David Meyer is thankful that his business is still plugging along during the wildest housing market in decades. With mortgage rates hovering around 7% and home prices still at record highs, buyers across America are calling off the house hunt and finding multifamily apartments.
“Buyers got a bit spoiled with the interest rates over the last five years and especially the last two, so the interest rate hikes have really spooked everyone,” said Meyer, a RE/MAX agent based in the Twin Cities metro area of Minnesota.
These high interest rates have cost Meyer several transactions in the past few weeks. Some of his would-be buyers are renting apartments until mortgage rates markedly improve. It could be a while.
The number of renters who can even afford to buy a home at the national median list price of $425,000 compared to a year ago is down 15%, according to the National Association of Realtors.
“The monthly mortgage payment is about $1,000 higher than a year ago,” said Nadia Evangelou, an economist at NAR. “Current buyers need to earn about $40,000 more in order to buy the median priced home compared to buyers who purchased their home a year ago.”
With more and more potential buyers remaining renters due to high borrowing costs, and younger Millennials and Gen Zers starting to venture out of their childhood homes, a logjam of renters has emerged.
“Household formation significantly increased over the last decade as millennials have aged and entered the next phases of their lives,” Mark Fleming, the chief economist at First American Financial, said. “We are experiencing the last leg of that, which is the demand switch into home owning. But at the same time, over the last decade, we have historically underbuilt and particularly underbuilt single-family homes. If we don’t build enough units of shelter, then it becomes very expensive to buy a home, then you add in higher interest rates, and everybody gets sort of stacked up in the multifamily world.”
In response, multifamily construction has skyrocketed over the last year, hitting a historic high of 841,000 units under construction nationwide in June of this year, according to research from the National Multifamily Housing Council and the National Apartment Association. In September, the number of multifamily housing starts rose 16.5% year over year to a seasonally adjusted annual rate of 530,000, according to data from the U.S. Census Bureau and the U.S. Department of Housing and Urban Development. In addition, the number of multifamily permits pulled rose 25.5% year over year, to a rate of 644,000.
Despite this uptick in construction, multifamily builders likely won’t be making much of a dent in the overall housing shortage over the next year or two. Those same interest rates pushing would-be homebuyers to the sidelines are also hurting developers. So although the number of multifamily permits pulled has continued to rise and rents are elevated, the number of multifamily units authorized but not yet started has also increased, jumping 33.3% year over year to a seasonally adjusted annual rate of 144,000. Industry professionals expect that this trend will only worsen, which is not good news for the estimated 4.3 million more multifamily units needed by 2035, according to data from the NMHC and NAA.
“Construction lending has sort of slowed to a crawl,” Peter DiCorpo, the co-founder and COO of Brook Farm Group, said. “The whole market has seized up, plus institutional investors are really taking a pause right now on new opportunities. I would anticipate multifamily housing starts are probably going to be down 40% year over year in 2023 and I think that is going to be the same for single family home building, if not higher.”
To make matters worse, according to Sean Kelly, the chairman of the National Association of Home Builders’ multifamily council, existing multifamily buildings are already very full.
“I think that we need folks at many different levels of the government to help us work on addressing supply chain issues and remove some of the regulatory roadblocks to building,” Kelly said when asked about improving the pace of new construction.
While this slowdown in construction is certainly not something developers or builders’ whose sentiment has been dropping since the start of the year want to see, conditions are improving for prospective renters. The NMHC’s Market Tightness Index came in at a reading of 20 for the third quarter of 2022, well below the breakeven level of 50, indicating looser market conditions for the first time in six quarters.
“The physical apartment market is also starting to normalize after six consecutive quarters of tightening conditions, with a majority of survey respondents reporting higher vacancy and lower rent growth compared to the three months prior,” the report stated.
According to Fleming, this decrease in rental demand is due to a slower rate of household formation.
“You look across a landscape of economic uncertainty as we are today with interest rates rising and people talking about a recession, and maybe you think that now might not be the best time to go out on your own and get your own apartment,” Fleming said. “In times of uncertainty that always happens. Maybe people go back and live with their parents after college or stay with their roommates longer than they wanted.”
But experts like Paula Munger, the assistant vice president of Industry Research and Analysis at the NAA, expects this slowdown in rental demand to only be temporary.
“We recently put out a forecast looking at how demand will play out from now until 2035,” Munger said. “I want to say a recession doesn’t matter – it does – but when you are looking at such a long timeframe there are going to be ebbs and flows in the business cycle. Between now and 2035 we anticipate we’ll need around 256,000 units a year.”
Evangelou added: “We expect the multifamily housing demand to remain relatively strong. The main reason for that of course is the increased borrowing costs. Mortgage rates are more than double what they were at the start of the year.”