By: Nathan Metheny, Managing Principal/Co-Founder
Multi-Family Performance During a Recession
The thought looms in the back of every investor’s mind; how will my investment fare in a downturn? The thought looms for good reason, as every market upswing is followed by a downturn. As the saying goes – every party ends at some point.
There have been two notable recessions in the first several decades of the 21st century; the 2001 recession and 2008 – 2009, commonly referred to as The Great Recession. To better gleam into the effects of a market downturn on multi-family, it is necessary to understand the results of the previously mentioned recessions.
One of the major insights into the resiliency of the multi-family sector pertains to the effect on rental rates. As shown in the small glimpse into history, multi-family rental rates incur a lower total rent decline and a larger, more rapid, post-recession recovery.
Although the 2001 recession is considered a minor among U.S. recessions, impacts were seen across the real estate market. It is notable that retail was the lone sector to experience zero rental rate decreases; with the digital age negatively influencing retail, this trend should not be expected in the future. On the other hand, all other commercial real estate sectors felt the downturn. Research provided by CBRE.
- Multi-Family: 6.7% decline over 9-quarter period
- Office: 17.7% decline over 13-quarter period
- Industrial: 7.4% decline over 15-quarter period
Multi-family also proved its resiliency with a strong post-recession recovery, outperforming the rest of the industry.
- Multi-Family: 10% growth beyond prior peak
- Office: 5.7% growth beyond prior peak
- Industrial: 4.3% growth beyond prior peak
2008-2009, The Great Recession
Known as the most severe recession since the Great Depression during the 1930s, the Great Recession is a wealth of knowledge to be applied to the commercial real estate industry. The likes of 2008-2009 is a testament to the multi-family sector; multi-family fared exponentially better than its counterparts.
- Multi-Family: 7.9% decline over 6-quarter period
- Office: 17.7% decline over 9-quarter period
- Industrial: 17.5% decline over 13-quarter period
- Retail: 14.1% decline over 21-quarter period
With the emergence and explosion of eCommerce, retail struggled to recover. As of Q1 of 2019, the retail sector has been unable to hit pre-recession levels. Due to several factors, including eCommerce, the retail sector is expected to struggle for the foreseeable future.
- Multi-Family: 25.7% growth beyond prior peak
- Office: 5.0% growth beyond prior peak
- Industrial: 7.8% growth beyond prior peak
- Retail: -4.5% growth beyond prior peak
Another key factor to assess during recessions involve vacancy rates. Although multi-family vacancy rates surely reflect recessionary times, the impacts of downturns are historically minor with swift recovery periods. During the previous financial crisis, multi-family vacancy rates rose to 11.1%, remaining within manageable levels. The increase in vacancy lasted a mere 7-quarters before rates began to decrease and an additional 5-quarters to decrease below pre-recession numbers. Currently, the multi-family national vacancy rate is 6.8%; a vacancy rate of 7%-8% is considered healthy, a 12% vacancy rate is considered high, and a 20% rate is considered hyper-vacancy.
Investment Weak Points
During recessionary periods, weak points pertaining to any investment are exposed. More often than not, when an investment fails during a recession, it was caused by the combination of the economic atmosphere with an investment weak point.
The ability to leverage an investment is arguably the most powerful financial advantages of real estate. Although the power of leverage is clear, it can also be the death of an investment during economic shocks. Over-leveraging an investment can create a dangerous environment if the market were to slow and rental rates decrease; the cash flow of the investment would no longer be capable of servicing the debt payments.
Since the Great Recession, over-leveraging has become difficult due to stringent lender underwriting criteria. It is no longer possible to obtain the pre-recession loan to value ratios. According to the most recent evaluations, debt has increased by 2.4% since 2010; property valuations have increased by 7.6%. Additionally, the rise of private equity capital to fund deals has forced leverage ratios to the lowest point in two decades.
Understanding the fluctuations of supply and demand in a given market is crucial; this is especially true when the economy is appearing to stagnate. If there is an insufficient amount of demand to absorb development, an investment will fail rapidly. Over-supply is also accurate with existing development; if an investment is within a heavily saturated market, the competition will be great during a recession, forcing rents down to inadequate levels.
Surprisingly so, given the commonness of over-development in the real estate industry, current data points to lagging construction in comparison to the rest of the economy. Most recent trends indicate that supply has continued to remain below demand with net absorption exceeding completions for the past four quarters. This trend is likely to extend into the future; Renter Nation dives into the reasons for the rental market’s expansion to continue.
It is tempting to secure short-term financing in creatively structured deals, but it places an investment at the whims of the market. A loan term that is shorter than the projected hold period could force the investment to be sold at a loss because the market was not strong enough to sell at the value needed. Securing long-term debt allows an investment to weather recessionary periods.
As shown, multi-family real estate is in an attractive position within the market. The resiliency of the asset class and the current stability due to post-recession caution will allow multi-family to thrive during the next downturn while continuing to outperform its commercial real estate counterparts.
Disclaimer: Information contained herein has been secured from sources believed to be reliable but should not be considered investment advice. Wealthrise makes no representations or warranties as to the accuracy of such information and accepts no liability. We suggest that you consult with a tax advisor, CPA, financial advisor, attorney, accountant, and any other professional that can help you to understand and assess the risks and risk implications associated with any investment.
About the Author: Nathan Metheny is Co-Founder and Managing Principal at Wealthrise. In this capacity, his primary roles include acquisition supervision as well as setting the long-term strategy and trajectory for the company.