Multifamily remains an income building machine. But now’s not to time to jump in.

By Michael Moran and Lori Santarelli

Those who have followed our research over the past year know that PCRP Group is not among those who, like the infamously deluded mayor in Jaws, are eager to push our investors back into harm’s way at this moment. That may sound odd coming from a company who makes its living putting together investment groups to buy large income producing apartment complexes. But we’d rather be right than rash.

Indeed, we’ve been watching in the past four months with some alarm as other voices in the multifamily commercial real estate world have encouraged investors to take advantage of allegedly distressed assets they claim are available right now due to the global pandemic and the economic shutdown it engendered.

Putting aside any qualms about profiting from the COVID-19 tragedy, that line of thinking is detached from economic reality. Multifamily real estate as an asset class has performed much better than other investment vehicles since the start of the lockdowns in March. Rent payments have held up, as have occupancy rates and valuations. In the long run, this underscores the enormous resilience of multifamily investments – something I’ll return to in more detail below.

But “safe to go back in the water” right now? Fageddaboudit!

The fact is, no matter what anyone says, multifamily residential real estate assets have not yet felt the full force of the COVID-19 emergency. Other real estate segments – office properties, retail space and especially senior and student housing – have been battered by the lockdowns and the very real fear people have of contagion in densely packed spaces.

Multifamily operators, in contrast, have enjoyed a unique government-funded period of safe harbor from the economic forces battering most of the rest of the economy, benefiting more than most than from government stimulus schemes like the Payroll Protection Plan (PPP), expanded unemployment checks, and on the local level, municipal eviction moratoriums and negotiated rent holidays being offered by some far-sighted landlords. By June 27, for instance, 94.2% of multifamily tenants had managed to pay rent.[i] It’s as if COVID-19 doesn’t exist!

Ivan Kaufmann is CEO of Arbor Realty Trust, a publicly traded multifamily lender and operator. Unlike some, Kaufmann knows his every word about the prospects for multifamily real estate will be scrutinized by the Securities and Exchange Commission (SEC) as well as the army of equities analysts who follow the public markets. So I give more weigh to statements from he and other regulated pros.

Not surprisingly, Kaufmann is clear eyed when it comes to the short-term investment environment, and his analysis synchs perfectly with our own.

“Lenders like us and property operators haven’t felt the impact of the employment losses created by COVID-19 to date,” Kaufmann told reporters recently. “The supplemental payments have put people in as good, if not better, positions than when they were working.”

In other words, multifamily has been able to kick the can down the road.

This, too, shall pass

We hope this comes as no surprise to our investors. As we noted in our April 8 newsletter (‘Waiting for the Buffett Moment’), distressed families will skimp and cut back on many things, but during a life-threatening pandemic, rent is going to be a priority. “The government checks and GoFundMe campaigns will forestall the worst for the moment. But there will be blood, don’t fool yourself.”

The questions now are, how long can multifamily hold out, and when the reckoning arrives, how can we determine the best moment to reenter the acquisitions market?

July’s rent payment numbers have slipped from June, and while reliable figures aren’t really available until the end of the month, the preliminary figures show a month-on-month slippage of about 3%. But we believe that the scale of this crisis requires the aperture to be opened a lot further. July rent payments still reflect a world in which the initial government programs aimed at mitigating the crisis are in effect. That will not be true in August.

Even then, August may see renters able to muster the resources to make one last payment. But the resurgence of the virus this summer – dashing hopes that warmer weather might bring a period of relief – has found many states reverting to lockdowns. With Congress deadlocked over how and whether to extend a new round of stimulus, a presidential election supercharging partisanship and health experts warning that an even more virulent second wave could be upon us in the autumn, it’s an easy call for us in the short-term. We don’t believe current values reflect reality.

Keep your mask on and your powder dry

With a name like “Preferred Climate Resilient Properties,” you might expect us to take science seriously. Well, you’d be right. And not only epidemiology, but also economics. They don’t call it the dismal science for nothing.

In spite of the short-term gloom, the future remains bright. In fact, COVID-19, as tragic as it is, will drive some of the elements that had already underpinned multifamily residential demand before the pandemic.

  • The pandemic has slowed construction both of multifamily and single-family dwellings, exacerbating a widening gap between housing demand and supply.
  • Middle class families remain priced out of the single-family market, and the pandemic has exacerbated job security, making it even less likely a middle-class household will qualify for a mortgage. Multifamily apartment demand is directly driven by this economic dynamic.

  • Multifamily residential vacancy rates historically stay much lower than those of other real estate assets during downturns. In 2008, for instance, vacancy rates for the “B” and “C” class apartments never reached 8% ­– not much higher than the normal turnover rate in a healthy period. “A” class luxury apartments, however, say national vacancy rates of 10% and more, and that pattern is repeating itself in this downturn.
  • Construction of multifamily properties has not kept pace with demand for rental housing, and the housing that has been build is primarily beyond the reach of middle-class families (i.e., Class A luxury apartments, which made up over 70% of multifamily completions in 2019). This is a big reason PCRP Group only purchases , B- and C-class units: demand is rock solid and driven by economic fundamentals (there’s that science thing again!). Fannie Mae, the government’s chief real estate lending guarantor, said in a February 2020 report, “Ongoing demand for affordable rental units has kept the estimated vacancy rate very low for many class B and C units,” the report said. “We do not expect the vacancy rates at apartment units affordable to workforce households to rise anytime soon.”[ii]

  • Demographic and cultural trends continue to push US homeownership rates downward to about 65% in the latest (April) US Census Bureau report. That’s down from a high of nearly 69 percent in 2005, before the real estate bubble of the first decade of this century spectacularly burst. Forecasts, drawing on factors as varied as the Millennial generation’s preference for urban amenities, the debt burden of recent college graduates, slowed single-family starts and their rising cost, suggest this is no short-term trend. A raft of new academic research suggests that over the next forty years, homeownership may flirt with the 50 percent rate by 2050. Either way, fewer homeowners means more renters, and that is good for multifamily investors.

Of course, all of this is underpinned by the unrivaled tax advantages that flow to multifamily investors, none of which appear to be on the chopping block in Washington. (For a full rundown of how multifamily investors rate as the most tax advantaged investor class in the world, see Mike’s January note on passive income, accelerated depreciation and other benefits our investors enjoy).

The good news is that we only work with long-term investors interesting in cash producing, risk tested assets. In our judgment, we remain, in our opinion, 6 months away from the moment when the three elements distorting the market ­­– unprecedented government stimulus, a devastating economic downturn, and of course, the COVID-19 virus ­– have worked their way through the system. Until then, pretending the market has “priced in” the effects of the pandemic is wishful and dangerous thinking.

Our belief is that the tide right now is out. When it comes back in, we plan to be riding high – and riding in a bigger, better boat.

[i] Rent Payment Tracker, National Multifamily Housing Council, https://www.nmhc.org/research-insight/nmhc-rent-payment-tracker/

[ii] Growing Mismatch Between Multifamily Supply and Renter Demand, Fannie Mae https://multifamily.fanniemae.com/news-insights/multifamily-market-commentary/growing-mismatch-between-multifamily-supply-and-renter