Walker & Dunlop: Spring multifamily market faces inflation and housing bubble fears

Downtown Nashville has seen an influx of residents interested in multifamily housing, especially tech workers emigrating from offices in New York and San Francisco.

By Walker & Dunlop Research Department

Inflation and a new era of monetary tightening

Amid 40-year high inflation rates, home prices that have jumped more than 40% in the past three years, and double-digit increases in the prices of basic necessities such as food, gas and electricity, the United States seems to be assailed from all sides. Inflation became the issue of the day with little relief even after monetary tightening began earlier in the year. Following a quarter-point increase in the Federal Reserve’s target rate in March, the Fed implemented a whopping 50 basis point increase in the target federal funds rate in May after April inflation was remained at 8.2%, near March’s high of 8.6%.[1]

The employment base, the Fed’s other priority objective, seems to remain solid. Unemployment (at 3.6% in April) remains low and employment growth of 390,000 in May exceeded economists’ expectations.

The Fed’s job now is to beat inflation and prevent it from integrating into consumer expectations. Why? Because once inflation is priced into expectations, it alters consumer behavior and becomes somewhat of a self-fulfilling prophecy, making it harder to tame without plunging the economy into a recession. In fact, it may already be too late for that. The New York Fed’s Consumer Expectations Survey indicates that consumers expect inflation to remain close to 6% over the next year and just under 4% over three years. , well above the Fed’s inflation target of nearly 2%. Additionally, the latest estimate of gross domestic product (GDP) growth for the first quarter (−1.5%) indicates that economic growth may have already turned negative, driven by lower private investment in inventories. , exports and government spending.

While it’s easy to suggest in retrospect that the Fed was behind the game in tackling inflation, just six months ago economists expected inflationary pressures to be all short-term: accommodative monetary and fiscal stimulus, pandemic-related supply chain shocks, and an increase in demand for goods. Unfortunately, inflation proved to be more rigid, further supported by geopolitical instability and significant increases in the money supply.

Whether or not the economy can withstand a quick tightening of monetary policy remains to be seen as the punch of fiscal policy has been removed. An already tight labor market could limit further business expansion, especially as labor force participation among working-age people remains below pre-pandemic levels.

Consumers may be in better shape today than they were at the onset of the global financial crisis (GFC) 15 years ago, given that their balance sheets are significantly less leveraged. However, consumers have depleted their excess savings thanks to pandemic-era stimuli, and growth in personal disposable income per capita has turned negative. These factors could affect future spending, the largest component of GDP.

A series of rapid interest rate hikes derail housing and equity markets (which are already down 16.7% year-to-date [S&P 500] in mid-May) would only accelerate the extent to which households reduce spending, increasing the risk of pushing the economy further into recession.

The policy guidance calls for monetary tightening, both in terms of raising the target federal funds rate and shrinking the Federal Reserve’s balance sheet, with 50-point hikes possible at the next two Federal Reserve meetings in June. and July.

In May, estimates for the federal funds were around 2.0% to 2.25% by the end of the year, against a target of 1.0% currently. The perception that the Fed will now have to act more aggressively than in previous cycles has led to a rapid rise in Treasury rates, from around 0.5% in August 2021 to over 3.0% in early May, as well as a steady rise in real rates (even if the latter still remain in negative territory). Notably, however, the ten-year Treasury yield fell to around 2.8% in mid-May after the Fed Funds target rate was raised on May 5.

Economists polled by the Federal Reserve Bank of Philadelphia remained optimistic in May, forecasting second-quarter GDP growth of 2.3%, though down from a forecast of 4.2% in the survey. previous year, with GDP growth for the whole of 2022 forecast at 2.5%.

Housing markets: Bubble territory?

Mixed signals on consumer confidence, still-rising construction costs and an increase in 30-year mortgage rates to over 5% from 2.8% in early August 2021 have left many worried about a possible foam in the housing market; the Dallas Fed noted in a recent research paper that there are signs of a “housing bubble in the making”.[2]

This would contrast with the strength of the residential market in 2021, where the desire for more space as well as reduced concerns about commuting distances have led to double-digit gains in single-family home prices. Likewise, apartment rents are above pre-pandemic levels in many places and vacancy rates are at record highs.

As a result, multifamily investment sales hit an all-time high in 2021 with nearly $290 billion in deals, more than double the 2020 total. Investment activity was strongest in Atlanta, Houston , Dallas-Fort Worth and Phoenix in the first quarter of 2022, as interest has shifted firmly from coastal markets to the Sun Belt region. Industry cap rates are at record highs and the unit price has risen 11% over the past four quarters to $239,000.

Part of the rebound in the multifamily market reflects the return of many renters who had left their city apartments at the height of the pandemic, although vacancy levels were also flattened by the lack of new multifamily completions. However, Zelman & Associates reports that new completions will likely be higher in 2022 than in 2021, modeling a 13% increase in housing starts this year. This sets the stage for more multi-family completions over the next three years than any comparable period dating back to 1988, with an above-average concentration in the suburbs.

However, even as supply is expected to increase, concerns about the pace of household formation have emerged, which could weigh on net absorption. Likewise, whether due to rising mortgage rates or the acceleration of home purchases due to COVID-19, sales of existing and new homes are expected to slow. According to the Fannie Mae Housing Market Forecast (May 2022), total home sales are expected to decline 11.1% in 2022 and 11.6% in 2023.

Looking further ahead, according to the US Census Bureau, US population growth rose just 0.12% year-over-year in July 2021, the lowest annual rate on record for the country. , reflecting the high number of deaths from the pandemic and weak immigration trends. Zelman & Associates notes that annual population growth, which has averaged 0.71% per year for the past decade, is expected to increase by 0.39% per year for the decade 2020-30.

While the multifamily market will face many headwinds in the coming year, with average U.S. vacancy rates at 5.5% and effective rents up 14.3% in the first quarter of 2022, the market has room to adapt to much more “normalized” growth levels. . With housing supply constrained by the lingering effect of eviction moratoriums, delays in new construction cycles, and institutional investors absorbing a growing share of single-family home purchases, multifamily fundamentals beat Zelman’s recent forecast. , leading them to increase 2022 economic income growth to 7.8. percent from 5.8 percent.[3] Despite inflation, rising rates and war in Europe, the multifamily industry retains many of the same strong fundamentals as at the end of 2021 and remains the best performing commercial real estate asset class.

Walker and Dunlop is a content partner of REBusinessOnline. For more Walker & Dunlop articles and news, Click here.

[1] The numbers refer to the more widely quoted CPI-U inflation index, although the Fed is tracking the Core PCE inflation index more closely which followed similar trends but rose 5.2% d year-over-year in March 2022.

[2] “Real-Time Market Watch Finds Signs of U.S. Housing Bubble Brewing,” Dallas Fed, March 29, 2022. https://www.dallasfed.org/research/economics/2022/0329.

[3] Source: March 29, 2022 macro rental market forecast, Zelman & Associates