“A Decade of Phenomenal Growth in Commercial Multi-Family is Coming to an End: Investors Beware!”
The commercial multi-family sector has been a source of tremendous wealth creation over the past 10 to 12 years, fueled by rising rents and declining interest rates. However, with cap rates expected to increase in the next 12 to 18 months, this wealth creation may be short-lived. It’s time to ring the alarm and warn investors to be cautious about this asset class heading into 2023.
But investing in multifamily apartments comes with risks, just like any other type of investment. In 2023, investors need to be aware of a number of things that could affect the performance of their investments, such as changes in cap rates, credit risk, supply and construction, and the Federal Reserve’s outlook on interest rates.
Cap Rates:
In 2023, the multifamily apartment market is expected to experience changes in cap rates. As the demand for multifamily apartments slows down and the supply of new properties increases, cap rates are expected to increase. This could result in lower returns for investors, as well as increased competition for properties.
Supply, Demand, and Construction:
The supply and construction of multi-family apartments is a crucial aspect to consider when analyzing the economic outlook for 2023. According to veteran housing analyst “Ivy Zelman,” there will be 1.6 million units coming online in the next 12 to 18 months, which is the largest amount of inventory since the 1970s. This increase in supply, along with the fact that construction cranes are popping up all over cities, could have a big effect on assumptions about rent growth. The market’s assumption that rents will continue to increase may be incorrect, as the increase in supply could result in flat or even declining rents in the multi-family space.
On the demand side, there are various factors that could impact household formation, such as the ongoing impact of the COVID-19 pandemic and economic volatility. The trend of accelerating household formation is expected to continue, but there is also a possibility of a mild recession or rising interest rates that could result in less wage growth and less household formation. In this scenario, rents may stay flat or even decline, which could lead to cap rates increasing and multi-family asset valuations declining.
Credit Risk and the Federal Reserve’s Outlook on Interest Rates:
Credit risk is another important consideration for investors in multifamily apartments. In 2023, credit risk could be higher due to rising interest rates and the possibility of an economic slowdown. This could lead to a higher number of defaults, which could impact the performance of multifamily apartments.
In its recent outlook for 2023, “Freddie Mac” says that the U.S. economy will continue to recover from the effects of the COVID-19 pandemic and that the housing market will stay strong. However, the outlook also suggests that interest rates may rise due to an increase in inflation, which could lead to a slowdown in the rate of home sales and price growth. Freddie Mac also points out that there could be more credit risk and uncertainty in the market, which could lead to a drop in the number of mortgages being made.
After a decade of growth, the multifamily apartment market has reached its peak, with mounting concerns of a slowdown in the coming year. As investors search for new opportunities, data warehouses, and life science projects offer a promising alternative. With a surge in demand for data storage and healthcare innovations, these sectors are poised for continued growth, offering long-term stability and ample opportunities for wealth creation.
In conclusion, it is important to be cautious when investing in the multifamily and commercial real estate markets, especially in a scenario where cap rates are lower than interest rates.
Avestix Insights can help investors and the market understand the current economic outlook, by providing market intelligence, research, and analysis. It is essential to have a team of experts and market intelligence around you to make informed investment decisions and navigate the challenges and opportunities in the multifamily, commercial, and alternative real estate markets.
