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Posted on DEC 13, 2018

Will the Multifamily Housing Development Boom Continue?

With its healthy supply and demand fundamentals, and low interest rates, the multifamily housing development market has seen much success in recent years. And with encouraging demographic trends for the long‐term and preferences for rentals over ownership increasing, the outlook for multifamily housing development remains positive. However, recent increases in construction costs and rising interest rates have made the near‐term more challenging and growth is beginning to subside. New starts on multifamily housing this year slowed to an annual rate of 324,000 units in September, down from 435,000 in January 2018.*

A look at the headwinds

After a decade of low interest rates and minimal inflation, costs are beginning to rise. “Higher interest rates are certainly a factor, but the increasing cost of construction is likely a bigger issue,” says Pat Lawton, SVP, Wisconsin Commercial Real Estate Manager, Johnson Financial Group. According to a Harvard study, between 2012 and 2017, the costs of labor, materials and contractor fees on multifamily housing construction rose 25 percent, compared with the general inflation rate of 7 percent.**

“A large factor contributing to rising costs is a deficit of younger people going into the trades to replace retiring workers,” Lawton says. “Shortages of master carpenters, electricians, plumbers and other skilled tradesmen can lead to delays on projects in addition to higher costs which may postpone the delivery of new projects. These delays not only increase overall construction costs but also increase holding costs, delaying when developers are able to achieve occupancy and receive rent on new units.”

Additionally, we have yet to fully feel the potential impact of new tariffs on construction materials like steel, aluminum and lumber.

Positive signs for the long‐term outlook

“There are a number of demographic trends that are likely to foster continued demand for multifamily rentals,” says Lawton. “For example, it's much more difficult for prospective single‐family homebuyers to qualify for a mortgage loan than it was before the financial downturn. Additionally, rising construction costs make it challenging for contractors to build affordable single‐family homes, and growth in the median sales price of existing homes continues to outstrip growth in median household income.”

Some other factors supporting multifamily housing development:

  • Many young people prefer the flexibility of renting to the commitment of homeownership. “There is less societal pressure to follow a predictable path, such as “graduate, get a job, get married and buy a home’ as there was a generation or two ago,” Lawton notes. “Additionally, millennials have also cherished geographic flexibility in their early adulthood and careers.”
  • Record student loan debt may be forcing millennials to put off home buying.***
  • More retirees are selling their homes and turning to rentals for increased accessibility and/or a maintenance‐free lifestyle.

“All these circumstances favor rental over homeownership and are beneficial to multifamily rentals in the long term,” Lawton says. In many markets, including some that have a glut of high‐end projects, there remains a pressing need for multifamily housing for low and moderate‐income earners. To address this issue federal and state governments offer tax breaks and subsidies for developers of affordable housing.

What about rising rates?

Potential multifamily housing developers may be hesitant to run the risk of higher interest rates and are unsure whether to pursue short or long‐term financing. Fortunately, there are tools available to help lower interest rate risk. Financial products such as interest rate swaps or rate caps can provide more predictability and protection from dramatic upswings in rates.

“Multifamily housing investment continues to be attractive for its steady cash flow and annual rent growth,” Lawton says. “A commercial real estate banker can help you explore financing options that may allow you to take advantage of new development opportunities as they arise.”

* Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/HOUST5F.
** Joint Center for Housing Studies of Harvard University, http://www.jchs.harvard.edu/sites/default/files/03_harvard_jchs_americas_rental_housing_2017.pdf.
*** HousingWire, https://www.housingwire.com/articles/46878-student-debt-crushes-homeownership-dreams.