Cortland Chief Economist Brad Dilllman: Multifamily’s Greatest Challenge is Supply

Cortland, San Francisco, Seattle, Los Angeles
Courtesy of Amanda Vick

By Meghan Hall

The multifamily industry has proved its resiliency over the past couple of years, weathering many of the challenges posed by the ongoing COVID-19 pandemic. However, in the future,

the multifamily sector’s greatest challenge is one that comes from within. According to Cortland Chief Economist Brad Dillman, the industry’s dearth of supply amidst high demand can hamper fundamentals in the future, more so than other challenges such as demographic shifts or inflation.

The economy has had an interesting 24 months. From your perspective, where does the U.S. economy stand now, and what does its current status tell us about commercial real estate?

The initial rebound from the COVID-19 recession appears to be behind us. The U.S. appears to be in the slowdown-phase, much of which will still be shaped by events outside the industry, ranging from geopolitical events to elections and monetary policy. 

Why do you think peak undersupply is now behind us?

We estimate that peak undersupply occurred several years ago, as relatively sustained housing completions outpaced population gains after controlling for longer-term relationships. Housing completions rose further for most of 2020 and early 2021, while U.S. net population gains appear to have continued a downward trend. For example, total private housing completions averaged 1.286 million in 2020 compared to a 2020 population gain of 1.154, according to recent data.

Below is a  graph of annual population gain and housing completions. It was only in 2017/2018 that annual population increases began to slow sharply (as births and immigration slowed), helping to alleviate the effects of housing shortage. At the same time, completions continued their upward trajectory, causing the situation to finally reverse. 

The Fed is raising interest rates this year to combat rapidly rising prices. How will this impact the multifamily industry through the end of the year? 

Higher interest rates are going to affect loan costs. We are already seeing this in reduced marginal investor activity in the class C space. Higher rates in relatively less risky investments may also siphon capital from multifamily investment. Mortgage rates have already increased and are therefore reducing homeownership affordability. In an underbuilt environment, this tends to be bullish for rental housing, all things equal.

From your perspective, what challenges (aside from the interest rates) does the multifamily industry face over the next year? Why?

The U.S. appears to be in an economic slowdown. When there is a slowdown, there is always a risk that it becomes a contraction, particularly as it is overlaid with geopolitical events, the political process, and Fed tightening. The increased institutionalization of housing will likely bring about more regulation over the long run. In some areas this may go as far as rent control or zoning interventions that rapidly change market dynamics.

In my analysis, the biggest single threat to multifamily is a supply-side stimulus based on exaggerated estimates of the country’s housing shortage. 

Can Cortland speak to how renter preferences have changed over the past two years, and how investors are working to meet those changes? 

Our research shows strong growth in the suburbs, exurbs and rural areas. But urban core areas are finally rebounding too. We expect a bit of a flattening in relative rent growth, compared to the last few years, when the suburbs, exurbs and rural areas had clearly outperformed. 

What is your take on re-urbanization? Do you think renters will return to downtown cores even when studies have shown that many do not want to return to the office?

Generally, rents in the geographic periphery have outpaced urban core rents for some time, most recently and intensely because of the pandemic. One result is that the consumer value gained by moving further out (geographically) has been eroded in many areas. This will likely lead to a rebound in urban rents as people move back in. A general re-urbanization may also be enhanced by energy prices, high used car prices and higher financing rates for those cars. We have seen in the past that strong year over year increases in oil prices are associated with urban core rent growth a few quarters later.

Do you foresee the multifamily sector experiencing further institutionalization in the future? Why or why not? 

Yes, the value to scale, branding, and professional management in the asset class point in this direction.

Gen Z is now entering the renter pool. What do you think this means for the multifamily industry over the course of the next market cycle? 

The industry will need to focus more on how to best serve these customers. This will certainly mean the typical hype around flashy technology, but also on things more likely to be initially overlooked such as the aesthetics and forms that appeal to the new generation, and the minor details of what they expect from the resident experience.

Are there any geographic markets that Cortland itself is following carefully? If so, what is it about these markets that is attractive from an investment perspective?

Florida and other migration-driven markets continue to perform very well, but we are also watching for the potential for markets that suffered during the pandemic to continue their rebound. In general terms, this would align with expected re-urbanization. Washington, DC has started to look more attractive.

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