs of low- and moderate-income neighborhoods.

Despite the federal LIHTC program’s overwhelming importance, LIHTC’s complexity and incremental funding expansions have made it more difficult for it to keep pace with the growing national need for new housing. However, progress has been moving faster at the state level. According to Novogradac, 29 states now have state-level LIHTC programs, more than double the amount just a decade ago, with 17 state-level programs introduced since 2013. This trend likely has staying power after Texas and Rhode Island both introduced LIHTC programs in the past year.

Project-Based Section 8

The Section 8 Project-Based Rental Assistance (PBRA) program is one of the largest affordable housing initiatives in the U.S., supporting an estimated 1.4 million rental units through 2023. It is open to low-income households earning at most 80% of their local area median income. Landlords participating in the PBRA program receive the fair market rent (FMR) for each occupied unit, as established by the local public housing agency. Tenants are responsible for paying up to 30% of their adjusted income toward rent and utilities or $25 — whichever is greater. The Federal PBRA subsidy will then cover the difference between the FMR and the tenant contribution.

 

For decades, this program has successfully attracted large numbers of private, for-profit owners. Between 1990 and 2023, the share of owners entering Section 8 PBRA that are profit-motivated has grown from 3.4% to 91.2% (Chart 4). The U.S. Department of Housing and Urban Development has also made a series of updates and rule changes in the past year that make the program more attractive to the private market and make it easier for owners to rehabilitate and re-capitalize their properties. In 2024, the PBRA is slated to receive a much-needed boost in federal support as HUD’s FY 2024 budget included a 7.4% increase above FY 2023 levels.

Housing Choice Vouchers (HCV)

LIHTC is the largest supply-side affordable housing program in the U.S., but the Housing Choice Voucher (HCV) program is the biggest overall and continues to grow. It accounted for nearly 2.8 million units or 53.7% of all federally subsidized rental units2, climbing 59 basis points (bps) from 2022 (Chart 5). The next largest program by unit count, Project-Based Section 8, is a distant second at 25.6%. (Note: LIHTCs are excluded from this analysis.)

The HCV program is primarily a form of tenant-based housing assistance in which renters spend 30% of their adjusted monthly income on rent, and the balance is covered through a subsidy — much like in the PBRA program. However, the HCV program allows tenants to move to a new location and maintain their voucher, which promotes housing mobility and greater access to economic opportunities. In 2023, the average household income for renters in this program was $17,835. Both major political parties and the private market broadly support the HCV program.

 

Unlike rent control, which places the subsidy burden on the landlord, HCVs interact openly in a market setting. The program gives households the option to retain their subsidy should they move, encouraging positive housing mobility. However, the HCV program has been slow to expand in recent years, failing to keep pace with the growing needs of low-income renters. Between 2019 and 2022, the program grew an average of 1.8% annually (Chart 6). The pace of its increase slowed to 1.3% in 2023, as federal government operations were funded through a series of short-term spending bills. But with more support from the federal government promised, next year’s projections are brighter. Funding for the HCV program is set to expand by nearly 7% (or $2.1 billion) in 2024.   

In October 2023, HUD announced that it was expanding its Small Area Fair Market Rents (SAFMR) rule to an additional 41 metropolitan areas. Under the SAFMR rule, the maximum rent covered by the voucher is determined by rent prices within local zip codes — rather than at the metro level. The updated policy allows the voucher program to track local market conditions more closely, improving their usability and utility. By extension, tenants can more easily use vouchers to access higher-rent neighborhoods with better-performing schools and improved economic opportunities.

Zoning

Zoning law reform has emerged as a favored policy tool among both tenant and industry advocates searching for a solution to the ongoing housing supply shortage. Recently, NPR called up-zoning the “hottest trend in U.S. cities,” with roughly 20 municipal-level reforms being considered nationwide as of April 2024.

 

Up-zoning allows an increase in the density of housing units in a given area. Experts consider it to be a way to lift the artificial cap on the amount of housing that can exist in a local area. The idea behind up-zoning is that allowing more new construction and improving the supply of rental units will decrease competition for housing and slow rent growth.

 

In recent years, states such as California, Vermont, and Montana, alongside numerous localities, have implemented generational changes to zoning laws. According to the University of California, Berkeley’s zoning reform tracker, Washington has had the most up-zoning reforms since 2007, with 15 adopted or ongoing. California follows closely behind, with 14 adopted or ongoing up-zoning reforms, while North Carolina, Minnesota, and Michigan round out the top five.

 

Although the Federal government doesn’t hold jurisdiction over zoning, Congress funded a new grant program in its 2023 budget through the Department of Housing and Urban Development (HUD) called the “Yes In My Back Yard” initiative. It aims to incentivize states and localities to reform their zoning laws. The program’s initial $85 million in funding was raised to $100 million in the recently passed FY 2024 budget as part of HUD’s Community Development Block Grant (CDBG) program.

Naturally Occurring and Workforce Housing

While public attention often centers on regulation and policy, naturally occurring affordable housing (NOAH) makes up a much greater share of the total affordable supply. According to an analysis of Freddie Mac lending data and other estimates, NOAH outnumbers regulatory-supported units by a factor of four. In 2023, NOAH properties accounted for nearly 75% of multifamily originations of units affordable at 80% or below the local area median income (AMI) (Chart 7)3.

In 2024, Fannie Mae and Freddie Mac each have a $70 billion multifamily lending cap — down from $75 billion in 2023. However, the FHFA is maintaining its direction that at least 50% of the agencies’ loan volume needs to be mission-driven lending, such as supporting the creation and preservation of affordable housing. Loans classified as supporting workforce housing properties are exempt from the volume caps, which should generate more liquidity within the workforce housing segment.

 

Nationally, workforce housing, which is often called the ‘missing middle,’ is starting to attract the policy attention it deserves. In December 2023, the Workforce Housing Tax Credit Act was introduced to both chambers of Congress. If passed, the bill would establish a middle-income housing tax credit (MIHTC), which is modeled after the success of the LIHTC program, to help finance the construction of an estimated 344,000 rental units. In addition to the bill receiving support from both Republicans and Democrats, the National Multifamily Housing Council and the National Apartment Association have also endorsed the proposed legislation.

Rent Control

Over the past few years, rent control has reemerged as a political issue. Cities like San Francisco, San Diego, and Washington, D.C., have imposed new restrictions on landlords in recent years, while new state-wide regulations in Washington could potentially follow those already in place in Oregon and California. But, rent control continues to be a contentious topic of discussion.
The long-standing position of housing market economists remains that rent control tends to adversely impact the same renters the policy intends to help.

 

A recent NMHC Report, Rent Regulation Policy in the United States, explores how, in the long run, rent control policies reduce the number of housing units in a market, exacerbating affordability issues. Rent control regulations can also negatively impact land values, reducing local communities’ tax revenues. A 2024 review of rent regulations by the Federal Reserve of St. Louis found that following rent control implementation, rental stock typically declines as landlords and developers pivot towards owner-occupied properties, undermining potential benefits to tenants.

 

At the Federal level, the rent control debate remains intense, especially concerning LIHTC. Earlier this year, HUD announced an update to its formula for the maximum allowable rental increase for units in properties receiving LIHTCs. Under the new methodology, the maximum annual rent increase is lowered to 10% — down from 14.7% using the previous methodology. Novogradac estimates that the share of units that the rent cap will impact will rise from 10% to 30%. Industry groups broadly oppose the rule change. Mortgage Bankers Association noted that the updated rent cap policy severely suppresses the LIHTC program and “contradicts many of the Administration’s other efforts to increase affordable rental housing.”

What to Watch

Looking ahead, increasing the affordable housing supply will continue to require an all-hands-on-deck approach. The bi-partisan Tax Relief for American Families and Workers Act of 2024 passed the House with overwhelming support earlier this year, although its fate remains uncertain in the Senate. If passed, the bill would restore higher allocation increases for LIHTC, which could lead to the creation of an additional 200,000 affordable rental units.

 

The path forward may differ depending on which major political party controls the White House and Congress in 2025. The Biden-Harris Administration’s proposed FY 2025 budget calls for meaningful expansions of key policy programs, including HCV, LIHTC, and PBRA. Meanwhile, the Republican Study Committee recently released its FY 2025 Budget Proposal, which calls for combining and re-purposing current Federal subsidies for programs such as LIHTC and PBRA into increased funding for Housing Choice Vouchers.

 

Although housing affordability is a national concern, state and local lawmakers continue demonstrating their worth in easing the crisis. As myriad solutions aimed at expanding supply begin building upon one another, fundamental change will be next to follow.

Terms and Definitions

Sources: U.S. Department of Housing and Urban Development; Tax Policy Center; Chandan Economics

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1 Housing cost burden measured as gross rents, including contract rents and utilities. For this analysis, households with no recorded gross rent are considered non-cost-burdened and households with positive gross rents and negative or no incomes are considered severely cost-burdened.

2 The total is based on data retrieved from HUD’s Office of Policy Development and Research as of the end of 2023.

3 According to a Chandan Economics analysis of Freddie Mac K-Deals.

 

Disclaimer
All content is provided herein “as is” and neither Arbor Realty Trust, Inc. or Chandan Economics, LLC (“the Companies”) nor their affiliated or related entities, nor any person involved in the creation, production and distribution of the content make any warranties, express or implied. The Companies do not make any representations regarding the reliability, usefulness, completeness, accuracy, currency nor represent that use of any information provided herein would not infringe on other third party rights. The Companies shall not be liable for any direct, indirect or consequential damages to the reader or a third party arising from the use of the information contained herein.

Top Markets for Large Multifamily investment Report 2023

Top Markets for Large Multifamily Investment Report 2023

Table of Contents

Overview | The Opportunity Matrix | Top Ranked Markets | Large Multifamily Investment | Supply and Demand Equilibrium | Rental Affordability | Climate Risk and Readiness | Market Spotlight: Orlando | Outlook | Appendix

Overview

In 2023, investors need a sharp eye to pinpoint the top multifamily real estate opportunities. With elevated interest rates and volatility becoming the new normal, the risk vs. opportunity assessments of individual markets have shifted as domestic migration and insurance market corrections have changed the calculus.

The Arbor Realty Trust-Chandan Economics Large Multifamily Opportunity Matrix analyzed the top 50 U.S. metros for real estate investment to identify those markets most prime for apartment sector growth in 2023. Rising to the top this year were Orlando, Austin, and Charlotte, three attractive Sun Belt markets ripe with opportunity.

Methodology

This report presents an analytical framework to develop a cross-market comparison for opportunistic multifamily investments. For the purposes of this analysis, “large multifamily” is considered to be assets containing 50 or more units with a combined valuation exceeding $20 million.

The top 50 U.S. metros1 are ranked using the Arbor-Chandan Large Multifamily Opportunity Matrix based on a weighted average of performance metrics. The Opportunity Matrix pays specific attention to how well metro-level economies have maintained strength over the past year and how they are positioned to handle shifting market conditions in 2024 and beyond.

 

1 The top 50 metros are based on population estimates. All metros are reported at the Metropolitan Statical Area (MSA) level.

Key Findings

  • Orlando is 2023’s most desirable metropolitan market for large multifamily investment due to its robust population growth, a rapidly growing financial services sector, and low risk of natural hazards.
  • The biggest cities in the U.S., including New York, Los Angeles, San Francisco, and Chicago, have become less attractive to multifamily investors as these metros become less affordable and more renters move elsewhere.
  • Austin ranked second out of 50 as it continues attracting new residents and has the highest percentage of renters under 35 of all metros on the list.

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The Opportunity Matrix

The Opportunity Matrix measures eight key categories, each described in more detail on the next section.

  1. Large Multifamily Investment: measured as a proxy for debt financing availability, overall liquidity, and a market’s ability to support additional multifamily investment. Multifamily loans (both acquisitions and refinancings) with original balances above $15 million are included for analysis.
  2. Labor Market: topline profile of key labor market performance indicators, including market size and growth, unemployment rate, change in the unemployment rate over the past year, and wage growth.
  3. Population Growth: overall growth of a metro over the short and medium term.
  4. Renter Demographics: spending power and age profile of existing renters (higher household incomes and younger renters assumed as conducive for higher levels of multifamily demand).
  5. Renter Vacancy: measures the current market tightness for all existing
    metro-level rental inventory.
  6. Supply and Demand Equilibrium: compares aggregate population increases to the volume of new multifamily permitting activity as a proxy for market tightness and ability to absorb new, large-scale multifamily supply.
  7. Affordability: minimum income needed to rent an apartment without
    being rent-burdened, included to capture a market’s attractiveness for
    incoming rental demand.
  8. Climate Risk: measures both risk and readiness, included to account
    for the increasing frequency of natural hazards and the evolving property insurance landscape.

The Opportunity Matrix includes factors a multifamily investor might consider in their market selection process. All eight categories have received equal weighting. In categories with more than one variable, each variable received equal weighting.

Top Ranked Markets

Orlando is 2023’s top ranked market due to its well-rounded fundamentals and impressive labor market performance over the past year (Chart 1). A premier travel destination, this central Florida city performed better than the average metro in a majority of the variables measured in the matrix. For instance, Orlando’s population inflows were impressive. In 2022, the Orlando metropolitan area saw its resident population swell by 2.4% — the second-highest mark in the country. Due in part to its inland location (42 miles from the ocean), Orlando has not only the lowest climate risk score in Florida but one of the lowest in the country.

For a full breakout of the 2023 scores and rankings, see Table 3 in the Appendix at the end of the report.

Now, with the introduction of Brightline, a privately operated high-speed train line, Orlando and Miami are enjoying the benefits of integrating two thriving economies.

Austin, the home of many large tech companies, claims the No. 2 spot in this year’s rankings. With the rental vacancy rate in Austin sitting at 7.3%
(1.6 percentage points above the top 50 median) and rents falling 1.8% year-over-year through July, the capital of Texas is going through a transition phase as it absorbs a deluge of new housing supply. Still, signs of a turnaround are already underway, and Austin’s demand drivers are too strong to ignore. Austin’s 2022 population growth rate reached 2.7%, which was 0.3 percentage points higher than any of the other 50 metros. Further, 50.8% of Austin’s renters are below 35 years of age, leading all other markets.

After ranking 10th in 2022, Charlotte has shot up the board to round out this year’s top 3. North Carolina’s largest city, where households can comfortably rent an apartment with an income of about $75,000, remains more affordable than the top 50 market average of $78,557.
Charlotte features major-city urban amenities in an affordable environment, making it a popular destination for young relocating renters. Charlotte’s population growth rate reached 1.8% in 2022 — the eighth-highest pace of the top 50 metros in the Opportunity Matrix. This southern commercial hub, which has the fifth-highest average rental household income ($95,007), also contains a strong base of higher-income renters.

Large Multifamily Investment

Large multifamily investment across U.S. markets has been anything but uniform. Here, we analyze a pool of loans across the top 50 metros with originations between July 2021 and June 2022 and original balances above $15 million. Lending volumes include loans originated for both investment sales and refinancings. These data are leveraged as a proxy to determine which markets have the most liquidity to support large multifamily investments. Leading the way were Dallas, New York, and Los Angeles, which accounted for 7.1%, 6.9%, and 6.8% of the observed sample, respectively (Chart 2).

Supply and Demand Equilibrium

To analyze the supply and demand equilibrium, we compared metropolitan markets’ 2022 population inflows to the volume of residential permitting activity from July 1, 2022, to June 30, 2023, to determine market tightness and the demand for new housing. For example, a market that is gaining new residents faster than adding new housing supply would theoretically exert upward pressure on pricing.

Applying this logic on the reverse side of the spectrum, markets with population outflows or high levels of new residential construction relative to incoming housing demand could expect softening prices. Tampa, No. 14 on the Opportunity Matrix, ranked first in the supply and demand equilibrium category (Chart 3). Tampa’s population increased by 61,653 people in 2022, while 25,854 housing permits were tracked from the third quarter of 2022 to the second quarter of 2023.

Other top performers in this category were Dallas, San Antonio, Oklahoma City, and Orlando. New York (41st), Los Angeles (46th), and Chicago (50th) — the country’s three largest cities — all rank in the bottom 10 in this category as a result of sizable population outflows in 2022.

Rental Affordability

One of 2023’s most compelling topics, housing affordability, factored heavily in the 2023 Opportunity Matrix. According to an analysis of the U.S. Census Bureau’s 2022 Current Population Survey, a desire for cheaper housing, better/new housing, a more desirable neighborhood, or another housing-centric reason motivated 35.6% of renter-moving decisions last year. Due in part to the adoption of remote work, Americans are less constrained by location than they were pre-pandemic, giving them greater flexibility in their housing choices. As a result, migration has begun accelerating to affordable metros. According to a recent analysis by Freddie Mac, “the pandemic amplified existing urban de-concentration by threefold, from large, expensive metro areas to smaller, more affordable destinations.”

To measure housing affordability in the Opportunity Matrix, we reviewed data from Waller, Weeks, and Johnson Rental Index — a collaborative research series produced by teams at Florida Atlantic University, Florida Gulf Coast University, and the University of Alabama, who calculate the minimum income required in each metro for households not to be considered rent-constrained. Those metros with lower income thresholds for affordability were then rewarded in our matrix since they are more attractive to renters in search of low-cost, high-quality housing options.

Milwaukee leads the country in terms of rental affordability in 2023. With an average monthly rental price of $1,344 through July 2023, households earning $53,760 or more are not considered rent-burdened in Wisconsin’s largest city. Just behind Milwaukee is St. Louis, another powerhouse city in the Midwest, where the rent-burdened threshold is $53,880. Rounding out the top 5 in this category are Buffalo ($54,440), Louisville ($54,640), and Oklahoma City ($54,960). Meanwhile, the threshold is more than twice as high in the coastal cities of New York ($137,800), San Jose ($137,000), and San Diego ($128,200).

Climate Risk and Readiness

A topical inclusion to this year’s opportunity matrix is climate risk and climate risk preparedness. According to a recent analysis by Redfin, migration into disaster-prone areas has accelerated in recent years. With incidences of major storms, extreme heat, and wildfires all on the rise, property owners now need to incorporate the risks into their investment decisions. Moreover, the risk to rental operators extends beyond direct damage from a climate event. Property insurance prices have skyrocketed in coastal markets in Florida, while some major coverage providers have pulled out of California due to wildfire risks. As insurance markets recalibrate to shifting climate risks, rental property owners may face a combination of rising costs and growing risk exposure.

To assess climate risk, we utilized the Federal Emergency Management Agency’s (FEMA) National Risk Index for Natural Hazards (NRI). FEMA describes the NRI as a “tool that shows which communities are most at risk to natural hazards. It includes data about the expected annual losses to individual natural hazards, social vulnerability, and community resilience.” Within our opportunity matrix, we included two composite indices tracked by the FEMA NRI: overall risk and overall readiness.

On the risk front, Miami is the most hazard-prone metro among the top 50, driven primarily by exposure to hurricanes and flooding. Following behind Miami are Chicago, Los Angeles, and Hartford. On the positive end of the spectrum are Oklahoma City, Orlando, and Charlotte — all of which are set away from the coast by at least 40 miles. When it comes to natural hazard readiness, Seattle, Minneapolis, and Raleigh receive the highest ratings among the top 50, while Riverside, Sacramento, and Providence are the least prepared metros for natural hazards.

Market Spotlight: Orlando

Does Orlando have a touch of magic — or just a strong set of economic fundamentals? Perhaps it’s a bit of both.

Driving Orlando up to the top spot in the 2023 Opportunity Matrix is a labor market continuing to grow at an impressive clip, which is, in turn, attracting new residents to Central Florida’s economic epicenter. Through July 2023, Orlando had an unemployment rate of just 2.8% while the number of jobs in the metro is up by 2.9% from the same time last year — the 6th highest mark of all 50 metros. With Orlando businesses hiring and local labor in short supply, firms have been bidding against each other for talent, leading to significant wage growth.

The largest industry in town is, of course, tourism. Orlando is America’s number one travel destination, welcoming 74 million visitors in 2022. Leisure and hospitality jobs have grown by 7.5% year-over-year and account for 20.2% of Orlando’s employment, making it the metro’s dominant sector. While tourism provides a comfortable bedrock of support, Orlando’s accelerating diversification is spurring optimism. Notably, Orlando’s financial sector has gained significant momentum since the start of the pandemic as more firms and households relocate to the area. Through July 2023, the financial services sector has swelled by 14.2% above its pre-pandemic peak.

Placing Orlando on an encouraging growth track is the Brightline — the country’s first high-speed private railway, which began service in September 2023. The Brightline runs from Orlando to Miami and completes its journey in about 3.5 hours — 30 minutes less than the average drive time. Fortress Investment Group, Brightline’s owner, estimates that ridership will stabilize at eight million people annually. This new interconnectivity of Central Florida with the state’s southeast corridor is expected to pump an additional $6.4 billion into Florida’s gross domestic product over the next eight years, Brightline has projected.

It appears that word of Orlando’s economic prowess has become universal, with the population growth rate for the metro reaching 2.4% in 2022 — more than six times higher than the national average. Looking ahead, there are credible reasons to believe that Orlando will maintain the wind in its sails. The Orlando City Government anticipates that the urban population will grow another 46% by 2050. However, the changing dynamics of climate risk may contribute to an even larger population increase. Due to its low natural hazard/climate risk and close proximity to high-risk cities, Orlando is strategically positioned to attract migrating households and businesses.

The present success of the Orlando economy and favorable outlook for its future are strengthening rental housing’s fundamentals. According to data from the U.S. Census Bureau, Orlando’s rental vacancy rate averaged 4.5% in the first quarter of 2023 — placing it 11th among our top 50. Further, it has surpassed all other Florida markets in terms of multifamily sales activity in the past year, according to CoStar, making it ripe for investment into 2024.

Outlook

In 2023, multifamily investors are in uncharted waters. Cap rates have risen and transaction volumes have slumped, a reflection of a challenging interest rate environment. But at the same time, property-level operations have held up remarkably well, and high mortgage costs have strengthened demand for multifamily properties. All else being equal, the U.S. multifamily market is balanced by a favorable combination of headwinds and tailwinds that are likely to remain into 2024.

Looking ahead, natural hazards (and their impact on insurance markets) are beginning to have more influence on the risk/opportunity calculus of multifamily investors. Concurrently, conventional considerations of local economic success and their ability to attract new residents are as relevant as ever, especially with the U.S. population growth rate continuing to sink lower.

On a metro-by-metro basis, competition for residents is poised to escalate in the years ahead, creating new opportunities for large multifamily investment in metropolitan areas.

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About Us
Arbor Realty Trust, Inc. (NYSE: ABR) is a nationwide real estate investment trust and direct lender, providing loan origination and servicing for multifamily, single-family rental (SFR) portfolios, and other diverse commercial real estate assets. Headquartered in Uniondale, New York, Arbor manages a multibillion-dollar servicing portfolio, specializing in government-sponsored enterprise products. Arbor is a leading Fannie Mae DUS® lender, Freddie Mac Optigo® Seller/Servicer, and an approved FHA Multifamily Accelerated Processing (MAP) lender. Arbor’s product platform also includes bridge, CMBS, mezzanine, and preferred equity loans. Arbor is rated by Standard and Poor’s and Fitch. In June 2023, Arbor was added to the S&P SmallCap 600® index. Arbor is committed to building on its reputation for service, quality, and customized solutions with an unparalleled dedication to providing our clients excellence over the entire life of a loan.

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