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Demand for apartments plummeted in the national apartment market in the third quarter, coming off what had been several quarters of strong run-up in demand and rent growth for the national multifamily market.
In fact, apartment demand turned negative last quarter, the first Q3 in at least 30 years that such a phenomenon occurred, according to RealPage Inc. The summer months are typically strong for the for-sale and rental housing markets, making the Q3 drop in demand this year particularly significant.
Net demand was -82,095 units in Q3 among the markets tracked nationally by RealPage, bringing year-to-date net demand to -47,143 units. Negative demand means more renters moved out of than into apartments during a specified period.
Jay Parsons, head of economics and industry principals for RealPage, in a statement accompanying the report said soft leasing numbers and weak home sales point to low consumer confidence. People tend to go into wait-and-see mode during periods of uncertainty, he also said.
It’s possible, too, record rental-rate growth across the U.S. observed in the past 18 months, up until the end of this summer, has more renters doubling up to split the rent.
There’s a record number of apartments under construction across the U.S., prompting questions of whether the sudden slowdown in apartment demand will affect that pipeline, as well as future investment decisions by capital groups and developers.
Carl Whitaker, director of research and analysis at RealPage, said in an email that a performance slowdown will almost certainly cause investor groups to reassess their view on the marketplace but it’ll take something more drastic than a one- or two-quarter period of moderation for groups to significantly adjust their approach to acquisitions and dispositions.
“Multifamily’s share of total (commercial real estate) investment grew steadily even in the pre-pandemic cycle, and the past two or so years have only further solidified apartments as a highly coveted space for investor groups,” he added.
There are some 917,000 apartments under construction, by RealPage’s count — the most on record since the company began tracking the market in the early 1990s.
Whitaker said what’s most likely to influence a construction slowdown are external economic factors, such as rising interest rates and supply chain challenges. Even with the performance slowdown and record amount of construction, he said it would take a prolonged and significant pullback to influence development appetite measurably.
One area of the market where at least some investors could slow development and investment as they tighten the screws on deals: real estate markets that boomed during the pandemic but are hitting the brakes hard.
Boise, Idaho, may be the poster child for such a market, with home values at $323,897 in March 2020, peaking at $515,378 in March 2022, which has since fallen to $502,547 in August, according to Zillow Group Inc. (NYSE: ZG). The typical observed market rental rate in Boise went from $1,333 in March 2020 to $1,886 in August 2022, according to Zillow.
The housing market has cooled very rapidly in Boise in recent months, although rental rates have yet to decline. They grew only 0.2% between July and August, though.
Sean Robertson, originations and underwriting director at New York-based Churchill Real Estate, said his company looked at tertiary markets that boomed in the wake of remote work during the onset of the pandemic. Churchill typically focuses on workforce-housing deals, or properties that can rent at or below 140% of the area median income.
But, ultimately, those pandemic boom markets didn’t make sense for investment — and less so now.
“Those markets were very difficult to comp,” he said. “A lot of developers were going in, overpaying for land, looking to be the market leader as far as amenity packages, finishes … (I)t hasn’t really been battle-tested yet.”
Like many others in multifamily, Churchill has been keen to finance deals in established Sun Belt markets, such as Austin, Texas, and Phoenix. With the cost of capital higher now, and companies like Churchill taking a harder look at which deals to move forward on, high-growth markets in the Southeast and Southwest are places it still feels good about, Robertson said.
But Sun Belt cities are becoming more suburban in nature, following migration trends and where more affordable projects can be pursued. Places like Katy or McKinney in Texas — about 30 miles from Houston and Dallas, respectively — are some of the places Churchill recently closed deals on.
It’s also targeting affordable metros on a relative basis, such as the Inland Empire in southern California, and markets that’ve undergone an industrial boom in the past few years.
When a deal in the Lehigh Valley of Pennsylvania first crossed his desk, Robertson said, it was a “no” initially. But after checking out the area, one of the most prolific warehouse markets in the U.S. that services much of the Northeast, his team’s thinking changed.
“There was not much supply of Class A or even B-plus apartments,” he said. “The housing stock was very old but you saw every industrial REIT sign up, massive (buildings) out there employing thousands of people. They need a place to live.”
Other investors that bet on small cities and towns that grew rapidly in light of the pandemic still see potential for some of those nontraditional markets — if there’s a sustainable growth story.
Chicago-based Pangea Mortgage Capital closes multifamily loans across the U.S., particularly for acquisitions and rehab deals. It’s a subsidiary of Pangea Properties, which owns about 13,000 apartments nationally.
Some of the apartment deals Pangea closed on recently were in places like Moscow, Idaho; Bend and Eugene, Oregon; Kennewick, Washington; and San Luis Obispo, California.
“There’s been a flight, I think, in the post-pandemic world to some of these non-urban areas, somewhere where there’s a work-life balance,” said Michael Bachenheimer, director and head of West Coast originations at Pangea Mortgage Capital. “There’s a whole argument to be made that the five-day workweek, where you’re in an office all five days, is slowly eroding.”
It’s particularly relevant for the tech sector, with those companies pulling back on their office plans as more of their employees are working remotely permanently. Some tech workers who once lived in the pricey Bay Area or Seattle have moved to places like Eugene, Oregon.
Tertiary markets tend are generally less competitive and offer better value plays and more yield, Bachenheimer said, but certain markets work for specific reasons.
Moscow, Idaho, for example, is home to the University of Idaho, which provides continued housing demand from the university as well as their suppliers.
Tertiary markets — perhaps, especially, ones on the fringe of larger metropolitan areas — may continue to be popular with apartment investors and developers, as affordability pushes people farther out or to new markets. And while the permanence of remote work is still debated, if a greater number of people have more choice in where they live, that can spur demand in new cities or towns.
When examining deals now, Bachenheimer said, there are no areas off the table, but because of the Federal Reserve’ position to continue to raise interest rates, Pangea is more closely examining the exit underwriting.
“A lot of deals, while they look great today, they don’t look good two to three years from now,” he continued. “We’re cutting leverage on the front end.”
The growing threat of a recession and deal slowdown in the wake of higher interest rates has some real estate groups preparing to seize on potential distressed opportunities.
The growing threat of a recession and deal slowdown in the wake of higher interest rates has some real estate investors preparing to seize on potential distressed properties or loans.
Real estate insiders say much of the investment market remains in a stalemate and price-discovery mode — some sellers aren’t willing to adjust pricing, and buyers are applying more scrutiny around deal terms and where they invest.
A lot of capital was raised in 2020, at the onset of the Covid-19 pandemic, in anticipation of a wave of distress, which mostly didn’t materialize. But now recession threats and rapidly raising interest rates have increased the potential for distress in the coming months.
“There are funds and groups coming together that want to play in the distressed market,” said George Mitsanas, principal at San Francisco mortgage banking firm Gantry Corp., which has an $18 billion portfolio of serviced commercial mortgages spanning more than 2,100 loans nationally.
Mitsanas said he also expects family offices to see opportunity. “A number of my clients are billionaires where their leverage has always been low, and they have a tremendous amount of capital … If there’s a disruption in the marketplace for good deals, I think the family offices will swoop in and start increasing their real estate holdings,” he said.
The office market is commonly cited as the property type that may face the biggest issues, which could present opportunities for those looking to buy distressed properties.
Estimates of how much office building values may decline because of pandemic changes to work vary. One recent analysis by the Mortgage Bankers Association found, if widespread hybrid work persists, companies would need around 80% of the office space they previously needed, resulting in building income and values dropping 10% to 20%.
Distress isn’t apparent yet, although there are warning signs. Trepp LLC’s commercial mortgage-back securities’ special servicing rate rose to 4.94% in September, a hair higher than the August rate of 4.92%. Loans enter special servicing when financial issues arise, affecting a borrower’s ability to stay current on payments.
Trepp noted in its report that September CMBS data reflects market suspicions that August was an inflection point for specially serviced loans.
“The office sector has a large concentration of loans with near-term maturities and tenants with expiring leases,” it said. “Lockdown periods during the pandemic displayed the ease at which companies can implement a work-from-home policy, and if many of the major tenants in the office sector shed their leases and opt to implement a full or hybrid WFH model, this could have a major impact on the CRE market.”
Looming maturities and lease terminations are starting to be reflected in the special-servicing numbers, according to Trepp.
Scott Sherman recently launched Torose Equities, a Miami company targeting value-add deals, including office buildings, in the Southeast.
Sherman said, since the pandemic, he’s been looking to buy office properties, a sector where he hasn’t seen many active buyers, given the questions over remote and hybrid work’s long-term impact.
“That’s where I’m seeing the best opportunities,” he continued. “Looking forward over the next year, with rates rising, there’s going to be a lot of potential distressed situations to take advantage of.”
That doesn’t exclusively mean distressed properties, but also potential issues when owners can’t refinance maturing debt.
South Florida is somewhat of an anomaly, as companies continue to relocate there, Sherman said, fueling demand for office space. But in other places, the outlook is cloudier.
The level and depth of distress in any property type is impossible to ascertain. But most market observers aren’t predicting a repeat of the global financial crisis fallout for commercial real estate in the late 2000s.
The political environment, both domestically and abroad, are also wild cards for what happens in the broader economy. The war in Ukraine and outcomes of the U.S. election are creating uncertainty, Mitsanas said, and questions investors have to ask include whether there’s going to be an energy shortage this winter.
“Are interest rates going to stay high? What about inflation? Those uncertainties have people nervous,” he said.
But, he added, most real estate owners have plenty of reserves if a rainy day becomes a storm.
Adam Ducker, CEO of Bethesda, Maryland-based RCLCO Real Estate Consulting, said in the past month or two, it’s become a more commonly held view there will be distress.
“It may not be 2009 levels of distress but enough to change investment strategy, create a new fund, reposition something,” Ducker said. “There’s been a meaningful change around the energy of this in the last 30 days.”
While office space gets a lot of the attention, Ducker said the market is bracing for real estate dislocation in general.
For example, in the multifamily market, which has been on fire during the pandemic, deals that closed at high values and low capitalization rates won’t necessarily see distress but are pricing so differently now than they did less than a year ago. It’s become more difficult to refinance or get construction financing, Ducker added, which may present opportunities.
“At the moment, there’s a historically high level of money that’s been earmarked for real estate investing that hasn’t been invested,” he said.
Workspace Property Trust out of Boca Raton, Florida, recently closed on a $1.1 billion portfolio deal that included 8 million square feet of suburban office space in 14 U.S. markets.
It was notable for its size but also because it exclusively included office space.
It was a challenging deal to close because of rapidly escalating interest rates. Workspace recently had a deal-closing party for the portfolio and handed out replica mallets because the sale was like whack-a-mole to get to the finish line, said Roger Thomas, Workspace co-founder, president and chief operating officer.
“We were able to craft together alternative balance-sheet financing, which many people had suggested we would never get that accomplished,” Thomas said. “We managed to get it done. If it had gone much longer, I’m not sure if we would have been able to hold it together.”
Such is the environment now for most commercial real estate deals, even for property types like industrial and apartments.
Roger Thomas is co-founder of Workspace Property Trust.
But Thomas said he remains bullish on suburban office’s future — given demographic shifts to the suburbs and an increasing unwillingness to commute long distances multiple days a week — and is looking for opportunities.
And there’s not a lot of competition in the suburban office buying market right now, Thomas added, as many public real estate investment trusts have pivoted from office more broadly.
“In this challenged market, you’re not going to see people starting up at this stage in the game,” he said. “They’re going to wait for the markets to come back.”
He said it’s possible his company will go through a bit of a quiet period as the markets settle. But because some owners will be coming up against debt maturities, that can be where a company like Workspace can get a deal done.
Sherman, who previously started Tricera Capital LLC, a real estate company that bought retail properties as that sector went through a repositioning, said buying potential or outright distressed properties requires creativity and figuring out how each deal is different.
“Borrowers that now have this issue are going to be faced with a choice: Do they give back the keys, put in more capital or find some other potential way to fill the hole?” he said. “I think that’s where I’d like to try to find opportunities, where we come in and fill that hole.”
The market is moving toward “a win-win experience” for buyers and sellers, according to a new report.
A home for sale in Centennial, Colorado.
Denver metro’s housing market continues to creep ever closer to balance, according to the latest monthly report from the Denver Metro Association of Realtors (DMAR). The shift is impacting all levels of sales, including the $1 million and up “luxury” category.
The end of September saw active listings increase to 7,683, a 10.72% increase from August and a 93.48% increase from September 2021. Month over month, sales volume decreased by 6.38%, and pending sales declined by 15.41%. Closed properties saw a sharp decline from last year, at 27.6%, with 4,113 residences closing in September. Average days on the multiple listing service (MLS) hit 26 days in September, a 100% increase from last year, according to the report.
Despite Denver Realtors seeing price reductions happen in desirable areas where they haven’t seen price reductions since the pandemic, some metrics are still on the rise; the median close price in September was $580,000, a .87% increase from August and a 9.43% increase from September 2021.
In the report, Realtor Libby Levinson-Katz described Denver as moving towards a balanced market, something the city has not seen in more than 16 years.
“A traditional cycle for the Denver real estate market is seven years. Due to an economic crash and a global pandemic, the cycles were extended, but a correction is needed,” she said. “The market is entering a period of neutrality where the bullish ways of extreme markets make way for a stage of compromise, with buyers and sellers working together for a win-win experience.”
After a year of questioning whether $1 million homes should be considered luxury properties in Denver, that category of homes is seeing significant shifts.
According to the DMAR report, home inventory to last the market less than three months creates a seller’s market, while home inventory that lasts the market more than six months creates a buyer’s market. The market for attached homes costing $1 million or more hit 2.83 months of inventory, just on the cusp of exiting the seller’s market category. Similarly, detached homes in the $100,000 to $199,999 are getting close to leaving a seller’s market, as it stands at 2.75 months of inventory.
Realtor Colleen Covell commented in the report that although the numbers may technically show the luxury market as still in a seller’s market, she’s seeing something different.
“We are experiencing full inspection objections, price reductions, no competing offers, no appraisal gaps and even contingent offers. The question on everyone’s mind is are we finally in a luxury buyer’s market? The technical statistics may say ‘not yet,’ but it sure feels close,” Covell said in the report.
More luxury home sellers (those with properties worth $1 million or more) listed their homes in September, at an 18.86% increase than in August, while the attached luxury market saw a 66.67% increase in new listings from the prior month. Total, 649 homes hit the market last month. The luxury market is seeing quite the influx of inventory, with 5,962 new listings so far in 2022.
The average days on the market rose month over month for the luxury market, 31.82% and 40% for detached and attached homes respectively, giving buyers more time to decide to make an offer. Pending sales also dropped in September, as did the close-price-to-list-price ratio, according to the report.
A Redfin report recently found that price drops are becoming increasingly common in the luxury home category — yet a Denver home recently listed at $28.9 million, which would be a high-water mark in residential sales here.
DMAR includes the metro counties of Adams, Arapahoe, Boulder, Broomfield, Clear Creek, Denver, Douglas, Elbert, Gilpin, Jefferson and Park counties in its monthly real estate reports. The organization pulls data from REcolorado.
Whether you are a first-time homebuyer or a seasoned veteran, the negotiation part of the transaction can be a little daunting and stressful. However, it is necessary to ensure you are getting the best possible deal for your money. So, what should you negotiate when buying a home?
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