January 2024 – Navigating Recession Risks in a Volatile Market

Happy New Year!

All of us at Essential hope you had a great holiday season and wish you the very best in 2024!

The Multifamily Market Pulse – 2023 in Review

Seems an eon ago, but three of the four largest bank failures in history happened before the 3rd quarter in 2023.  In addition, real estate’s largest investment managers experienced the equivalate of a bank run on their flagship funds. Unlike the banks, they were able to restrict the withdrawals to avoid any major implosions.

The culprit – the fastest rate increase in history by the Fed. What started as a series of gradual raises in 2022 ended in crescendo of 50bps rate hikes through the 3rd quarter of 2023.

As real estate is a major consumer of debt, the downward pressure on multifamily transaction volume and valuations has been significant since its peak in June of 2022. Green Street is reporting an additional 50%+ decrease in transaction volume from a dismal 2022, and a 30% slide in values since the peak.

In addition to the capital market headwinds, the news on the fundamentals side of the equation was challenging as well, with Moody’s Analytics showing rent growth down -1.7% and the vacancy rate hitting 8%. Additionally, supply over the next 24 months is slated to hit a record of nearly 1M units.  This does not bode well for the industry as Moody’s reported of only 9k units were absorbed in the 4th quarter – down significantly from the average quarterly absorption of 45k.

The bottom line? The multifamily market has experienced severe malinvestment over the last several years, resulting in a massive bubble that at the end of 2023 is now around 2/3rds deflated. The pricing reset is nearing the sweet spot to start deploying capital into assets that once again will provide attractive cash distributions.

Expert Insights:  Deciphering Market Cycles

The downturn phase of the market often arrives in three broad phases; denial, migration and panic. We saw denial  though-out 2022 into the 2nd quarter of 2023.  Since then, we have been seeing migration as increasing numbers of owners have started to navigate to the opposite polarity entering into loan extensions and modifications in 2023, but realizing the tactic will only prolong the inevitable.

Nest up is panic – where everyone runs for the exit at once.

Even though we anticipate the Fed embarking on a series of interest rate cuts in the next six months and the 10-year Treasury yield dipping below 4% in 2024, we do not foresee this providing any relief for the multifamily investments made from 2020 -2022. Contrarily, we expect the 10-year yield to fluctuate between 4-4.25% from 2025 to 2028, which will force owners with maturities to confront capitalization rates not witnessed since 2013.

Pricing capitulation will be forced on the market beginning this year as a wall of floating rate debt burns through extensions and modifications. Roughly, 90% of debt issued for multifamily transactions from 2020 to 2022 was short term floating rate debt.  What is apparent is that nearly 40% of those loans mature over the next twelve months and over 80% in the next eighteen months.  This will provide compelling value to the smart money that has been patiently waiting on the sidelines for the distress to play out.

We will wrap up this issue’s Expert Insights by saying we never wish ill fortune on any industry participants, but market cycles have been around since the beginning of capitalism. Real estate is no exception, and the least experienced sponsors without a historical market perspective are usually the ones caught without a chair when the music stops.

That is a wrap for this issue.  We look forward to bringing you more insights into the challenging but rewarding world of professional multifamily investing in the next issue.

Notice!

FORE Investment Forum 2024

This is a must attend event if you want to evaluate the best options to position your family office for upcoming destressed and opportunistic investment opportunities.

Please drop us an email if you would like to learn more about attending.