Research Report Category: Small Multifamily Investment Trends

Expense Ratios

State of the Market

The U.S. economy grew by 5.7% in 2021, reaching $19.4 trillion (measured in inflation-adjusted, 2012 dollars), according to the Bureau of Economic Analysis. Considering the ongoing pandemic, the annual growth figure is a testament to the resiliency of the U.S. economy and strength of the current recovery.

Supply chain disruptions, labor shortages, and a shift to more goods consumption (as opposed to services) have all collectively stoked inflationary pressures. According to the Bureau of Labor Statistics (BLS) Consumer Price Index, prices of goods and services increased 7.0% from one year ago through December — the highest mark since 1982. In response, the Federal Reserve is prepping for a monetary policy tightening cycle. As of the latest Summary of Economic Projections, the policy-setting body of the Fed currently forecasts hiking interest rates three times in 2022 and three times again in 2023.

Annual lease structures within the multifamily sector are proving a valuable feature in a high inflation setting. According to Real Page, new lease rent growth reached 13.9% in November 2021 — a record-setting pace. Beyond inflation, data from the Mortgage Bankers Association indicates that mortgage credit availability remains significantly below pre-pandemic levels, supportive of rental housing demand.

Within the small multifamily sub-sector, there is significant recovery optimism, though some pandemic-era concerns remain. According to a recent analysis by Chandan Economics and RentRedi, independent landlords operating small multifamily properties continue to see lower full- and on-time collection rates compared to a pre-pandemic benchmark. With operating expenses rising with inflation and collection rates remaining below normal levels, small multifamily expense ratios have risen through 2021. Still, as this report will detail, small multifamily cap rates remain stable near their all-time lows, and loan-to-value ratios have started to recover. Moreover, a frenzied return of buyers and a wave of borrowers seeking to refinance ahead of the Fed’s monetary tightening are leading to record levels of origination and transaction activity. All else equal, while risks remain, demand stability and growing liquidity for small multifamily assets are broadly supportive of the sector heading into 2022.

Lending Volume

The initial year-end 2021 estimate of new multifamily lending volume on loans with original balances between $1 million and $7.5 million1 — including loans for apartment building sales and refinancing — surged to $85.4 billion (Chart 1). The estimate is a substantial step-up from previous 2021 annualized estimates, reflecting a sizable increase in originations at the end of the third quarter through the end of the year. The current estimate would represent an annual increase of $27.7 billion from last year’s total, or a 48.1% growth rate— the highest annual growth rate since 2012. Moreover, the 2021 originations estimate blows past the previous high of $59.2 billion set in 2019. Behind the dramatic surge in small multifamily lending volume are two interrelated trends. Confidence in the multifamily sector’s growth and the protection that tangible assets offer against inflation risk contributed to a wave of transaction activity through the end of the year. At the same time, with a Federal Reserve preparing for monetary tightening in 2022, borrowers are increasingly refinancing to lock into low-interest rates.

The balance of small multifamily originations for the purpose of refinancing versus acquisitions has come back in line with pre-pandemic levels. The refinancing share of small multifamily lending fell to 65.9% in the fourth quarter of 2021, declining from 70.3% in the previous quarter (Chart 2). The refinancing share of originations grew considerably through 2020, reaching a high of 79.7% of new small multifamily debt as lenders kept up production while pandemic-triggered uncertainty limited “arm’s length” transactions between buyers and sellers.

Arbor Small Multifamily Price Index

As measured by the Arbor Small Multifamily Price Index2, small multifamily asset valuations accelerated in the final quarter of 2021, notching robust quarterly and annual gains of 6.3% and 9.7%, respectively (Chart 3 and Chart 4). On an annual change basis, the fourth quarter rise in small multifamily asset values marks the largest jump since 2011. Compared to the crisis-low point reached in the second quarter of 2020, asset valuations are up by a significant 18.4%. Moreover, valuations are up by 13.8% over where they were at the onset of the pandemic.

Cap Rates & Spreads

National average cap rates for small multifamily properties were effectively flat in the fourth quarter of 2021, rising 1 basis point (bps) and remaining at a rounded 5.2% (Chart 5). While cap rate movements over the past half-year have been marginal, the fourth quarter reading marks the first time that small multifamily cap rates have risen in consecutive quarters since 2017. Small multifamily cap rates compressed considerably during the last real estate cycle, declining from a cyclical high of 7.6% in 2010 to their current range near 5.2%. Since the second quarter of 2020, small multifamily cap rates have sat in a narrow range between 518 bps and 534 bps.

The small multifamily risk premium, a measure of additional compensation that investors require to account for higher levels of risk, is best measured by comparing cap rates to 10-year Treasury yields. The credit quality of the U.S. government is perceived as unmatched, making the price it pays for its debt an approximation for the risk-free interest rate. The small multifamily risk premium averaged 368 bps in the fourth quarter of 2021, down from 388 bps the previous quarter (Chart 6). After reaching as high as 466 bps in the second quarter of 2020, risk premiums have normalized, declining in five of the past six quarters. In 2019, small multifamily risk premiums ranged from 318 bps to 405 bps, indicating that current levels are in-line with pre-pandemic assessments of risk. The cap rate spread between small multifamily assets and the rest of the multifamily sector, a measure of the risk that is unique to smaller properties, rose by 26 bps in the fourth quarter of 2021, settling at 42 bps— the largest spread since the first quarter of 2021 (Chart 7).

Expense Ratios

Expense Ratios, measured here as the relationship between underwritten property-level expenses to effective gross income, have risen for small multifamily properties over the past year— a sign that operators have not been able to boost rents enough to offset rising expenses. Moreover, a dip in rent collections is also impacting property-level cashflows. On-time rent payment rates in independently operated small multifamily properties were down by 6.0% from their pre-pandemic benchmark through December 2021. In 2019, before the pandemic, small multifamily expense ratios sat in a narrow range between 40.5% and 41.1% (Chart 8). Through the fourth quarter of 2021, expense ratios have grown to 43.6%. According to an analysis by the National Apartment Association, renter delinquencies and rising operating expenses, namely insurance premiums, have squeezed net returns during the pandemic.

Leverage & Debt Yields

The general trend for loan-to-value ratios (LTVs) on newly originated small multifamily loans was that of declines throughout most of the past two years. Prior to the fourth quarter of 2021, LTVs fell in five of the past seven quarters. For reference, small multifamily LTVs fell on a quarter-over-quarter basis only five times in the entire decade leading up to the pandemic. In the fourth quarter of 2021, small multifamily LTVs showed signs of recovery, jumping 146 bps to 67.8%. Still, compared to the high watermark of 70.6% reached in the fourth quarter of 2021, LTVs remain down by 285 bps (Chart 9).

Debt yields for small multifamily loans fell by 20 bps to 7.8% in the fourth quarter of 2021— just 19 bps above its all-time low (Chart 10). Debt per dollar of NOI, the inverse of debt yields, rose for small multifamily loans in the fourth quarter. Small multifamily borrowers were securing an average of $12.85 in new debt for every $1 of property NOI, up 32 cents from the previous quarter.

Outlook

Small multifamily remains well-positioned to for 2022. With inflation reaching its highest levels in a generation and higher interest rates on the horizon, a higher expense environment over the short-term is probable for many properties. The success of small multifamily operators will rest on their ability to match rising costs with rising rental revenues. Nevertheless, with standard apartment leases lasting only for an average of one year, cashflows can more quickly adjust to inflationary pressures than other commercial real estate sectors, making the asset class more attractive in the current environment. Resurgent levels of multifamily transaction activity and the abundant presence of buyers offers significant insulation to downside pressures potentially posed by the pandemic and expectations for monetary tightening. Moreover, despite rising levels of residential construction, the U.S. housing shortage is present. With the small multifamily sector acting as a critical source of the nation’s affordable housing stock for renters by necessity, the demand for these properties remains strong.

For more small multifamily research and insights, visit arbor.com/articles

Small Multifamily Investment Trends Report Q3 2021

Q3 2021
Small Multifamily
Investment Trends Report

Reliability of Small Multifamily Tenant Base Fuels Recovery

Key Findings

An analysis of work from home trends finds that small multifamily properties may be less affected than larger properties because fewer tenants can work remotely
Small multifamily cap rates held at 5.2% in the third quarter, effectively unchanged from last quarter
The refinancing share of originations rose as investors locked in rates ahead of potential monetary tightening and an expected rate rise
Asset prices rose 2.9% from a year earlier and 7.7% over pre-pandemic highs

Table of Contents

State of the Market

Compared to one year ago, macroeconomic conditions are in a markedly better place. However, the recovery has not been without its fair share of challenges.

The total size of the U.S. economy eclipsed its 2019 peak in the second quarter of 2021, reaching $19.4 trillion (measured in inflation-adjusted, 2012 dollars). According to the Bureau of Economic Analysis’ preliminary estimate, the U.S. economy grew at seasonally adjusted annual rate of 2.0% in the third quarter of 2021 — well below the 6.7% rate observed in the prior quarter. Looking ahead, the Congressional Budget Office forecasts the U.S. economy will expand by a healthy 5.0% in 2022, before settling back into the long-term trend of sub-2% growth.

Supply chain disruptions, labor shortages and rising inflation top the list of concerns keeping policymakers and business leaders up at night. According to the Bureau of Labor Statistics (BLS) Consumer Price Index, prices of goods and services are up an average of 5.4% from one year ago through September — the highest mark in more than a decade.

The multifamily sector is already demonstrating why it is often considered an ideal hedge against inflation headwinds. Unlike most other commercial leases that tend to have multi-year terms, most rental housing units’ leases are one-year long, allowing landlords and property managers to absorb inflationary pressures by adjusting rents. According to RealPage, through August 2021, effective asking rents were up 10.3% from a year earlier.

A longer-term uncertainty for the multifamily sector is how work from home (WFH) adoption will impact rental demand. The luxury of living close to work and having a shorter daily commute is an amenity that has historically commanded higher rents. The ability to work remotely allows workers to expand the number of markets and neighborhoods they consider when choosing where to live. As a result, remote-work tenants are less tied to one specific location and are less likely to pay a close-to-work rent premium.

Understanding where there are high concentrations of workers who are capable of transitioning into remote work may offer some clues about where rental demand may fall and where it is most likely to hold up. According to a recent BLS study, the ability to telework is most common among workers with a bachelor’s degree or higher (Chart 1). According to a Chandan Economics analysis of the U.S. Census Bureau’s latest American Community Survey, 71.8% of householders in small multifamily properties (under 50 units) hold less than a bachelor’s degree, well above the 58.7% observed in large multifamily properties (50 or more units).

Taking these above trends together suggests that small multifamily properties may be less affected by an impact from WFH because a smaller portion of these tenants can work remotely. They are therefore more likely to be locationally tied to their place of work.

As the report details, small multifamily assets continue to retain the stability that has become a defining hallmark for the sector. Small multifamily asset pricing continues to set new highs, and annual origination volume is on pace to do the same through the end of 2021. Cap rates have settled near record lows, and risk premiums are in line with their pre-pandemic levels. The small asset multifamily sector benefits from a unique set of stabilizing tailwinds as market demand for affordable, market-rate units remains robust and sector-level liquidity continues to be abundant.

Lending Volume

Annualized 2021 estimates of new multifamily lending volume on loans with original balances between $1 million and $7.5 million¹ — including loans for apartment building sales and refinancing — are on pace to finish the year at $59.4 billion (Chart 2). The current estimate would represent a modest annual increase of about $2.0 billion from last year’s total, or a 3.4% growth rate. According to Chandan Economics, small multifamily originations reached an all-time high of $59.2 billion in 2019. If current annualized estimates hold up through the fourth quarter of this year, 2021 will narrowly eclipse the 2019 high watermark by 40 basis points (bps).

Refinancing activity has fallen considerably from its 2020 peak, though it remains elevated compared to pre-pandemic conditions. The refinancing share of multifamily lending ticked up to 70.3% in the third quarter of 2021, rising from 67.3% and 68.0% in the first and second quarters of this year, respectively (Chart 3). Still, the third-quarter reading sits well below the 79.7% peak observed in the third quarter of 2020.

The refinancing share of originations rose as investors locked in rates ahead of potential monetary tightening and an expected rate rise. The Federal Open Market Committee’s median forecast for 2022’s year-end federal funds rate jumped from 0.1% at the June meeting to 0.3% in September. Multifamily asset owners with higher debt servicing costs than prevailing market interest rates are likely recognizing the closing window for locking in lower rates, leading to a rush in refinancing demand.

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 $7.5 million and loan-to-value ratios above 50%.

Arbor Small Multifamily Price Index

As measured by the Arbor Small Multifamily Price Index², small multifamily asset valuations continued to improve in the third quarter of 2021, notching solid quarterly and annual gains of 2.3% and 2.9%, respectively (Chart 4 and Chart 5).

Compared to the crisis-low point reached in the second quarter of 2020, asset valuations are up by a healthy 12.2%. Moreover, valuations are up by 7.7% over where they were at the onset of the pandemic.

Cap Rates & Spreads

National average cap rates for small multifamily properties were effectively flat in the third quarter of 2021, remaining at 5.2% (Chart 6). Small multifamily cap rates compressed considerably during the post-Great Recession expansion, declining from a cyclical high of 7.6% in 2010 to their current range near 5.2%. Since the second quarter of 2020, small multifamily cap rates have sat in a narrow range between 5.2% and 5.4%.

The small multifamily risk premium, a measure of additional compensation investors require to account for higher levels of risk, is best measured by comparing cap rates to 10-year Treasury yields. The small multifamily risk premium averaged 389 bps in the third quarter of 2021, up from 359 bps the previous quarter, as Treasury yields dipped by 27 bps and cap rates increased by a marginal 3 bps (Chart 7).

After reaching as high as 466 bps in the second quarter of 2020, risk premiums slid for four consecutive quarters, reflecting a normalization of risk pricing. The cap rate spread between small multifamily assets and the rest of the multifamily sector, a measure of the risk of smaller properties, declined to 16 bps in the third quarter of 2021 (Chart 8). The “small” versus “all” multifamily cap rate spread hit an all-time high of 121 bps in 2010, and the current reading represents a new all-time low.

Over time, the yield structure of small assets has come to look more like the rest of the sector as liquidity has improved and technological adoptions have added operational efficiencies. Further, the renter-by-necessity profile of small multifamily renters will likely be perceived as a more reliable source of demand as the impact of WFH adoption and suburban flight are absorbed into the multifamily sector.

Leverage & Debt Yields

Loan-to-value ratios (LTVs) on newly originated small multifamily loans fell sharply during the pandemic, from a high of 70.9% at the end of 2019 to a low of 66.4% at the end of 2020 (Chart 9). In 2021, with the small multifamily sector already in recovery mode, credit risk measures have been slow to return to their pre-pandemic conditions. Through the third quarter of 2021, small multifamily LTVs averaged 66.5%, marking the second straight quarter of declines and returning the metric to just 9 bps over its 2020 low.

Debt yields for small multifamily loans rose by 17 bps to 8.0% in the third quarter of 2021, undoing some of the post-shutdown reversion seen over the previous two quarters (Chart 10). Debt per dollar of NOI, the inverse of debt yields, fell for small multifamily loans in the third quarter. Small multifamily borrowers were securing an average of $12.52 in new debt for every $1 of property NOI, down 28 cents from the previous quarter.

The entrenchment of lower LTVs and higher debt, in part, reflects tighter underwriting standards as lenders sought to reduce relative risk within their portfolios. However, as lenders become increasingly convinced of the small multifamily sector’s return to health, underwriting standards are likely to see some easing.

The latest Federal Reserve Senior Loan Officer Opinion Survey (SLOOS) signals that an easing of underwriting standards may already be underway. Surveyed in the second quarter of 2021, a net 18.1% of senior loan officers reported easing underwriting standards for multifamily lending — a major shift from the same period one year earlier when a net 64.3% reported a tightening of underwriting standards. If underwriting standards continue to ease, it is likely that LTVs would rise and debt yields would fall from their current levels.

Outlook

Heading into the third quarter, the major uncertainty for the small multifamily sector was the timing of the national eviction moratorium’s conclusion and how its end would impact evictions. While the national eviction moratorium has since been lifted, many statewide moratoria are still in place. As a result, long-term developments remain to be seen.

The look ahead is one of gradual progress for the small multifamily sector. Most indicators for the sector are in recovery or fully recovered. WFH adoption and increased demand for suburban housing options may prove to have a marginal impact on multifamily demand. However, small multifamily properties, which cater to moderate-income households who are more likely to rent by necessity, are well-insulated from downside pressures.

On the horizon, there could be more upward pressure on cap rates than there has been over the past decade. Higher levels of inflation are passing through to higher rents, boosting property-level incomes. Additionally, the Federal Reserve is signaling that it will begin a monetary policy tightening cycle over the next year — a development that should push up benchmark interest rates. If benchmark interest rates do rise, small multifamily buyers are likely to respond by increasing their required acquisition cap rate. At the same time, agency support and a high degree of market liquidity may limit the amount of observed upward pressure on yields. All else equal, small multifamily continues to boast solid operating fundamentals, a deep pool of liquidity and a reliable tenant base that signal a generally positive outlook for the market.

For more small multifamily research and insights, visit arbor.com/articles

Small Multifamily Investment Trends Report Q2 2021

Q2 2021
Small Multifamily
Investment Trends Report

Small Multifamily Sector Returns to Normalcy as the Recovery Takes Hold

Key Findings

Small multifamily cap rates continued to edge down, sinking to 5.2%, down from 5.3% last quarter
Acquisitions drove a larger share of lending volume as refinancings settled near pre-crisis levels
Asset prices rose 10.2% year over year and 1.3% quarter over quarter

Table of Contents

State of the Market

From the second quarter of 2020 to the second quarter of 2021, the U.S. has gone from experiencing all-out public health and economic crises to a recovery mode so robust that the debate du jour is whether policymakers are letting the economy run too hot.

The 2021 macroeconomic recovery is gaining steam as it comes back from the 3.5% annual decline it suffered in 2020, which was the largest contraction in the post-war era and the outcome of historic volatility in quarterly GDP figures. Inflation-adjusted GDP grew at a 6.4% annualized rate in the first quarter of 2021. According to the Federal Reserve Bank of Atlanta’s GDPNow projection, second-quarter growth is forecast to land near 7.9%.

According to the U.S. Bureau of Labor Statistics, labor market progress has become more consistent. The three-month moving average for job gains gradually increased from 518,000 to 567,000 between March and June 2021. Additionally, June’s employment increase of 850,000 positions represented the highest level of job growth since August 2020 and still nearly four times the monthly average seen through the recovery following the last recession.

By some measures, the U.S. multifamily sector is an industry in recovery — by others, it is already shaking off the rust and moving into expansion. After dipping slightly during the depths of the COVID-19 recession, the value of new multifamily construction put in place returned to growth mode by July 2020, and it has broken its all-time high record for the past nine months in a row (Chart 1). As a comparison, after reaching a high point in 2007, it then took the value of new multifamily construction more than eight years to eclipse pre-Great Recession levels.

Trends within the small multifamily sub-sector match the broader industry, with measures of health ranging from ‘in recovery’ to ‘fully recovered.’ Driven by ample liquidity and continued downward pressure on cap rates, valuations of small multifamily assets are gaining momentum. The balance between refinancings and acquisitions is settling back into its pre-pandemic norms, reflecting a stable interest rate environment and the return of active buyers.

However, challenges remain. Some operators may still see some COVID-related distress. Smaller mom-and-pop landlords who are subject to the CDC’s eviction moratorium are asymmetrically impacted by the Federal policy. Since these landlords typically have fewer units, a non-performing unit diminishes a greater share of potential income than if the same non-performing unit were to reside in a larger multifamily property.

In a June letter addressed to the Biden Administration signed by 12 of the nation’s leading rental housing advocacy and trade groups (including National Multifamily Housing Council, Mortgage Bankers Association and others), industry leaders commended the Federal Government’s role in staving off a rental housing crisis. However, they urged the Administration to suspend the CDC’s eviction moratorium. The letter states, “the continuation of a nationwide, one-size-fits-all” approach at this point will only place “insurmountable levels of debt on renter households and prevent recovery in the housing sector.” Despite these calls, CDC Director Dr. Rochelle Walensky extended the eviction moratorium by another month. However, it came with the announcement that it

was intended to be the final extension, setting up an expiration of the moratorium on July 31.

All else equal, the small multifamily recovery is well underway. The second half of 2021 has a firming outlook for the small asset sector. Macroeconomic tailwinds and the sunset of the CDC’s eviction moratorium will take the reins from the reliable underlying demand and the agencies’ (Fannie Mae and Freddie Mac) support that kept small multifamily going during the pandemic-related recession.

Lending Volume

Annualized 2021 estimates of new multifamily lending volume on loans with original balances between $1 million and $7.5 million¹ — including loans for rental apartment building sales and refinancing — are on pace to finish the year at $57.1 billion (Chart 2). The current estimate would represent a 0.5% annual decline, or a decrease of about $315 million (Chart 3). The current 2021 annualized estimate is a downward revision from the $60.2 reported last quarter, reflecting the impact of a normalizing pace of refinancings. According to Chandan Economics, small multifamily originations reached an all-time high of $59.2 billion in 2019. In 2020, origination volumes only fell by 2.9% — a drop-off that would have proven much worse had a surge in refinancing activity not buoyed loan production.

Refinancing activity continues to make up the bulk of new lending activity, though the balance between refinancings and acquisitions has fallen back in line with pre-crisis levels, averaging 67.3% and 68.0% in the first and second quarters of 2021, respectively (Chart 4).

With the interest rate environment proving more stable in 2021 than it had in 2020, the overwhelming rush to refinance has normalized.

Last year, as buyers and sellers were far apart in their asset value assessments, operators turned to mortgage lenders to pull equity out of their properties. Moreover, rapidly falling interest rates meant that operators could also lower their monthly debt servicing costs through refinancing. After rising for four consecutive quarters, the refinancing share of small multifamily reached a high watermark of 79.7% in the third quarter of 2020.

¹All data, unless otherwise stated, are based on Chandan Economics’ analysis of a limited pool of loans with original balances of $1 million to $7.5 million and loan-to-value ratios above 50%.

Arbor Small Multifamily Price Index

As measured by the Arbor Small Multifamily Price Index², small multifamily asset valuations continued their trajectory of improvement in the second quarter of 2021, notching solid quarterly and annual gains of 1.3% and 10.2%, respectively. (Chart 5 and Chart 6).

The robust annual growth is in part due to base effects, where declines in asset values measured last year make this year’s data appear particularly strong. Nonetheless, on average, small multifamily valuations have already more than recovered from the COVID-19 disruption, rising 5.8% above their pre-pandemic mark.

²The Arbor Small Multifamily Price Index (ASMPI) uses model estimates of small multifamily rents and compares them against small multifamily cap rates. The index measures the estimated average price appreciation on small multifamily properties with 5 to 50 units and primary mortgages of $1 million to $7.5 million. For the full methodology, visit arbor.com/asmpi-faq.

Cap Rates & Spreads

National average cap rates for small multifamily properties continued their long-term trend of steady declines in the second quarter of 2021, shaving off 12 basis points (bps) from the previous quarter and settling at 5.2% (Chart 7). Small multifamily cap rates have, except briefly during the pandemic, compressed since 2011, falling an average of 21 bps annually. Through second-quarter 2021, small multifamily cap rates are down 18 bps from one year ago, in line with the post-Great Recession trajectory.

The small multifamily risk premium, a measure of additional compensation demanded by investors to account for higher levels of risk, is best measured by comparing cap rates to 10-year Treasury yields. The credit quality of the U.S. government is perceived as unmatched, making the price it pays for its debt an approximation for the risk-free interest rate. The small multifamily risk premium averaged 360 bps in the second quarter of 2021, down from 397 bps the previous quarter, and a pandemic-triggered 468 bps one year ago (Chart 8). These risk premiums have now sunk for four consecutive quarters as widespread fears have continued to ease with the recovery.

The cap rate spread between small multifamily assets and the rest of the multifamily sector, a measure of the idiosyncratic risk of smaller properties, shaved off 14 bps from the previous quarter, settling at 23 bps (Chart 9). The small versus all multifamily cap rate spread hit an all-time high of 121 bps in 2010 and an all-time low of just 18 bps in third-quarter 2020. Over time, the yield structure of small assets has come to look more like the rest of the sector as liquidity has improved and technological adoptions have added operational efficiencies.

Leverage & Debt Yields

Between the first quarter and fourth quarters of 2020, loan-to-value ratios (LTVs) on newly originated small multifamily loans cratered from a high of 70.6% to a low of 65.3% (Chart 10).

For a sense of scale, between the end of 2011 and the start of 2020, small multifamily LTVs rose an average of exactly 1.0% annually, making the pandemic-induced 5.3% drop-off appear particularly severe. Now in 2021, with the small multifamily sector already in recovery mode, LTVs have started the process of reversing their freefall and climbing back to their pre-pandemic conditions. Through the second quarter of 2021, LTVs on small multifamily loans averaged 66.2%, up 23 bps from the previous quarter and up 90 bps from their recent low of 65.3% measured in fourth-quarter 2020.

Debt yields — the ratio of net operating income (NOI) and loan balance — for small multifamily loans fell by 25 bps to 7.8% in the second quarter of 2021, the most sizable decrease in six quarters (Chart 11). After shooting up by 53 bps in late-2020, small multifamily debt yields have now fallen for two consecutive quarters and are only 21 bps above their all-time low. Debt per dollar of NOI, the inverse of debt yields, increased for small multifamily loans in the second quarter. Small multifamily borrowers were securing an average of $12.78 in new debt for every $1 of property NOI, up 39 cents from the previous quarter.

Outlook

The COVID-19 pandemic and subsequent recession offered a rare jolt of volatility for a sector that has proven reliable as they come since post-Great Recession. With the recovery taking hold, getting back to the small asset sector’s steady progress is downright exhilarating. A recent Arbor Realty Trust-Chandan Economics analysis indicates that transaction volume across the multifamily sector is improving on last year’s drop-off, with the Sun Belt already running ahead of its pre-pandemic pace in 2021.

Some uncertainty exists around vaccination rates and the path of the virus. Vaccine hesitancy will likely prevent many U.S. communities from reaching local herd immunity. The rise of Delta variant, and the specter for others like it, may mean that the COVID-19 threat will persist long beyond the full resumption of our pre-pandemic lives. Even with the uncertainty, days of empty streets in Times Square and crowded lines at mass testing sites, thankfully, appear firmly behind us.

All else equal, between a growing pool of returning buyers and the end of the CDC’s eviction moratorium, the ingredients for sustained expansion are falling into place, and the outlook for the small multifamily is both positive and improving.

For more small multifamily research and insights, visit arbor.com/articles

Small Multifamily Investment Trends Report Q1 2021

Q1 2021
Small Multifamily
Investment Trends Report

Market Conditions Broadly Improve as Sector Begins Path Back to Normal

Key Findings

Small multifamily prices rose 2.3% quarter over quarter and 5.5% year over year
Origination volumes for 2021 are on pace to finish the year above 2019’s peak
Refinancing activity and credit conditions show signs of a return to pre-COVID levels

Table of Contents