Will multifamily flag or continue its relative strength?
Multifamily assets have been the work horse of the commercial real estate market since the beginning of the post Great Financial Crisis recovery. The asset class seemed to shrug off its various obstacles ranging from the newly resurrected rent control laws, inclusionary zoning, Portland’s F.A.I.R. Housing Ordinance, a glut of permitted class A multifamily projects, and even a 100 basis point rise in mortgage interest rates in 2018. In the face of all of those headwinds, multifamily remained a strong and appreciating asset class. It was almost unstoppable.
In March, the country was hit hard with the novel coronavirus shutdown as the world came to a screeching halt. The state of Oregon imposed a statewide ban on evictions for non-payment of rent, issued multiple executive orders restricting the ability for landlords to collect rents even after the eviction ban was scheduled to lapse. Day to day operations were turned upside down. At the time of maximum panic as Q2 began, the sales market froze solid and landlords across the state slashed expenses and negotiated loan forbearance on as many properties as possible as they prepared for an apocalypse of non-paying tenants.
When the summer sun returned to Oregon, citizens’ acclimatization to the new safety protocols along with significant stimulus from the federal government brought hope and eventually momentum back to the multifamily sales market. Thankfully the fears that came about at the inception of Q2 did not manifest in catastrophically low collections along with an overwhelmed hospital system and disrupted supply chains. Before we get into the ramifications of the shift in the operational fundamentals, let’s couch the Portland MSA in context of the national market.
National Sales Outlook
All real estate fundamentals stem from rent collections, and the national multifamily trends are essential for understanding the nuances of any local market data. Since Coronavirus had such a jarring effect in the world, let’s look at the rent collections starting in May. Surprisingly, the data shows robust collections in May at 95.1% and an even more unexpected uptick to 95.9% in June. Unfortunately that seems to have been the peak and the current trend shows a decline of total collections, with steady movement in the rental receipt date moving further and further towards the end of the month.
A major driver of rent collections stems from the stimulus programs that were quickly enacted by Congress, whether it was the Paycheck Protection Programs (PPP) designed to reimburse business for employees they retained on the books, or the Economic Income Disaster Loan (EIDL) programs, or the bonus $400 per week unemployment program for those lucky enough to be able to navigate their state unemployment offices that were in danger of being overrun. No matter which programs were utilized, tenants were not left as bag holders during the shutdown.
The bonus $400 weekly unemployment subsidy burned off in August, much of which was used to pay down revolving consumer debt. It is likely that the reduction in the high cost debt service of revolving debt will put residents in a better financial position over the long run. With a potential second shutdown looming, a lower debt burden on tenants could be the difference in a make or break collections scenario.
Sales volumes in Q2 were down 46% year over year across the US, and cap rates remain compressed with median cap rates declining to 5.10%. Although the compression seems impressive, it is part of a consistent downward trend that is illustrated by the year over year decline of 20 basis points from the 2019 Q3 cap rate average of 5.30%.
Cap rates are often driven by yields. After a significant rise in the interest rates that began in December of 2018, the corresponding fear that they were heading higher has receded. Instead they have fallen significantly as the search for yields continues for investors.
Intriguingly, the price per unit continues to remain strong for investors, and those with the wherewithal to weather the storm have seen their portfolios hold up with median price per unit setting a record at $143,994.
Portland Metro Market
Portland apartments remain the least damaged asset class in commercial real estate with relatively strong fundamentals. Despite the executive orders restricting landlords’ abilities to collect rents or evict non-paying tenants, collections have remained strong with 91.3% collections across the metro area. The once unflappable investment has significantly slowed the sales volume in both a dollar volume and transaction count.
The price per unit appears to have peaked north of $190,000 in Q1 and has seen a moderate reduction with expected Q4 pricing coming in below $165,000 per unit with a renewed growth in Q1. Some of this decline in value can be attributed to reduced collections that had historically floated near 94%.
There has been a flight of capital from the core of dense midrise properties to suburban garden style apartments. This transition is exemplified by the Meadows at Heron Creek sale, where 178 unit garden style property constructed in 2012 that sold in September of 2020 to Rise Property Trust for $48.2 Million or $270,000 per unit.
As the shutdowns restrict businesses that involve in person interaction, many of the external amenities that previously benefited mid and high rise core properties are no longer available to tenants who are confined to their units. Understandably, tenants have transitioned their tastes to units with larger square footage and amenities that support work from home features and self-sustainability such as free wifi, work nooks, and other outdoor amenities such as walking paths, patios, and greenspace.
The close in class A space is likely to suffer the most in the coming years due to significant oversupply of new close in core projects. Class B complexes have fared slightly better with workforce housing holding up the strongest of the three. Workforce housing is protected by a dearth of projects constructed by affordable housing developers, whereas new workforce housing from the private market does not pencil due to high construction and soft costs.
Outlook
The apartment asset class has remained a workhorse in many investment portfolios and will continue on the same trajectory for less prestigious properties. We may have seen the peak in the arms race of unit finishes and amenities, but the demand for housing remains strong. The trend away from core locations is likely to continue as tenants shy away from dense locations and micro-units. The economic trend of work from home will likely continue and larger units will continue to rise in demand. Rent collections will continue to be turbulent, and will rise and fall with economic capacity, with quality management being the differentiator at the margin. Are we done with the pain? Not by a long shot, but there will always be a demand for quality housing and it is likely to continue to be the cleanest shirt in the dirty clothes hamper.
About the Author:
Carson Halley, CCIM is a principal broker at SVN – Imbrie Realty specializing in private client multifamily investments in the Pacific Northwest with a focus on the Portland Metropolitan Area.