NAR Real Estate Outlook: Valuations, Rent Growth & Financing

March 30, 2023

The ripple effects of the recent banking crisis could impact commercial real estate finance in a few ways, including valuations.

The ripple effects of the recent banking crisis could impact commercial real estate finance in a few ways, including valuations, according to Lawrence Yun, chief economist for the National Association of Realtors (NAR). Yun presented an economic update focused on commercial real estate at NAR’s recent Real Estate Forecast Summit.

If more regional banks have problems and lending tightens further in 2023, Yun anticipates values for commercial properties above $2.5 million to decline. Because there have been fewer transactions in recent quarters, measuring the decline in commercial property values is difficult. Combined commercial property values were down about 2% in the fourth quarter of 2022 compared to their peak value in the fourth quarter of 2021, according to Federal Reserve data. However, Yun pointed out that the Green Street Advisors commercial property appraised value index was down 16% from peak values in January 2023.

Rent Growth and Vacancy Rates

In terms of demand, in Q4 2022, asking rents for new leases rose 6.6% compared to Q4 2021, according to Real Page data provided by Caitlin Sugrue Walter, vice president of research for the National Multifamily Housing Council (NMHC). Consumer Price Index rents, which include existing and new leases, rose by 7.9% in that same period. But more recent rental data shows a deceleration over the past several months, according to CNBC.

Vacancy rates average 4.4%, with the tightest occupancy now in New York City, Walter said. In some markets, vacancy rates are increasing slightly, but Walter said the NMHC anticipates that to be a temporary scenario because of new supply.

Temporary Holding Pattern for Multifamily Sector

“However, the multifamily market is in a holding pattern at the moment,” said Walter, referring to both renters and the finance side of the sector.

“People are just trying to figure out what’s happening with the economy,” she said.

In NMHC’s most recent quarterly survey, 78% of respondents said their market was loosening, which means that rent growth is slowing and vacancy rates are rising compared to three months previously. In addition, 82% said they saw fewer sales, which Walter said is a natural outcome of the uncertainty about the economy.

“Sales of multifamily properties have almost come to a standstill and that makes it more difficult to know about pricing,” Walter said. “People don’t know what their property is worth right now when there are so few transactions.”

The high volume of sales during the height of the pandemic and when interest rates were extremely low means that many owners find it unnecessary to sell or refinance yet, especially when they have good rent growth, Walter said.

In addition, 60% of NMHC members reported that there was less equity financing and less debt financing available, which further slows transaction volume.

However, NMHC researchers found that 4.3 million more apartments need to be built by 2035 to meet national housing needs, with 600,000 needed immediately. Of the remaining 3.7 million apartments required, 1.5 million of them will be needed in Texas, Florida and California to meet anticipated housing shortages in those states.

The current construction pipeline is primarily Class A apartments in certain markets, which doesn’t necessarily match with the need for apartments in different class levels. Phoenix, Austin and Charlotte are building a lot of apartments compared to their existing stock, which is causing some softness in those locations, Walter said.

Multifamily Cap Rates

The national average of apartment cap rates is the lowest of any property sector, according to data from CoStar, Yun said, at about 5% compared with 6% for industrial properties. Office and retail cap rates are just above and just below 7% respectively. Historically, implied cap rates are 3% above the 10-year Treasury yield, which is currently 3.6%, Yun explained. That would mean cap rates should be about 6.6% today, which is close to the level of office and retail properties.

The explanation for lower apartment cap rates is likely because of continuing rent growth, Yun said. However, he thinks multifamily cap rates may rise because rent growth is slowing. Apartment owners who need to sell in 2023 may need to adjust their price down because it will be difficult to extract higher rent, he said.

Job Growth and Multifamily Construction

Multifamily construction is at a 40-year high, but the rate of new apartments coming online continues to be slow, so Yun doesn’t anticipate an increase in vacancy rates.

Job growth in many markets continues to increase demand for apartments, particularly in states with the highest percentage of job increases. The states with the highest net job increases – ranging from 6.2% to 8.9% - when comparing pre-Covid with January 2023 include Idaho, Utah, Florida, Nevada, Texas and Montana. The states with the most net job losses (ranging from 1.5% to – 2%) in that same period include Vermont, West Virginia, Louisiana and North Dakota.