COVID-19 and Multifamily Real Estate: Early Thoughts

by Vince Brady

Although the full impacts of the COVID-19 pandemic on multifamily real estate have yet to be realized, early indications reveal a number of near-term challenges.  This post will review the emerging trends that are sure to impact multifamily investment programs.

Demand is down

The tenuous finances of many renter households, particularly when combined with the shelter-in-place restrictions now affecting most of the nation, is dampening overall demand. An early indicator is the level of apartment web searches, which are down 15% nationwide as compared to this time last year. This is notable as the spring months are typically the busiest time of year for apartments and when the majority of annual leases are put in place.

Rental rates are not growing

The reduction in leasing activity is impeding the ability of landlords to increase monthly rents, which traditionally grow at a weekly rate of nearly 0.15% during the spring rental season.  Prior to news of the pandemic taking hold, a mere six weeks ago, average monthly rents nationwide were reportedly 2.9% higher year over year, with Phoenix experiencing the highest annual growth in the nation at 7.6%. 

Although it’s too early to assess overall trends, initial indications are that property owners are favoring maintaining occupancies over efforts to turn over units in order to realize higher rents. Whereas earlier projections called for rental increases in 2020 ranging from 3% to 5%, many landlords are now assuming rent growth for the year will be flat and possibly even negative.  CBRE, for example, is projecting that the average rent per unit nationwide will drop by 6.7% this year, from $1,717 in Q3 2019 to $1,603 in Q4 2020. 

Property revenues are being challenged

Job losses are mounting and their impacts on property revenues may be devastating.  One widely reported survey shows that 53% of renters nationwide have been either laid-off or furloughed over the past few weeks.  The National Multifamily Housing Council, which tracks rent payments across 13.4 million units nationwide, is reporting that through the first five days of April, 31% of tenants had failed to pay their rent. This is a noticeably higher figure than the 18% rate reported during the same period a last year.  Revenues are also facing downward pressure as many landlords are now offering to defer rent as well waiving late fees and other charges in order to maintain occupancies. Finally, a growing number of jurisdictions are now imposing eviction moratoriums, also a requirement imposed on any landlords granted loan forbearance by Fannie Mae, Freddie Mac or HUD. 

Again, although it’s still early, the effect of any sustained delinquencies and late/waived payments on overall 2020 revenues may be significant. 

Borrowing has become more expensive

The multifamily mortgage market has deteriorated as lenders grapple with pricing the pandemic’s risks.  Though banks are generally still lending, indications are that they are being very selective and favoring borrowers with whom they have on-going relationships. Stabilized properties, those with the clearest line of sight to revenues, are also suddenly in favor as opposed to other asset types including ground-up developments, value-add and student housing. The net effect is that borrowing costs are rising with most lenders now implementing higher interest rate floors and/or raising spreads.  Higher rates will place additional stress on landlords, particularly those with near term financing needs.

 

Valuations may trend lower

From their highs in February and through late-March, the shares of the publicly traded multifamily REITs decreased by approximately 40.0%. Although share prices have rebounded slightly in the weeks since, this loss in value may provide a proxy to the larger multifamily market. The drop in the market capitalizations of the REITs significantly impacted the implied cap rates of their properties, which jumped from 4.8% in mid-February to 6.9% in late-March. As such, the implied value per unit in their aggregate portfolio fell by nearly 30%, from $390,000 to $275,000. The bottom line is that as revenues are challenged and as borrowing costs are escalating, property values will be threatened.

Alternative investment due diligence considerations

From a due diligence perspective, the medium and longer-term effects of these and other challenges will become clearer over the coming months. Their impacts will undoubtedly vary by location and property class, and require heightened analysis at the property level. Among other things, the pandemic underscores the need to identify the risks and opportunities associated with local and submarket conditions as well as an those associated with property’s tenant mix, financial condition and breakeven occupancy, ability to service debt payments and the level of reserves.   

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