Despite the backdrop of inflationary pressures, rising interest rates, broader market volatility, and geopolitical uncertainty, the real estate market was incredibly active during the first quarter of 2022. Multifamily garnered the majority of the capital flows with $63 billion of transaction volume, which set a quarterly record and accounted for 37% of all commercial real estate investment in that period (1). Investment activity is likely to remain elevated as dry powder earmarked for North American commercial real estate investment rose to $250 billion. Assuming a 65% loan to value, tis equates to $714 billion of purchasing power.
Multifamily Investment Activity Drivers
The drivers for the increased multifamily investment activity are simple; investors are focused on increasing portfolio diversification; as they want increased exposure to resilient and predictable financial assets that are less correlated to broader market economic cycles. The need for shelter is not cyclical; the housing sector is undersupplied creating a scarcity that is unlikely to be resolved anytime soon, homeownership affordability is as challenged as anytime in modern history, and demographic trends are creating a deep pool of rental demand for many years to come.
Rental housing has been a consistent performer over a long period of time.
Investors seek financial assets that have the potential to provide the opportunity for elevated risk-adjusted returns through market cycles and improve diversification, the multifamily sector has historically provided those benefits.
Source: Bloomberg and NCREIF. Real estate from NCREIF Indices (All and multifamily based on the property type: Apartments). Annualized real estate returns calculated using quarterly data since inception from March 31, 1978 (except for multifamily which has an inception date of March 31, 1984) to March 31, 2022. Historical Sharpe ratio and portfolio return analysis calculated using 20 years of quarterly returns from December 31, 1999 to March 31, 2022.
– Traditional allocation: 60% stocks, 40% US bonds.
– Diversified portfolio: 40% stocks, 40% US bonds, and 20% multifamily real estate.
Given the current cyclical headwinds for traditional assets created by inflationary pressures, investors are adding exposure to financial assets that have a positive correlation to inflation. Despite brief periods where inflation outpaced total returns, over the long term, multifamily has on average outperformed inflation by 6.8% annually. Even with historically high levels of inflation over the trailing twelve months, multifamily total returns averaged 24.1%, exceeding inflation by 1,560 basis points.
From 2005 to 2022 the average rent for multifamily grew 90.2% vs the Consumer Price Index of 50.0%.
Rental Housing Demand
Lack of housing supply, homeownership affordability challenges and changing demographics are fueling a red-hot rental market. With one-year lease structures, multifamily investors are favorably positioned to be able to grow their revenues in high-demand, low vacancy environments.
On a year-over-year basis, effective rent growth outpaced inflation in 129 out of the top 150 markets and no market experienced a rental decline over that time. As the rental pool continues to expand, new rental housing construction has been met with even stronger demand. In the first quarter of 2022, 95,000 units were absorbed, outpacing new supply by over 16,000 units (2). The overall vacancy rate fell by 20 basis points quarter-over-quarter and 2.5 percentage points year-over-year to a record-low 2.3%. Average net effective rent increased by 15.5% year-over-year to $2,007 per month (3).
This demand is unlikely to abate as for-sale inventory nationally has plunged 68.4% over the past three years, while prices have increased 34.9%. Limited inventory for sale, escalating prices and rapidly risking mortgage rates are anticipated to benefit demand for rental housing.
Multifamily Remains Compelling
The result here is simple to understand. The fundamental necessity of housing, declining homeownership rates, an increasingly younger population, and short duration leases make multifamily a highly coveted financial asset to own. What is quite clear is that investment activity is likely to remain elevated underpinned by incredibly compelling secular fundamentals and return characteristics that are difficult to replicate.
Nick Rosenthal, Managing Director, Griffin Capital
(1) Source: https://ww.cbre.com/insights/figures/q1-2022-us-multifamily-figures.
(2) Source: Sean Marmora Research Analysis. (2022, May 18). United States Multifamily Capital Markets Report. Newmark; #creator. https://nmrk.com/insights/market-report/unites-states-multifamily-capital-markets-report?utm_medium=email&utm_cource=nkf-cb&utm_campaign=1Q2022%20U.S.%20Multifamily%20Capital%20Markets%20Reports&utm_term=05%2F18%2F2022
(3) Source: CBRE.com. Retrieved June 15, 2022, from https: //www.cbre.com/en/press-releases/record-breaking-start-to-2022-for-us-multifamily-market#:~:text=Average%20net%20effective%20rent%20increased,San%20Francisco%20and%20San%20Jose
Important Risk Disclosures:
This is neither an offer to sell nor a solicitation of an offer to buy securities. An offering is made only by a private placement memorandum or a prospectus. An investment in any program offered by South Coast Investment Advisors or sponsored by Griffin Capital Company may involve a high degree of risk and there can be no assurance that the investment objectives of the respective program will be attained. Investors should carefully consider the investment objectives, risks, charges, and expenses of any program before investing. There is no assurance that real estate investment described herein will achieve capital appreciation or provide regular, stable distributions.