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COVID-19 and Multifamily Real Estate: May Update

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 follow-on post updates FactRight’s analysis of the emerging trends that are sure to impact multifamily investment programs.

Retention is strong

The initial weeks of the pandemic witnessed 50% declines in leasing activity nationwide with certain markets, including New York, San Francisco and Los Angeles, seeing decreases nearing 90%.   Activity has since rebounded though it has been in the form of lease renewals as opposed to leases to new tenants.  Apartment retention hit a record high in April with nearly 58% of renters with expiring leases electing to renew as opposed to relocating.   Thus far, a clear majority of renters are either unable or unwilling to relocate due to the pandemic.

Rental rates are flat

Record-high renewals, however, are not translating into higher monthly rental rates which grew nationwide by just 1.4% in April, the lowest rate in five years.  Further, the renewal rent trade-out, which measures the change in rent for renters renewing leases in the same unit, came in at the lowest level since December 2010.   This is notable as the spring months are typically the busiest time of year for apartments and when the majority of annual rental increases are put in place.  Prior to news of the pandemic taking hold, 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 3.0% to 5.0%, 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. 

Collections are holding steady…for the moment

Despite the fact that twenty-two million Americans are now unemployed, there is strong evidence that renters are making their monthly payments.  The National Multifamily Housing Council, which tracks the payments of 13.4 million apartments nationwide, is reporting that rent collections for April and May (through May 6th) were down by only 4.9% and 1.5%, respectively, from a year earlier.  The council further expects that this month’s payment pattern will largely mirror April, when the payment rate increased throughout the month as renters obtained financial assistance.

The country, however, is navigating uncharted waters.  Rent collections will need to be monitored closely over the coming months as assistance in the form of stimulus payments, unemployment and other benefits diminish.  Given the tenuous finances of many renter households, many renters may be unable to cover rent in addition to all the other financial pressures caused by the pandemic.  This difficulty will likely be most pronounced in the high-cost areas.

Property revenues are being challenged

Mounting job losses and their impacts on property revenues may be devastating.  Revenues are already facing downward pressure as many landlords are now offering to abate and/or defer rent as well waiving late fees and other charges in order to maintain occupancies. In addition, a growing number of jurisdictions are 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.  Rental incomes are expected to be particularly challenged in class C properties, whose tenants tend to be lower wage earners with little or no savings, and downtown class A properties, which tend to reserve their street-level spaces for businesses such as  boutiques to eateries and are being forced to forgoing rent in order to retain occupancy.  As in previous downturns, these properties may also suffer from higher vacancies as tenants relocate to cheaper alternatives.

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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