The Time Is Right to Go on the Offensive

By David Scherer, co-chief executive officer, Origin Investments

Investors and fund managers are realigning and recalibrating portfolio allocations by beefing up multifamily real estate positions. They are following market forces and gravitating to the position that now is the time to go on the offensive – and perhaps capture generational investment opportunities in the process.

This approach has been gaining momentum over the last six-plus months. During the first half of 2024, interest rate volatility has been tamed, with growing potential for downward movement through year-end; the disparity between renting an apartment and buying a home has grown even more; and the delivery of new multifamily units has outpaced new construction starts at levels not seen for decades. Behemoth investment entities KKR and Blackstone lead this “go on the offensive” mindset with their recent billion-dollar portfolio acquisitions.

Combined with other market forces discussed below – the possibility of further declines in multifamily valuations, a growing likelihood of market distress, and the enduring strength of market fundamentals – those transactions could be the rising tide that lifts the multifamily investment market for the balance of 2024 and beyond.

Asset Valuations Will Decline Further

During the first half of 2024, multifamily valuations fell as much as another 5% from a 15% to 30% decline throughout 2023. While the downward pressure and trajectory of lower valuations has slowed, the correction may be incomplete. And there could be further declines of as much as 10% this year, depending on the individual market and property characteristics.

This slowdown portends well for the multifamily sector but makes it difficult and perhaps premature to call the bottom of the market. However, the greater probability that values will go up rather than down makes it easier to identify upside potential.

The impact of the Blackstone and KKR deals, as well as other one-off transactions taking place, is helping to realign pricing expectations and narrow the bid-ask spread that has kept market activity largely in check for 18 months. There is enough activity to establish price points that lenders and equity sources will become increasingly more comfortable with to complete further trades.

Potential for Distress Remains

The potential for lower valuations is only one of the forces pointing to a period of distress this year. Stubbornly high interest rates and the enormity of rapidly maturing variable-rate bridge loans contribute to growing concerns about the future impact distress will have on the market.

The distress that occurred amid the Global Financial Crisis from 2008 to 2009 is very different than the distress that is occurring today and that I believe will play out into 2025. “Distress 1.0” took place in an economy that was distressed. Notes were being bought from banks, and in some cases, those banks were failing. It wasn’t a distressed real estate situation. Banks were fighting for their lives and unemployment was huge.

Although there have been bank-related issues, the current conditions for “Distress 2.0” are quite different: Banks aren’t failing at 2008-09 rates, and unemployment remains in check.

I expect the current distress to create generational investment opportunities in multifamily as assets become available at significantly below replacement costs, deal flow increases, and more nontraditional capital solutions such as restructurings become available. Further, there is an abundance of dry powder on the sideline waiting to seize opportunities when they occur.

Strong Fundamentals Persist

The persistent nature of housing market fundamentals is a compelling rationale for investors recalibrating investment portfolios. The most compelling fundamentals include:

• Record deliveries, lack of new starts: The multifamily market is experiencing the greatest disparity between construction starts and the delivery of units since 1975. A major contributing factor: the presence of zero interest-rate policies that helped finance the development boom and whose absence has since slammed the door on new development. Year-over-year starts dropped a dramatic 43.7% from March 2023 to March 2024. At the same time, 644,000 units were delivered in February 2024, the most since 1974, according to the U.S. Census Bureau.
• Renting versus buying: As higher interest rates continue to choke off new construction and home purchases, the discrepancy between renting and buying is growing. According to sources from Bankrate to Heitman, homeownership is anywhere from 50% to 70% more expensive than renting. As a result, demand for conventional rental assets and build-for-rent housing will only increase.
• Supply imbalance: Freddie Mac estimates the current housing shortage at 1.5 million to 3.8 million units. Record levels of new construction and deliveries have not materially changed that imbalance, and the decline in construction starts will only exacerbate it.

• Positive rent growth: The combination of market forces, including population growth patterns, is bringing rental rate growth projection levels back to historic levels, as many sources have been predicting.

The big caveat is interest rates. There is no expectation for a substantial drop in 2024. The latest consumer price index indicates further softening of inflation, which reaffirms an interest rate outlook of 3.5% to 4.5% in the 10-year note yield.

As an investor or fund manager, it is imperative to look beyond today’s reality and instead look at what next year – and the year after that – will look like. Considering the various factors, I expect multifamily investments to perform well in the years ahead. As these forces and the level of dry powder and pent-up acquisition demand would indicate, the time is right to go on the offensive and start scaling up.

David Scherer is co-CEO of Origin Investments, a multifamily real estate fund manager.

The views and opinions expressed in the preceding article are those of the author and do not necessarily reflect the views of AltsWire.

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