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In today’s uncertain US commercial real estate (CRE) market, multifamily stands out as a resilient asset class. While we observe short-term trends such as decelerating rent growth, increasing expenses, and lower transaction volumes, it is important to consider them within the context of structural housing-market challenges, including an overall shortage of housing and increasing barriers to ownership. In light of this, we view long-term debt as a compelling option to access the multifamily asset class.
Deceleration in rent growth
Deceleration in rent growth has become a point of concern making headlines in 2023. While factors such as slower job growth, reduced household formation, and weaker in-migration may contribute to the deceleration, our primary focus is on the supply pressures affecting various markets. Generally, we observe that markets with higher new deliveries as a percentage of existing inventory are experiencing slower rent growth (exhibit 1). In the near term, we expect that rent growth in these markets will continue to be constrained as projects in construction reach completion.
Exhibit 1: Nine out of the 10 MSAs with the most supply experienced below average rent growth
YoY effective rent Change
Annual supply as a % of inventory
Top 50 US MSA (metropolitan statistical area) average
2.15%
2.12%
Top 10 MSAs Where Supply Increased the Most
Nashville-Davidson--Murfreesboro--Franklin, TN
1.10%
5.81%
Jacksonville, FL
-0.70%
5.21%
Charlotte-Concord-Gastonia, NC-SC
2.54%
5.06%
Salt Lake City/Ogden/Clearfield, UT
0.06%
4.83%
Austin-Round Rock, TX
-1.58%
4.55%
Phoenix-Mesa-Scottsdale, AZ
-4.03%
4.20%
Raleigh/Durham, NC
0.74%
4.17%
Orlando-Kissimmee-Sanford, FL
1.90%
3.43%
Fort Worth-Arlington, TX
1.90%
3.42%
Atlanta-Sandy Springs-Roswell, GA
-0.27%
3.01%
Tampa-St. Petersburg-Clearwater, FL
0.40%
2.70%
Denver-Aurora-Lakewood, CO
1.72%
2.69%
Minneapolis-St. Paul-Bloomington, MN-WI
1.83%
2.48%
Source: Realpage Financial Data. As of June 30, 2023
Expenses continue to increase
In addition to decelerating rent growth, expenses continue to increase. Reports of insurance cost increases in the southern and western regions continue to permeate throughout US CRE for good reason. Operating expenses across markets typically track inflation, with certain factors beyond borrower control such as taxes and insurance. Major expense categories have shown quarterly growth since 2019 that significantly outpaces the average quarterly expense growth since 2010 (exhibit 2). Stagnating rent growth, coupled with continued expense growth, are expected to weigh on expense ratios in the short term.
Exhibit 2: CRE expenses increase since 2019 significantly outpacing long-term average
4-quarter rolling average
Source: Realpage Financial Data. As of June 30, 2023
The multifamily sectors' sustained appeal is rooted in fundamental factors like evolving homeownership patterns, affordability concerns in the housing market and shifting demographics.
Valuation gap impeding transactions
Property owners are holding onto property values from 2021 and 2022, while buyers are attempting to earn increased target IRRs to keep up with higher interest rates. This disconnect has led to a significant slowdown in multifamily transaction volume (exhibit 3). Green Street's CPPI suggests that CRE values have also declined 16% from the recent peak in 2022, despite a lack of transactions that are skewing actual results higher.1 This slowdown has created uncertainty related to property values when evaluating new opportunities due to a lack of comparable sales information.
Exhibit 3: Multifamily transaction volume is down 68% in 2Q 2023 compared to last year
Source: MSCI Real Capital Analytics. As of June 30, 2023
Across the investment landscape, borrowers continue to seek shorter loan terms coupled with some level of interest-only and flexible prepayment options. These preferences reflect borrowers’ mindset that rates will decrease once the US Federal Reserve (Fed) is finished with the rate hikes, allowing for increased cash flow/loan proceeds in the future.
However, despite market expectations, the Fed’s projections indicate rates will remain elevated for longer than expected. According to the Federal Open Market Committee (FOMC) projections in September, short-term rates in 2025 are expected to be 3.9%, compared to a 3.4% estimate in June.2
A long-term Investment horizon can help mitigate short-term risks
We believe the risks identified above appear to be short term in nature and can be mitigated by adhering to a disciplined underwriting approach and focusing on longer-duration investments to weather the short-term disruptions in the multifamily market. Longer-investment horizons will allow for more time for market fluctuations to stabilize.
Rental income growth, while slowing, typically aligns with long-term demographic trends and local demand dynamics. In our view, expense increases are expected to return to levels closer to the long-term inflation rate, and the uncertainty surrounding valuation rates today can be mitigated through strategic investment decisions.
The relationship between compounded quarterly rent growth since 2Q 2018 and new quarterly construction completions indicates that markets experiencing the highest completions relative to overall supply tend to encounter a larger increase in rents over the same period. This relationship suggests that developers responded to strong housing demand by building more units, indicating that current supply levels will be absorbed, despite the short-term lack of pricing power.
Expense Inflation is being driven by the repricing of insurable risks, municipal budget adjustments in response to growth and inflation, and general inflation that may not have been experienced immediately across all expense categories.
Property values may take more time to stabilize as investors adjust to higher borrowing rates and identify properties for sale within their portfolios. We believe strategic investments that prioritize downside protection, disciplined underwriting of the property and business plan, and careful sponsor selection will help drive performance during the investment period.
The multifamily sector's sustained appeal is rooted in fundamental factors like evolving homeownership patterns, affordability concerns in the housing market (exhibit 4) and shifting demographics. These factors collectively indicate that multifamily real estate remains well positioned for stability and growth in the years ahead.
We believe strategic investments that prioritize downside protection, disciplined underwriting, and careful sponsor selection will help drive performance during the investment period.
Exhibit 4. Home ownership affordability monitor index at lowest point since 2018
Source: Federal Reserve Bank of Atlanta. September 20, 2023.
As we navigate the uncertainties of the present, we believe it is crucial to maintain a forward-thinking mindset, recognizing the multifamily sector's potential to provide durable value and investment opportunities over the long term.
1Green Street Property Insights. September 11, 2023 2Board of Governors of the Federal Reserve System. FOMC Projections. September 20, 2023
Unless otherwise noted, the information in this document has been derived from sources believed to be accurate at the time of publication.
This material is provided by Aegon Asset Management (Aegon AM) as general information and is intended exclusively for institutional, qualified, and wholesale investors, as well as professional clients (as defined by local laws and regulation) and other Aegon AM stakeholders.
This document is for informational purposes only in connection with the marketing and advertising of products and services, and is not investment research, advice or a recommendation. It shall not constitute an offer to sell or the solicitation to buy any investment nor shall any offer of products or services be made to any person in any jurisdiction where unlawful or unauthorized. Any opinions, estimates, or forecasts expressed are the current views of the author(s) at the time of publication and are subject to change without notice. The research taken into account in this document may or may not have been used for or be consistent with all Aegon AM investment strategies. References to securities, asset classes and financial markets are included for illustrative purposes only and should not be relied upon to assist or inform the making of any investment decisions. It has not been prepared in accordance with any legal requirements designed to promote the independence of investment research, and may have been acted upon by Aegon AM and Aegon AM staff for their own purposes.
The information contained in this material does not take into account any investor's investment objectives, particular needs, or financial situation. It should not be considered a comprehensive statement on any matter and should not be relied upon as such. Nothing in this material constitutes investment, legal, accounting or tax advice, or a representation that any investment or strategy is suitable or appropriate to any particular investor. Reliance upon information in this material is at the sole discretion of the recipient. Investors should consult their investment professional prior to making an investment decision. Aegon AM is under no obligation, expressed or implied, to update the information contained herein. Neither Aegon AM nor any of its affiliated entities are undertaking to provide impartial investment advice or give advice in a fiduciary capacity for purposes of any applicable US federal or state law or regulation. By receiving this communication, you agree with the intended purpose described above.
Past performance is not a guide to future performance. All investments contain risk and may lose value. This document contains "forward-looking statements" which are based on Aegon AM's beliefs, as well as on a number of assumptions concerning future events, based on information currently available. These statements involve certain risks, uncertainties and assumptions which are difficult to predict. Consequently, such statements cannot be guarantees of future performance, and actual outcomes and returns may differ materially from statements set forth herein.
The following Aegon affiliates are collectively referred to herein as Aegon Asset Management: Aegon USA Investment Management, LLC (Aegon AM US), Aegon USA Realty Advisors, LLC (Aegon RA), Aegon Asset Management UK plc (Aegon AM UK), and Aegon Investment Management B.V. (Aegon AM NL). Each of these Aegon Asset Management entities is a wholly owned subsidiary of Aegon Ltd. In addition, the following wholly or partially owned affiliates may also conduct certain business activities under the Aegon Asset Management brand: Aegon Asset Management (Asia) Limited (Aegon AM Asia), Aegon Private Fund Management (Shanghai) Co., Ltd.
Aegon AM UK is authorised and regulated by the Financial Conduct Authority (FRN: 144267) and is additionally a registered investment adviser with the United States (US) Securities and Exchange Commission (SEC). Aegon AM US and Aegon RA are both US SEC registered investment advisers. Aegon AM NL is registered with the Netherlands Authority for the Financial Markets as a licensed fund management company and on the basis of its fund management license is also authorized to provide individual portfolio management and advisory services in certain jurisdictions. Aegon AM NL has also entered into a participating affiliate arrangement with Aegon AM US. Aegon AM Asia is regulated in Hong Kong by the Securities and Futures Commission of Hong Kong for Professional Investors only (under SFC Ordinance Cap 571); in China, Aegon Private Fund Management (Shanghai) Co., Ltd is regulated by the China Securities Regulatory Commission (CSRC) and the Asset Management Association of China (AMAC) for Qualified Investors only.