In the Wake of Delays: Multifamily Development Landscape

On March 27, the National Multifamily Housing Council (NMHC) unveiled its Quarterly Survey of Apartment Construction and Development Activity. The data pointed to a surprising 88% of participants reporting hold-ups in their projects, up from 85% a year ago. Notably, the reasons for these delays depicted a different picture from last year.

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Source: National Multifamily Housing Council

Understanding the Factors Behind Construction Delays

The survey data mirrors an evident repercussion of the Federal Reserve's policy on interest rates - unfavorable conditions in the debt capital markets. According to the Federal Reserve Economic Data (FRED), new private housing unit starts in early 2023 decreased by 19.5% year-over-year. However, this might not entirely spell doom, given the pronounced dip in construction costs since the latter half of 2022.

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In the recent three months, 47% of developers reported upward deal repricing, down from 92% in March 2022. Meanwhile, 21% saw a downward repricing (a substantial increase from 0% last year), and 14% didn't observe any repricing, compared to 5% the previous year. Considering the tightening credit climate and a gloomy short-term rent outlook, developers have started to question the profitability of their investments.

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The most common reason for construction delays, as the survey indicates, is the current non-feasibility of projects, hinting that developers are awaiting a turn in the tide. So, what needs to shift for projects to regain viability?

Decoding the Variables for Viable Development

Land Values:

While limited transactions in the past nine months make market assessment speculative, there's a palpable discrepancy between sellers' asking prices and buyers' bids. Sellers forced to sell at a discount due to debt are likely to be the first to budge. However, even cash purchasers must ponder whether they can afford to wait out for more lucrative opportunities.

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Construction Costs:

Material prices have subsided from their 2022 highs. Yet, expecting a drastic fall in construction costs may be wishful thinking. Based on historical patterns, costs are likely to face downward pressure through 2023 and possibly 2024 before stabilizing. A return to pre-pandemic pricing, however, seems highly unlikely.

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Financing Costs & Availability:

How the Federal Reserve manages inflation curbing and concerns about potential economic downturn due to ongoing rate hikes is a looming uncertainty. This uncertainty could intensify with the current turbulence among regional banks, likely leading to a stricter regulatory environment and further credit tightening.

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Revenue Potential:

Our research indicates a slowing or even reversing trend in rent growth across many key markets. This trend is expected to persist through 2023 as almost a million new rental units hit the market, the highest since the 1970s, according to U.S. Census Bureau. A supply shock might increase vacancies and exert downward pressure on rents in the near term, thereby lowering investment returns.

Shifting Gears in the Multifamily Market

Evidently, we're at the onset of a slowdown following a period of unprecedented development activity. We anticipate an increase in vacancies and a decrease in effective rents as operators offer concessions to attract tenants. If a significant recession surfaces - the Federal Reserve could return to a more supportive rate environment to stimulate the economy. This shift could propel the construction of new apartments to meet the supply-demand imbalance.

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Although a rocky short-term forecast is in view, it might be the needed jolt to stabilize longer-term fundamentals and secure the risk-adjusted returns central to our multifamily investment strategy.

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