Research Report Category: Special Reports

Special Report: Spring 2023

Navigating a Corrective Environment

By Ivan Kaufman and Sam Chandan

About The Authors

Ivan Kaufman is the Founder, Chairman and CEO of Arbor Realty Trust, Inc. (NYSE:ABR), a leading multifamily and commercial real estate lender and real estate investment trust. Arbor manages and services a $30 billion real estate loan portfolio and originates more than $7 billion in loans annually. Arbor is recognized as a top lender by Fannie Mae and Freddie Mac. Ivan is also the cofounder of Arbor Multifamily Acquisition Company (AMAC), an investment firm created in 2012, which owns and operates over 8,000 units and has acquired more than $1.75 billion of multifamily properties across the country. Through his successful development and evolution of many companies that span nearly four decades through all cycles, Ivan Kaufman is a trusted thought leader and pioneer in all aspects of commercial real estate finance.

Sam Chandan is a professor of finance and Director of the Chen Institute for Global Real Estate Finance at the NYU Stern School of Business. He joined the Stern faculty in late January 2022. From 2016 through early January 2022, he was the Larry & Klara Silverstein Chair and academic dean of the Schack Institute of Real Estate at the NYU School of Professional Studies, one of the world’s largest centers of real estate education. He is also the founder of Chandan Economics, an economic advisory and data science firm serving the institutional real estate industry, a contributor to Forbes, and host of the Urban Lab on Apple Podcasts. Dr. Chandan is chair of the Real Estate Pride Council, a global association of lesbian, gay, bisexual, and transgender leaders in the professions of the built environment. Dr. Chandan is a Fellow of the Royal Institution of Chartered Surveyors (FRICS), the Royal Society for Public Health (FRSPH), and the Real Estate Research Institute (RERI), and an Associate Member of the American Society for Microbiology (ASM). His multifaceted research interests address real estate as well as urban epidemiology and the preparedness of global cities and other systemically important urban areas in managing novel public health threats.

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Key Findings

  • The sustainability of consumer financing and geopolitical tensions are risk factors capable of triggering an economic contraction more severe than baseline forecasts.
  • Unlike other commercial property types, the market standard of amortizing mortgages will insulate the rental housing sector from expiring debt distress.
  • SFR/BTR should see structural gains despite cyclical headwinds as awareness for the product type grows and hybrid work supports a broader geography of housing choices for urban-working Americans.
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The Outlook

With the books closed on 2022, it is time to take stock and calibrate our expectations for the 12 months ahead. As we sit here today, in our industry and throughout the economy as a whole, we are in a corrective environment. However, the upshot is that, in our baseline forecasts, the economy is equipped and capable of absorbing a mild recession without triggering a 2008 (or pandemic shutdown) style event.

 

One unknown clouding the outlook is the Federal Reserve’s ongoing monetary tightening as it seeks to slow runaway inflation. The Fed moved its policy rate up by 425 bps between March and December last year. Even as the pace of inflation and interest rate increases have slowed in recent months, markets believe the tightening cycle has more runway ahead — a sentiment echoed in Federal Reserve Chairman Jerome Powell’s public statements (Chart 1).

 

Of course, the central bank is mindful of the fact that changes in monetary policy impact the economy with a lag. As a result, it risks overshooting its target and tightening by more than is needed. Still, the Fed has stated it will engage in monetary policy that balances the importance of price stability with strong employment to maximize the likelihood of a soft landing.

 

Risk Factors Abound

Front and center on the list of concerns for rental housing investors heading into next year are the business cycle and macro economy. Changes in the macro environment impact capital availability, tenant and buyer spending power, and risk appetites generally. While our median forecast for the year ahead calls for the economy to bend rather than break, the scope of uncertainty is broader today than it was before the pandemic. Beyond ongoing geopolitical tensions, several sources of concern are capable of triggering a severe contraction in 2023.

 

One of these significant risk factors is the sustainability of consumer activity. Thus far, despite a pervasive nervousness surrounding inflation and the economy’s year-ahead prospects, consumers have remained resilient and have not cut back on spending. Personal consumption expenditures are up through October by 7.9% from a year earlier. Even after accounting for the impact of inflation, consumption is 1.8% above last year’s levels (Chart 2).

 

A tight labor market and healthy levels of wage growth have, up until this point, allowed consumers to postpone a spending curtailment. The challenge is when we look at how consumers are financing current expenditures. Credit card debt is at all-time highs, and we are seeing higher levels of utilization of existing consumer credit lines even as the cost of revolving credit is significantly higher than it was one year ago. Worse, personal savings rates have dropped off dramatically, reaching their lowest levels since 2005 (Chart 3). Taking these factors together paints a picture of consumers quickly drawing down on their safety cushion resources.

 

Beyond the risks within our borders, we would be wise to remember that the U.S. sits inside a global ecosystem of trade, politics, climate, and epidemiology. There is no escaping the fact that the current geopolitical landscape is tense, and the potential for greater disruption is significant. If the war in Ukraine were to escalate to involve NATO coalition forces directly, implications for energy markets would be substantial. Additionally, the potential for further deterioration of trade or diplomatic relations with China also stands as a source of concern.

 

Rental Housing: Insulated, Not Immune

Within the market for rental housing in the U.S., the sector is uniquely positioned to withstand the unrelenting blitz of economic headwinds. Of course, many commentators are pointing to a slowdown in apartment rent growth as a sign of growing weakness. However, we do not view that as reflective of any structural change in the profile of demand or supply but rather a cyclical feature. It is normal to expect a period of slowing rent growth while there is uncertainty in the economic outlook and greater risk aversion among households.

 

While no asset class is immune from the challenges of higher interest rates, the presence of amortization makes the multifamily sector less likely to see mounting distress. All HUD-conforming multifamily loans are fully amortizing. Moreover, Fannie Mae- and Freddie Mac-conforming multifamily loans require at least partial amortization. Where we are most likely to see debt-related difficulties next year and beyond are with CMBS transactions. According to data from Trepp and the Mortgage Bankers Association, a majority (64.6%) of outstanding CMBS loans are categorized as interest-only over their entire term. Operators with expiring interest-only loans may run into trouble next year as they try to replace debt at roughly twice the cost. Accounting for just 10.5% of CMBS debt outstanding, the multifamily sector’s exposure to these transactions is limited. Meanwhile, the same cannot be said for the office, retail, and hotel sectors — all of which rely more on CMBS capital markets.

 

On the margins, subsets of mortgages in the multifamily portfolio will still require careful monitoring, especially those that originated in the years leading up to the pandemic, where over-leveraging was a re-emergent concern.

 

The criterion where real differences are likely to emerge over the next year is along geographic lines. According to MSCI Real Capital Analytics, through the third quarter of 2022, nearly half (48%) of U.S. markets are seeing rising apartment cap rates —  the highest share since 2010 (Chart 4). We can expect that these performance trends will continue, driven by slowing business sectors and evolving migration patterns.

 

Work-from-home, a trend that seemed capable of upending the rental housing market’s appraising assumptions just a few months ago, now looks like less of a risk than initially feared. Hybrid has quickly become the dominant alternative to full onsite employment. As a result, more workers are expanding their housing search radius, though they are not un-tethering from their offices completely (Chart 5).

 

Among the beneficiaries of the hybrid work proliferation is a product type that was already enjoying a run of success: single-family rentals (SFR). Beyond a growing willingness of workers to locate further away from their urban offices, the SFR sector is likely to benefit from increased visibility. Although built-to-rent (BTR) communities with amenities have received less attention thus far, their demand should climb as greater awareness of this product type develops.

 

As accessibility to affordable quality housing remains a pressing challenge across the country, it is critical to note that the BTR sector is an area of growth that is adding net new homes. According to U.S. Census Bureau, BTR construction starts reached all-time highs even as the broader single-family construction landscape reached an inflection point (Chart 6). Ultimately, we see SFR/BTRs as critical alternatives in the diversification of housing opportunities for all Americans, no matter their homeownership capacity or preference.

 

The Road Ahead

In the months ahead, we can broadly expect a continued correction in the residential housing market, though we do not anticipate a 2008-style crisis. Mortgage underwriting standards for owner-occupied single-family homes remained tight over the past several years. Moreover, the combination of low locked-in interest rates on outstanding mortgages and relatively strong labor market conditions means that defaults and disclosures should remain limited. Of course, owners that need to sell will have no choice but to capitulate, and market clearing prices should move lower. However, many of the risk factors necessary for widespread distress in the residential housing market are simply absent.

 

The historically low interest rates enjoyed by existing owners are unlikely to return over the medium term. Even as the Fed eventually regains control over pricing pressures and has the rate-cutting ammunition to reintroduce monetary accommodation, it is unlikely that we will revert back to near-zero interest rates. According to the Fed’s estimates, it expects a long-run average of 2.5% for its Federal Funds Rate. If these estimates hold true, 30-year mortgage rates would remain well above levels that buyers have become accustomed to in recent years. As a result, home financing conditions will continue to support higher levels of rentership.

 

Undoubtedly, the current market environment contains an underlying anxiousness. This is a moment of accelerated change both in our industry and throughout the economy, and we will not make it to our final destination without some in-flight turbulence. All signs point to the economy entering the early stages of a contraction. However, the big difference between this moment and the housing bubble we saw in the 2000s is that housing in the U.S. today is undersupplied, not oversupplied. While the rental housing sector will not be immune from challenges along the way, it sits in a position of strength to withstand the ongoing storm.

 

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Rental Housing Market Exhibits Cyclical Stability, Contains Structural Questions

Rental Housing Market Exhibits Cyclical Stability, Contains Structural Questions

Special Report Summer 2022
By Ivan Kaufman and Sam Chandan

About The Authors

As founder of the Arbor real estate finance and investment companies, Ivan Kaufman brings more than 30 years of real estate finance experience to the Arbor platform, with a significant track record of success across both the residential and commercial markets. Ivan serves as Chairman, President and CEO of Arbor Realty Trust, a leading national multifamily lender and mortgage real estate investment trust listed on the New York Stock Exchange (NYSE:ABR). In addition to leading Arbor Realty Trust, Ivan also serves as a Principal for Arbor Multifamily Acquisition Company (AMAC), an acquirer of multifamily properties which he established in 2012, and as the CEO of ArborCrowd, an online real estate investment platform which he formed in 2016. He has previously served as the chair of the Independent Judicial Election Qualification Commission for the 10th Judicial District of New York, on the national and regional advisory boards of Fannie Mae, and on the board of directors of the Empire State Mortgage Bankers Association. He has been named regional “Entrepreneur of the Year” by Inc. Magazine, and he has served as a regional spokesperson for Global ReLeaf, a program of the American Forestry Association. He has guest lectured at Harvard Business School’s Real Estate Club, Columbia University and Wharton Business School.

 

Sam Chandan is a professor of finance at the NYU Stern School of Business and head of the Stern Center for Real Estate Finance. He joined the Stern faculty in late January 2022. From 2016 through early January 2022, he was the Larry & Klara Silverstein Chair and academic dean of the Schack Institute of Real Estate at the NYU School of Professional Studies, one of the world’s largest centers of real estate education. He is also the founder of Chandan Economics, an economic advisory and data science firm serving the institutional real estate industry, a contributor to Forbes, and host of the Urban Lab on Apple Podcasts. Dr. Chandan is chair of the Real Estate Pride Council, a global association of lesbian, gay, bisexual, and transgender leaders in the professions of the built environment. Dr. Chandan is a Fellow of the Royal Institution of Chartered Surveyors (FRICS), the Royal Society for Public Health (FRSPH), and the Real Estate Research Institute (RERI), and an Associate Member of the American Society for Microbiology (ASM). His multifaceted research interests address real estate as well as urban epidemiology and the preparedness of global cities and other systemically important urban areas in managing novel public health threats.

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Key Findings

  • The Federal Reserve continues to engage in aggressive monetary tightening.


  • The rental housing sector is well-positioned to withstand growing economic headwinds because the cyclical forces that lower homeownership rates also historically have increased rental housing demand.


  • Superstar cities must undertake strategies to address affordability and livability concerns to compete in a remote-work economy.
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The Outlook
As we turn past 2022’s halfway mark, optimism surrounding the U.S. economy’s expansion has dimmed. An erosion of household spending power, spiking financial volatility, declining consumer sentiment, and now consecutive quarters of negative growth are all combining to depress the near-term outlook. When high levels of inflation started to emerge as a primary concern last year, the big question was whether the Federal Reserve could pull off a soft landing by calming price pressures without derailing the recovery. Now, the debate has shifted from if some economic pain will be on the horizon to how much and for how long. As reported by the U.S. Bureau of Labor Statistics, consumer prices were up 9.1% during the 12 months ending in May, keeping today’s inflationary environment at its highest sustained level in over 40 years. At its June and July policy meetings, the Federal Reserve moved its Federal Funds Rate (FFR) up by 75 basis points (bps), its largest single-meeting rate hikes since 1994. Markets are currently betting that the Federal Reserve will need to increase its policy rate by another 100 bps by the end of this year, bringing the FFR up to a target range between 325 and 350 bps (Chart 1). Thereafter, markets are split on whether more monetary tightening will be necessary, or if the FOMC may have to start cutting interest rates and reintroducing accommodation.
chart 1

Over the short-term, with the Fed embracing hawkish monetary policy, fears are rising that a recession may lie around the corner if we are not in one already. By increasing the cost of capital, a decrease in investment activity is the intended mechanism for pulling the reins back on the economy and cooling runaway prices. An echoing chorus of notable voices, including former Treasury Secretary, Lawrence Summers, has forecasted a near-term recession in recent months. Similarly, as captured by the Wall Street Journal Economic Forecasting Survey, which reflects the sentiments of a broad cross-section of leading economists, respondents pegged the probability of near-term recession at 49% when polled in July — up from 28% in April and 18% in January. As reported by Morning Consult, the technical declarations by the National Bureau of Economic Research mean little to the average American, with two-in-three adults thinking we are already in a recession.

 

Beyond just a recession, the specter of a stagflationary environment — where inflation remains untamed as the economy contracts — is the most significant macroeconomic risk on the table today. Disposable income per capita declined in 12 of the last 15 months through June — making recent history one of the most entrenched periods of consumer spending power loss on record (Chart 2). According to the U.S. Census Bureau’s Household Pulse Survey, declining spending power is having a tangible effect on the ability of consumers to afford daily expenses. In July, the share of households reporting at least some difficulty in meeting their expenses in the past week reached 65.5%.

chart 2

In an economy where consumption accounts for the dominant share of gross domestic product, there is no plausible scenario where households can fall behind for an extended period without a commensurate deterioration in both spending and growth. While the probability of returning to a 1970/80s-style stagflationary environment remains low, its presence in the national conversation alone necessitates caution and vigilance from policymakers on both sides of the monetary and fiscal divide.

Multifamily Resiliency

Within the market for rental housing in the U.S., the multifamily sector is uniquely positioned to withstand growing economic headwinds. An extraordinary run-up in single-family home prices and rising borrowing costs are pushing ownership out of reach for many first-time homebuyers. Mortgage interest rates are up above 5.3% in the second quarter of 2022, making the debt servicing costs for new homebuyers roughly twice as high as they were just one year ago. According to John Burns Real Estate Consulting, potential homeowners could expect to pay $839 more per month if they were to buy instead of rent, the highest such premium on record. Subsequently, the Mortgage Bankers Association notes that mortgage credit availability declined for the fourth consecutive month in June, and credit standards are significantly tighter today than before the pandemic.

 

Historically, where access to homeownership has declined, the rental market has benefited. Rental vacancy rates, which are currently at their lowest levels since the early 1980s, tend to move directionally with the homeownership rate (Chart 3). With barriers to homeownership mounting, the multifamily sector will likely have to make room for an influx of renters.

Beyond stable tenant demand, several other headline gauges of health continue to support confidence in the rental housing sector’s ability to withstand distress. Trepp notes in its tracking of CMBS loans that the delinquency rate for multifamily has continued to improve in recent months and sat at a benign 0.9% through July 2022. Further, asset valuations continue to rise, even as public equity markets are struggling, and the cost of capital is rising. According to
MSCI Real Capital Analytics, apartment prices continued to press higher, gaining 23.7% year-over-year and 1.6% month-over-month.

A Moment of Risk and Opportunity
While rental housing nationally remains on strong footing to weather growing economic headwinds, the long-term competitiveness of individual markets is justifiably under the microscope. The success of work from home (WFH) adoption is challenging the understanding of the need to co-locate in proximity to an office. In the summer of 2020, employers expected employees who were able to work remotely to WFH about 1.6 days per week.1 As the public health crisis has lessened and corporate offices have re-opened, that number has only risen, with employers currently forecasting a post-pandemic WFH average of 2.4 days per week for these types of workers (Chart 4).
chart 4

The WFH trend has changed more than workplace culture. Never have we found ourselves in a position where the workforces of our superstar cities, which comprise the lifeblood of their metropolitan economies, could completely divorce their housing decisions from their physical place of work. In no uncertain terms, the threat to costly superstar cities is real. The values of agglomeration, from both a lifestyle and a productivity standpoint, are significant. However, there is a limit on how much employees and employers will pay for this agglomeration premium when there are viable, cost-effective alternatives.

 

To cement competitive advantages and retain labor force talent, superstar cities, now and in the decades to come, require strategic investments. Structural affordability crises and a lack of infrastructure modernization are issues that will require expensive solutions, though their price tags will be dwarfed only

by continued inaction. More than ever, effective public leadership that understands these needs will be critical for the success of the nation’s largest cities.

Of course, public leaders need-not go it alone. Cities are symbiotic ecosystems that require buy-in from residents and private industry, not just local governance. Through deepening public-private partnerships (PPP), local leaders can access both the expertise and capital resources needed to accomplish transformational projects. In New York, from Hudson Yards and Moynihan Train Hall to Cornell Tech and the reconstruction of the World Trade Center, where there have been alterations to the urban fabric, it has required PPPs to graduate action plans into action. Elsewhere, Challenge Seattle’s efforts to bring ultra-high-speed rail and broadband internet access through the interconnected Pacific Northwest’s “Cascadia Corridor” is another example of an ambitious PPP course setting.

The Road Ahead

Inflation has exceeded the Central Bank’s initial expectations in both severity and duration. In the months ahead, the Fed plans to continue to engage in aggressive monetary policy, prioritizing re-asserting control of price dynamics over the longevity of the economic expansion. Still, the rental housing sector is in an idiosyncratic position of stability. The combination of risks to growth and rising rates may keep even more households in the rental market for the foreseeable future, buttressing the sector against growing macroeconomic headwinds. For cities, the time is now to leverage strengths — not rest on them. Otherwise, rental housing demand in the U.S. will begin to look more like a zero-sum game, where the superstars risk losing their shine.

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Multifamily Fundamentals Prepare Industry for Macro Uncertainties Ahead

Multifamily Fundamentals Prepare Industry for Macro Uncertainties Ahead

By Ivan Kaufman and Sam Chandan

About The Authors

Ivan Kaufman is the Founder, Chairman and CEO of Arbor Realty Trust, Inc. (NYSE: ABR), a leading multifamily and commercial real estate lender and real estate investment trust. Arbor manages and services a $30 billion real estate loan portfolio and originates more than $7 billion in loans annually. Arbor is recognized as a top lender by Fannie Mae and Freddie Mac. Ivan is also the cofounder of Arbor Multifamily Acquisition Company (AMAC), an investment firm created in 2012, which owns and operates over 8,000 units and has acquired more than $1.75 billion of multifamily properties across the country. In addition, Ivan is the CEO of ArborCrowd, an online real estate crowdfunding business he launched in 2016. Through his successful development and evolution of many companies that span nearly four decades through all cycles, Ivan Kaufman is a trusted thought leader and pioneer in all aspects of commercial real estate finance.

Sam Chandan is a professor of finance at the NYU Stern School of Business and head of the Stern Center for Real Estate Finance. He joined the Stern faculty in late January 2022. From 2016 through early January 2022, he was the Larry & Klara Silverstein Chair and academic dean of the Schack Institute of Real Estate at the NYU School of Professional Studies, one of the world’s largest centers of real estate education. He is also the founder of Chandan Economics, an economic advisory and data science firm serving the institutional real estate industry, a contributor to Forbes, and host of the Urban Lab on Apple Podcasts. Dr. Chandan is chair of the Real Estate Pride Council, a global association of lesbian, gay, bisexual, and transgender leaders in the professions of the built environment. Dr. Chandan is a Fellow of the Royal Institution of Chartered Surveyors (FRICS), the Royal Society for Public Health (FRSPH), and the Real Estate Research Institute (RERI), and an Associate Member of the American Society for Microbiology (ASM). His multifaceted research interests address real estate as well as urban epidemiology and the preparedness of global cities and other systemically important urban areas in managing novel public health threats.

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Key Findings

  • Labor shortages and a consumption shift toward goods over
    services are key factors contributing to supply chain disruptions,
    stoking inflation.
  • The Federal Reserve’s monetary tightening is front and center
    heading into the new year as the central bank anticipates three
    rate hikes in 2022 and 2023, setting the stage for higher costs of
    capital.
  • Historically low vacancy rates reflect a rental housing market
    where household demand continues to exceed available supply.
  • Changes in where and how people work are allowing Americans
    to choose housing options across a wider geographic area.
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A Balancing Act Recovery

The emergence of the Omicron variant in the last days of 2021 cast a dark cloud over the new year’s global economic outlook. Quickly reintroducing limits on mobility, governments worldwide hope to stem the spread of the new threat. The impacts on international trade and the supply chain are simultaneously dragging on growth and stoking inflation. These challenges reinforce the pandemic’s continued role in our lives, tempering economists’ and policymakers’ short-term forecasts.

As we move into 2022, the retrospective data reveal an economy at once constrained by the pandemic and bolstered by extraordinary interventions. The Wall Street Journal’s October 2021 Economic Forecasting Survey projects the U.S. economy will grow an impressive 5.2% in 2021, lifted by federal support for businesses and households. Annualized gross domestic product approached $19.5 trillion during the
third quarter, fueled by robust consumer activity that surpassed its pre-crisis peak (Chart 1).

The resulting demand for goods and the pandemic’s shift away from services has pushed inflation well above the Federal Reserve’s target, reaching 6.8% year-over-year in December. Before the shutdown, consumers had a generally stable set of purchasing preferences, with roughly 69% of all consumer spending going toward services (Chart 2). Spending began to shift toward goods during the pandemic, and even as the economy re-opened and cultural touchpoints became accessible again, the share of spending on goods remained elevated. Increased demand for goods has worsened existing supply chain disruptions, further challenging the speed of the recovery.

Due to rising prices and continued labor market progress, the Federal Open Market Committee (FOMC) has updated its guidance on the course of monetary policy in the year ahead. The December release of the FOMC’s summary of economic projections signals the Federal Reserve anticipates three rate hikes per year in 2022 and 2023 (Chart 3). While the tightening may be more aggressive than economists were forecasting, there are still fears the central bank may be behind the curve in removing monetary accommodation. Our macroeconomic recovery has exposure to both up-and-downside risks heading into the new year. It’s essential that the Federal Reserve successfully calibrates its tightening schedule, but it also faces the challenge of doing so in an environment of heightened uncertainty.

Apart from supply chain bottlenecks, record imbalance in the labor market has seen the tally of job openings spike to record highs while companies’ capacity to fill those positions has declined. The latest job numbers have fallen short of the mark. Payroll employment rose by just 210,000 jobs in November, even as the inventory of unfilled positions sits above 10 million. Aggregate employment totals remain down from pre-pandemic peaks by more than 2%, despite more job openings per unemployed worker today than at any point in history. Businesses’ desperate search for workers has resulted in significant wage pressures (Chart 4).

The juxtaposition of a labor market with excess demand and an untapped pool of potential workers is unusual, but the pandemic’s unique conditions have created structural access barriers preventing labor engagement.

For unmarried men, a demographic group that is the least likely to have children, employment totals have surpassed their pre-pandemic peak (Chart 5). For women and married men, employment totals remain stubbornly far-off from a full recovery. Last year’s unpredictability of child schooling put a significant additional time burden on working parents. The continued rapid spread of Omicron and its unclear impact on in-person schooling in early 2022 validates the concerns of childbearing adults weighing the tradeoffs of re-seeking employment. Furthermore, the question of who is most likely to re-enter the labor force and who will stay out indefinitely is becoming more important in assessing where full employment is in the post-pandemic economy.

Continued Strength in Rental Housing

The forces impacting the broader economy have proven powerful tailwinds for a wide swath of the nation’s multifamily markets. Concerns about mass evictions undermining housing security and upending the larger multifamily ecosystem of renters, owners and lenders, have not borne fruit. Eviction moratoria provided some relief to the pandemic’s most impacted renters, but renters’ prioritization of housing has been the more important driver of market stability. According to the National Multifamily Housing Council’s reporting on more than 11 million professionally managed units, 93% of renters paid rent in November.

An even broader measure of rental performance from the Census Bureau showed vacancy rates across all rental housing fell to 5.8% during the third quarter of 2021— down from 6.4% a year earlier and currently near its lowest level in 37 years (Chart 6).

As the pandemic upends long-held norms governing place and time of work, employers continue to update and refine their strategies for balancing the benefits of in-person collaboration with employees’ proven ability to work remotely effectively. The structural adjustment is ultimately favorable for rental housing.

The dominant narrative has focused on the regional migration of skilled professionals, generally favoring Sunbelt markets at the expense of the Northeast and Midwest. Rents and investment volume in the Sun Belt skyrocketed in 2021. However, the data show the economy’s evolving dynamics are allowing Americans to choose housing preferences across a wider geographic area.

Dispersion from downtowns into the suburbs represents a partial reversal of the last cycle’s focus on core urban areas. The shift is fueling demand for a broader range of rental housing options, most notably single-family homes for rent (SFR). Historically high prices for homes, the need for larger down payments and the possibility of higher residential mortgage rates pushed many would-be homebuyers into the SFR market in 2021.

While many secondary markets certainly benefitted from pandemic-related migration shifts, gateway markets have also seen a recovery in rental demand.

To be sure, the rental housing market will not be without challenges in the coming year. The potential for tighter monetary policy and an increase in the economy-wide cost of capital will exert some pressure on investment and lending. Erosion in affordability from rising rents has also sustained calls for local intervention, sometimes in the form of far-reaching rent controls. However, many in the industry support a supply-side solution to address affordability in the long-term.

2022 and Beyond

Even as the Omicron variant evades our collective vaccine protection and prompts recalibrated expectations for the new year, our economic sensitivity to the viral threat is markedly less than it was in spring 2020.

A potential outcome is the pandemic will gradually fade into a highly contagious though comparatively manageable endemic through this upcoming year and beyond. The execution of the Federal Reserve’s monetary tightening and the ability of investors to absorb higher costs of capital will be among the most impactful storylines of the year to come. Still, even as new housing construction has rebounded above its pre-pandemic pace, the growing demand for high-quality, affordable housing options continues to outpace our ability to add new supply. On balance, while the recovery may sometimes prove uneven, underlying fundamentals remain broadly supportive for rental housing in 2022 and beyond.

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An Abnormal Recession, A Unique Recovery

An Abnormal Recession, A Unique Recovery

A Look at the Road Ahead for the U.S. Economy

By Ivan Kaufman

Overview

Recessions tend to be viewed through the lens of the previous crisis. This was certainly true in the early months of 2020 when COVID-19 brought the U.S. economy to a halt and credit markets froze. Those of us who lived through the Great Recession feared the makings of another financial crisis and braced for a blow to real estate markets. What has occurred since, however, has defied many of those fears. A financial crisis never materialized, people have continued to pay their bills, and almost paradoxically, the housing market has boomed. While counterintuitive, these dynamics have been driven by the unique nature of the crisis.

What happens in the economy over the next six to eight months and years ahead will largely depend on the success of the vaccine rollout, the strength of fiscal policy, and how deeply the COVID-induced behavioral shifts have become ingrained in households and businesses.

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Key Findings

  • The pandemic has created a two-tier economy where higher-income people who are able to work from home have regained employment, while those in high-touch industries remain unemployed
  • Shelter-in-place measures coupled with the closure of offices, gyms, restaurants and other leisure outlets have driven a huge demand for more space in less dense, suburban areas
  • The first half of 2021 will resemble much of 2020, but widespread vaccinations should begin to ease the abnormal market dynamics by September
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A Recession Unlike Any Other

Understanding the atypical nature of the crisis provides insight into the path of the recovery. The current downturn has been fueled by an external health event – a pandemic – not fundamental weakness in the economy. Most of the impact has come from changes in behavior: changes designed to avoid the spread of the virus, and changes to adapt to living with the virus. This is very different from recent recessions where bubbles burst and sent the economy into a tailspin, such as what happened when tech stocks collapsed in 2000 and the housing market fell apart in 2007.

 

The earliest and most significant blow to the economy came from measures to alleviate the spread of the virus. As people sought to protect their health and governments enacted statewide lockdowns, the economy came to a standstill. In the first months of the crisis, 22 million Americans lost their jobs, and the unemployment rate shot up from 3.5% to nearly 15%. However, unlike prior recessions, the vast majority of these early layoffs were temporary and quickly reversed as the lockdowns eased. This is why the unemployment recovery has been quicker than expected and is set to outpace that of previous recessions (Chart 1).

 

Even as parts of the economy have bounced back, health concerns and new lockdowns have driven an uneven recovery. Employment losses remain significantly elevated in high-touch service industries, such as leisure and hospitality, that struggle to limit in-person interaction and often face mandated restrictions (Chart 2). On the other hand, employment in sectors such as financial services has nearly recovered. This has created a two-tier economy where those who can work from home, and typically earn higher wages, have regained employment, while those who are in high-touch industries remain unemployed.

The avoidance of specific types of businesses have flipped recessionary dynamics on their head. Typically, it is the goods-based sector of the economy that suffers during a downturn. But because consumers are constrained in their ability to spend on experiences, their only outlet is to spend on things. The two-tiered recovery explains half of the uncharacteristic housing boom. As higher-wage workers have regained their jobs, they have been able to benefit from ultra-low interest rates and generous work-from-home policies. The other half can be explained by the importance housing has taken in peoples’ lives as they adapt to living with the virus. Shelter-in-place measures coupled with the closure of offices, gyms, restaurants and other leisure outlets have driven a huge demand for more space in less dense, suburban areas. Similarly, because people are relying on their homes to provide for more aspects of their lives, they have prioritized paying their rent and mortgages. This is one of the reasons why housing across most asset classes has held up well.

 

Perhaps the most significant differentiator of the COVID-19 crisis has been the response from policymakers. In March 2020, Congress passed the largest stimulus plan in U.S. history – the $2.2 trillion Coronavirus Aid, Relief, and Economic Security (CARES) Act. The CARES Act not only dramatically expanded the scope of those eligible to receive unemployment, but it boosted those benefits by $600 a week and issued individuals $1,200 stimulus checks.

 

Together with five other bills, including the $900 billion year-end follow up to the CARES Act, the support enacted by Congress in 2020 far surpassed the stimulus response during the Great Recession (Chart 3). Combined with mortgage forbearance measures and moratoriums on student loan debt payments, the aid provided by Congress has been able to keep households afloat and delinquencies low (Chart 4).

A New Year, a Similar Economy

The first half of 2021 will resemble much of 2020, but widespread vaccinations should begin to ease the abnormal market dynamics by September. The trends that persisted for much of last year will continue in the first few months of 2021. As COVID-19 continues to stress healthcare systems around the country, high-touch businesses will be plagued with stop-and-go reopenings. This will maintain pressure on individuals who rely on those industries for employment and keep layoffs elevated. However, similar to what we saw with the CARES Act, the stimulus that passed at the end of 2020 should support incomes and households through the winter months (Chart 5). With elevated incomes and fewer outlets for spending, delinquency rates should remain low as people continue to focus on important bills such as their rent and mortgage payments.

 

 

While the labor market will continue to improve throughout the year, the progress will not be linear. Nearly 60% of remaining job losses are in high-touch industries (Chart 6). Employment at hotels, restaurants airlines, daycares and other COVID-sensitive businesses will be essentially locked-up until the health concerns are addressed. Until then, job creation will be slow and limited to industries that are able to operate under work-from-home models. Education and health services could also see a boost as the Biden administration has prioritized the reopening of schools, and hospitals seek to address significant worker shortages. As states begin to achieve widespread vaccinations, the initial rebound in the hard-hit industries will likely be rapid, but regional. States that are more efficient with their vaccination programs and those that have lower population density will see the benefits first.

One of the biggest challenges for Congress in 2021 will be to avoid stimulus fatigue. While there is another relief package already being discussed, many people who work in high-touch industries will need ongoing and targeted support throughout much of the year.

 

The perfect, positive storm for suburban housing will continue in 2021 and will further drive interest in single-family rentals. The housing market drivers of 2020 are not going anywhere. Mortgage rates should remain near historic lows as the economy recovers and the Federal Reserve continues to purchase longer-term treasuries and mortgage-backed securities. The push for more space will keep people looking for single-family homes with home offices and gyms. While the lack of inventory and rising prices may begin to dampen the purchase market, it should drive further interest in single-family rentals. Potential first-time homebuyers who may be facing affordability issues or those looking to try out suburban life before purchasing will likely turn to rentals. Additional fuel could arrive in the form of student loan forgiveness that could further boost demand from millennial homebuyers.

Beyond 2021

As the economy returns to more normal conditions in the fall of 2021, we will get greater insight as to what the future holds. One of the most significant factors in the strength of the post-vaccine rebound will depend on the amount of excess savings consumers are holding. Throughout 2020, the strong stimulus from Congress and limited outlets for spending have allowed consumers to sock away $1.65 trillion in excess savings (Chart 7). If these savings are unleashed in a meaningful way in hard-hit service industries, then we could see a significant economic rebound in late 2021 and 2022. However, if consumers have become more wary of future economic weakness or if the preference for savings has shifted higher, then the bounce could be weaker than expected.


Some of the behavioral shifts that have developed during the pandemic will persist. The move away from densely populated spaces is likely to be one of the most ingrained changes. Not only are people moving out of the urban cores and into suburban areas, but those transitions are likely to be enduring. Once people start becoming part of their new communities, sending their kids to school, and filling their larger spaces with home offices and gyms, it makes the transition back to smaller, urban markets more difficult. This dynamic should continue to drive the single-family purchase and rental markets, along with suburban multifamily units.


When looking at the employment picture, it is possible that many of jobs lost early in the crisis will be recouped by the end of 2022. However, investments made by some industries and businesses to get by with fewer workers and less dense workspaces may change the landscape. Industries such as manufacturing have seen a significant rise in business but not in employment (Chart 8). While this could be a temporary phenomenon, the longer this trend persists, the more likely it could become permanent as companies make technological updates. This is something to watch as more businesses will be required to alter how they operate in order to maintain safe working conditions.

The COVID-induced recession has been unlike any other downturn we have experienced in modern history. The acute shock to the economy has not been driven by fundamental weakness, but by measures to avoid and adapt to living with the virus. How the recovery proceeds over the next six to eights months will largely depend on the success of the vaccination rollout and the strength of fiscal policy. The people and industries that have been most impacted cannot be allowed to fall through the cracks, or this abnormal recession risks turning into a normal one. What happens to the recovery over the longer term is more difficult to predict. It will only become apparent when we can answer the question: how deeply has the pandemic permanently altered consumer and business behavior and changed the fabric of our economy?
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