After a difficult start to the year, the multifamily sector produced a characteristically strong second quarter. Vacancies fell to 5.9% from 6.2% on estimated demand of nearly 74,000 units, near an all-time record. Rents rose 1.3% quarter-over-quarter, on par with second-quarter increases in 16Q2, and 2.4% year-over-year.(as shown in Exhibit 1).
These healthy fundamentals, however, belie starkly different capital market conditions. Multifamily deal volume slumped for the second straight quarter, totaling $31.9 billion in 17Q2, down from $37 billion in 16Q2. For the first half of the year, multifamily transaction volume has totaled about $63 billion at the time of writing, down from $81 billion for the first half of 2016. Consistent with lower transaction volume, multifamily pricing (per CoStar’s Commercial Repeat-Sale Index) has plateaued over the past year (weaker pricing has also affected commercial real estate).
What has spooked multifamily investors? Higher interest rates since the election have eroded a key attraction of the asset class: the wide spread that even historically low cap rates have offered to Treasuries. The concentration of luxury, urban supply underway increases rental competition for existing institutional product, and the retrenchment in rents at the end of last year sent a clear signal that the laws of supply and demand still apply. Finally, the upward trend in the homeownership rate threatens to dry up the renter demand pool as affluent households, which have rented in record numbers, buy homes instead.
These risks loom over Class A assets, especially the newest deliveries. On the other hand, the broad multifamily market boasts a record of steady rent growth and high occupancy with low volatility. These features make apartment assets—especially Class B assets more immune to homeownership risk—an ideal defensive asset, an increasingly important consideration as this economic cycle matures.