Landlords carry burden and risk as they run the housing marathon
“In the midst of chaos, there is also opportunity.” -Sun Tzu
After a wild 2020 derailed by COVID 19, the range of investor predictions for the multifamily market was all over the map for 2021. Yes, you are probably suffering from as much “COVID fatigue” as I am, but context is important. The only thing that was consistent is that nobody predicted how Q2 actually turned out. Across America, multifamily delinquencies continued to grow in 2021. Local municipalities struggled to deliver stimulus funds allocated by the federal government to compensate landlords for back rent, and eviction moratoria remained in full force. Mysteriously, capitalization rates compressed as lenders lowered rates, loosened lending standards, and reduced the amount of funds required in “COVID” reserves, and buyers emerged from the woodwork to bid on anything and everything that was in the multifamily space. You could say that the market went full “risk on.”
Nationally, renters moved back to the cities in droves. They followed the trend set by local governments as amenities and entertainment re-opened. Rental collections remain strong overall, but are still behind historical trends by 4.6%. In 2019, 81.6% of all rents were received by the 6th of June, whereas on the same date in June of 2021 only 77.0% of all rents were received according to NMHC. Total collections remain strong, coming in at 95.6% by months end. National regulation such as eviction moratoria and penalties for potential violations continue to make collections a challenge.
Supply chain issues have increased the cost of materials and have made operation of existing complexes more expensive. New projects have been sidelined thanks to the inflation in materials and labor shortages. In some states such as Washington, non-governmental construction was deemed non-essential and many job sites ground to a halt. As the economy re-booted at the end of 2020 and the beginning of 2021, multifamily construction hit a bottleneck and the already low number of apartment deliveries were delayed and over budget. This drag on supply has sent ripples into the pipeline that we do not expect to be worked out for at least the next 12 months.
The state of Oregon has done exceptionally well with tertiary cities and suburbs seeing continued strength thanks to remote working. The Portland area remains relatively robust despite a strict regulatory environment and instability surrounding protests and a growing homeless problem. Across the Portland Metro area, vacancy rates dipped to 3.7% by the end of June. After slowly trending upwards, rents across the MSA jumped significantly in the last month of Q2.This is caused by a confluence of a supposed end to the Oregon eviction moratorium, and dearth of available units. Construction delivered historically few units over the preceding 15 months, and the overhang of non-paying tenants remaining in units has significantly reduced the effective supply in the marketplace. We are closely tracking this “shadow vacancy” and are expecting a spike in vacancies (and capital expenditures) when the moratorium finally does expire in October.
Despite a likely short-term blip, the fundamentals for the long term in the Portland MSA and Oregon in general remain extremely strong. According to the State of Oregon economic report, they expect net migration rate of 30,000 people annually into the state over the next decade. When compared with new multifamily housing in the pipeline, the expectation of supply is slated to be significantly below demand. Difficult land use and permitting processes, combined with restrictive inclusionary zoning in some cities, and high materials prices along with labor shortages make for a challenging environment for developers to deliver new units to market. The developers that do engage with projects will be relying more on trended rent and vacancy numbers as opposed to having attractive economics from day one.
The traditional rental demographics for apartments, meaning pre and early household forming adults, is also strong and trending upward over the next decade. The coveted 25-34 year old demographic continues to show the most growth of the cohort. As marriage and household formation continues to push out in age, the need for rental housing will continue to extend longer than previous generations. The state of Oregon has relatively few single family home sites available for builders make for a significant tailwind for multifamily investors.
Rents in the Portland MSA show a surprising variance with the cheapest rents residing in Portland proper. As an example 2 bedroom units in the Portland MSA for 2 bedrooms averaged $1,502 in Portland, whereas similar units in Beaverton averaged $1,576. Suburban locations also track with higher occupancy rates than core locations. Costar reported that rents grew over all multifamily unit types by an average of 2% month over month, with an expected 15% year over year growth by the end of 2021. This rent growth appears to be unsustainable in the long term, but as long as the supply-demand curve is distorted by public policy, we expect these trends to continue.
Employment recovered more quickly and completely in rural areas than the city core. This is a unique trend that has not been observed in modern times and may be a tectonic shift. With the acceptance of remote work there is a strong likelihood this trend will continue in the coming years. We do anticipate that the city cores such as Portland will begin to shake off their doldrums, but the biggest hurdle will come when the city’s national reputation improves. It was severely damaged in 2020 thanks to pervasive homelessness and the violent protests, and the process of building back will rely on public policy and their ability to execute.
The outlook in the short term is tentatively bullish. With a lack of available inventory, rents continue to trend upward as qualified tenants compete for units. The biggest cause for caution is an event that would open up the shadow vacancy lurking on the balance sheets of many multifamily operators. This risk is difficult to quantify. Public policy changes drastically in short periods of time. In contrast, the long term is much clearer. There is a huge imbalance in the supply-demand curve that will favor ownership of multifamily assets. As Oregon continues to grow, it needs to evolve the regulatory side to make it easier for developers to add units to the housing supply. If not, the rents for existing housing stock will continue to appreciate in excess of economic growth as a growing number of tenants fight for fewer and fewer units.
From an operational perspective, it appears the regulatory burden will continue to get heavier on landlords as the short supply of housing stock drives rents up. The political will to protect tenants has only treated the symptoms and has ignored the root cause so far. In fact, many of the regulatory burdens have made it more expensive for tenants. Is it going to be a slam dunk for landlords? Absolutely not. Unfortunately, there is likely to be more expense, regulation, and lower margins for investors. The success of investors will come down to which landlords have the stamina, skills and staying power to operate over the next couple of years to make it through the pain. The investors that stick with their investments will have to evolve to meet the increased rigors of the market. And those that evolve will thrive.
About the author:
Carson Halley, CCIM is the head of business development at Westland Investors. Westland syndicates value added multifamily investments in the Pacific Northwest with a focus on the Portland Metropolitan Area.
Carson can be reached at: firstname.lastname@example.org