In recent months, there has been speculation as to whether we are in a housing bubble. Some pundits have argued that the current run-up in prices is unsustainable. They think it’s only a matter of time before the housing market implodes. Others say the opposite: yes, prices are rising. But other economic indicators suggest we are nowhere near the brink of a recession.
To some extent, both sides could be right. It’s possible that we’ll experience a significant market correction—but at the same time, this correction may have little impact on the multifamily market. By all indications, the multifamily market still has significant room to run.
What is a housing bubble?
A “housing bubble” is said to occur “when the price of an asset is rising faster than the fundamentals can justify, often driven by overly optimistic speculation or loose financing.”
According to Investopedia, a housing bubble usually begins with a supply/demand imbalance that takes some time to resolve. In the interim, speculators pump money into the market, which drives demand further. Eventually, demand decreases or stagnates at the same time supply eventually increases. Eventually, this results in a sharp drop in prices and then—the bubble bursts.
A housing bubble usually begins with a supply/demand imbalance that takes some time to resolve.
On the surface, one might think this means we’re in a housing bubble today. After all, there is a tremendous supply/demand imbalance that has caused prices to rise to record highs. But that notwithstanding, the other factors indicative of a housing bubble have yet to emerge. In short, the sector’s underlying fundamentals otherwise remain strong.
2008 vs. 2022 – what’s the difference?
- Bubble Lifecycle
The housing market crash that occurred in late 2008 was different. It was driven by years of over-inflated housing prices and loose lending requirements. The federal government’s push to promote homeownership resulted in nearly 20% of the mortgages made between 2005 and 2006 being made to “subprime” borrowers – i.e., people who would not have typically qualified for a bank loan. An estimated 75% of these subprime borrowers took out adjustable-rate mortgages (ARMs). With an ARM, the interest rate could increase from time to time.
Meanwhile, more people qualifying for loans meant more competition for homes. Accordingly, housing prices shot up 55% between 2000 and 2007.
When the economy began to improve in 2006, interest rates began to rise. Those with ARMs faced higher monthly payments, often more than they could actually afford. Recognizing this risk, investors panicked and began selling off mortgage-backed securities. In turn, housing prices plummeted nearly 20% between 2007 and 2009. The bubble had burst.
The run-up in home prices in 2022 is a result of significantly different factors.
First, there’s a true supply/demand imbalance that continues to widen.
According to the U.S. Census, more than 12 million new households formed over the past decade, but we built only 7 million new homes during that time. The Census goes on to report that single-family home construction is now running at its slowest pace since 1995, which will only exacerbate the nation’s home shortage.
A combination of factors—including supply chain issues, labor shortages, and rising material costs—make it unlikely that new construction will pick up speed any time soon. Absent any significant new construction, there will continue to be pressure on the nation’s existing housing stock.
This is another major difference between 2008 and 2022. In 2008, demand for housing was high but the supply of new housing was also high. As interest rates rose, fewer people could afford these newly constructed homes. Today, that problem doesn’t exist.
Moreover, lending requirements are significantly more stringent today. Banks received a tremendous bailout during the Great Recession, and a condition of this bailout included more rigorous underwriting of borrowers. People who shouldn’t have gotten loans in the early 2000s would no longer be eligible to get those same loans today.
Home prices (and rents) have experienced
double-digit increases over the past year.
In other words, those taking out mortgages today are more qualified (i.e., more likely to repay their loans) than borrowers in years past. Unlike the last bubble, borrowers’ employment, credit history, and income are all verified and home appraisals are well documented.
So yes, home prices are on the rise. In some markets, home prices (and rents) have experienced double-digit increases over the past year. However, those price increases are a result of high demand for very limited inventory. Those who are paying these exorbitant prices can generally afford to do so.
This isn’t 2008 where unrestricted capital flooded the marketplace and speculators were flipping houses for quick profits.
What’s driving investor demand for multifamily housing?
As noted above, demand for multifamily housing remains strong. There are several reasons for this, again, starting with the demographic trends causing the nation’s housing supply/demand imbalance.
Widening Supply/Demand Imbalance
In 2019, the median age of first-time homebuyers was 34. According to the U.S. Census, an estimated 46 million Americans will turn 34 years old over the next decade – the largest wave of first-time homebuyers ever recorded.
Yet many of these would-be buyers are going to be priced out of homeownership, especially as home prices and interest rates simultaneously rise. The nation’s shortage of entry-level homes is particularly acute. Many people who want to buy will instead rent for longer as they become more financially prepared to buy a home.
In the wake of recent stock market volatility, more investors are pouring capital into multifamily given its strong underlying fundamentals. According to DLA Piper’s Global Real Estate Annual State of the Market Survey (conducted in February/March 2022), more than half of investors are bullish on multifamily given explosive rent growth, low vacancies, spiking absorption, and favorable migration trends. Many investors cited the sector’s stable, strong yields that they are unable to achieve elsewhere. In terms of geography, investors’ top pick remained multifamily homes located in the Sunbelt region
Multifamily in the Sun Belt region remained
investors top pick in terms of geography.
Access to Capital
Interest rates are rising, but that has not yet tempered demand for multifamily housing.
According to Jeff Erxleben, Executive Vice President of the capital brokerage firm Northmarq: “There is continued liquidity and likely spread compression due to lender demand. I don’t see a slowdown in the momentum in the lending market at all.”
Erxleben also notes that “bridge lending was off the charts in 2021,” as a result of so many people investing in value-add multifamily deals, something he expects will continue in the foreseeable future as investors look to maximize property values and yields.
The federal government, which pushed for homeownership in the leadup to the 2008 crash, now promotes more sensible lending and home buying practices.
The federal government has also shown its willingness to intervene if a crisis appears to be on the horizon.
For example, the federal government acted quickly at the onset of the pandemic: legislators enacted a foreclosure moratorium and authorized forbearance on payments of government-backed mortgages. As a result, there were remarkably few foreclosures. The federal government’s quick action helped prevent another major housing crisis.
Now, the Federal Reserve is raising interest rates as a way to combat rising inflation (and conversely, it kept interest rates low until now to strengthen the economy after the last downturn).
These interventions provide stability to the multifamily sector, which again, bolsters investor confidence.
To be sure, as interest rates rise, the rapid price and rent growth we’ve seen over the past two years may begin to taper off. But by all indications, demand for multifamily will otherwise remain strong.
Even in a worst-case scenario, where the housing bubble bursts and a foreclosure crisis ensues, multifamily is positioned to out-perform other CRE asset classes. This is because, historically, when single-family home sales decline, people tend to rent apartments in lieu of homeownership. They also tend to stay in those apartments for longer than they may have previously.
This all bodes well for the multifamily sector moving forward. Yes, the stock market may face turmoil, but there is little correlation between the stock market and commercial real estate. The great equities sell-off that investors fear could still occur while having little, if any, impact on the multifamily market today.
Are you interested in investing in multifamily real estate? If so, contact us today to learn more about how Smartland positions its investments to outperform regardless of where we are in any market cycle.