Pulse on the Marketplace

A Quarterly Review of Key Financial Data for the

Total Apartment Sales Transactions

Total Sales Volume

18 69 52 1,838 4,628 4,675

$90 Million

$574 Million

$694 Million $15.7 Billion $53.9 Billion $83.2 Billion

• Actual Average Cap Rate 4.09 3.85 4.05 5.57 4.92 4.40

• Average Gross Rent Multiplier 15.66 16.07 17.69 13.64 13.91 15.34

• Price per Square Foot $319.64 $432.43 $492.37 $147.40 $176.79 $238.20

Source: Co-Star www.costar.com 5 unit + properties

• Price Per Unit $290,244 $347,258 $451,380 $145,909 $171,354 $236,305

Average Rent Level

$2,107 $2,240 $2,667 $1,423 $1,485 $1,736 Source: RealPage, Inc. www.realpage.com Annual Effective Rent Growth –0.5% 6.1% 17.9% –0.3% 4.1% 14.5% Primarily 100 unit + properties; “concession percentage” is the Concession Percentage 4.0% 3.8% 5.1% 4.1% 6.1% 5.8% percentage of units offering concessions.

Average Occupancy Rate

Average Monthly Employee Wages** 95.8% 97.6% 98.2% 95.3% 96.2% 96.8% Source: RealPage, Inc.

$5,031 $5,279 $5,557 $4,365 $4,565 $4,760 Source: US Bureau of Labor Statistics; uses private sector wages, last month of quarter;

Apartment Building Permits Issued by total # of units (not buildings)** 2–4 Units 281 442 584 10,000 13,500 14,500 Source: U.S. Census Bureau: Privately owned, 5+ Units 2,628 3,128 5,862 100,700 125,400 163,400 new construction

Consumer Price Index*

Unemployment Rate** 1.4% 4.0% 8.6% 0.6% 5.4% 9.1%

16.7% 9.2% 4.6% 11.0% 5.9% 3.6% Source: U.S. Bureau of Labor Statistics; % change using last month of quarter versus same month one year previous Source: U.S. Bureau of Labor Statistics; reflects last month of quarter

Pulse on the Marketplace is produced and edited exclusively for Apartment News by Nick Lieberman, President, Bona Fide Mortgage and AAOC Board Member. For questions or comments: (949) 651-0999, or nlieberman@cox.net

* For CPI, “Orange County” includes Orange, Los Angeles, and Riverside Counties. ** For Apartment Building Permits, Average Monthy Employee Wages and Unemployment Rate, “Orange County” includes the Los Angeles–

Long Beach–Anaheim, CA Metropolitan Statistical Area.

It’s been a minute since anyone or anything has been able to sap the strength of the rental housing industry, which seemingly has become a superpower among asset sectors.

One must go back to the great recession of 2008–2009, and its aftermath, to find a time when apartments showed any signs of weakness; and of course, nearly every nook and cranny of the US economy was receiving a drubbing during those painful years, not just rental housing.

But, once the nation got its legs back under it, it’s has been off to the races for multifamily assets. Rents and values have surged by leaps and bounds, unabated by a myriad of challenges, including rent control, unemployment issues, political strife, COVID-19, and the war in Ukraine. Through it all, the rental housing industry proved impervious, though now an old nemesis appears to pose a threat: elevated inflation.

We began to take note of this unwelcome phenomena in Spring 2021. By May, inflation had risen to a 5% annual rate as measured by the Consumer Price Index (CPI).

The 5% figure stirred concerns given that the entirety of the 21st century

annual pace. That impressive track record had embedded low inflation expectations among investors, with interest rates, which take their queue in large measure from the anticipated future rate of inflation, remaining anchored at low levels. 2021 had begun with a gentle 1.4% CPI rate in January, but the 5% inflation number four months later forced the Federal Reserve to comment, and that’s when Chairman Jerome Powell made his now infamous remark suggesting that recent inflation was merely “transitory” in nature.

Obviously, that turned out to be a major goof. The cold, hard facts are that CPI has moved well above those spring 2021 numbers, averaging a distressing 8.34% during the first eight months of 2022.

To review an Econ 101 principal: Low interest rates, i.e., low borrowing costs, are conducive to higher values for assets, such as real estate. On the other hand, accelerating inflation

on asset values, and this is the risk now confronting investors.

As this article goes to press, “high inflation” has become the phrase permeating financial discussions across America from the lunch truck to the board room. And so, for AAOC members and the industry as a whole, the pressing question is whether inflation will indeed be the chink in the armor that finally rolls back values on an otherwise stalwart multifamily sector.

For me, logic dictates that apartments, like virtually all assets, are going to be negatively impacted by inflation. After all, investors are mostly driven by “real return,” which is nominal return (dollars actually received), less the rate of inflation. If one buys property at a 5% cap rate and inflation runs at 8%, one’s real return will be a negative 3% for as long as the nominal return is 5% and inflation remains 8%.

These fundamentals portend that cap rates must increase (pushing values down) unless the marketplace buys into the idea that inflation will quickly recede, which does not at all seem to be present market sentiment. Yes, the Fed’s target inflation rate is 2%, but it could take years to get there (barring a nasty recession).

Certainly, there are offsets which should mitigate harm to apartment values. Clearly, there continues to be disequilibrium in the supply-demand ratio for rental housing units, with the pronounced shortfall giving landlords leverage to aggressively raise rents (within legal limits). Additionally, high mortgage rates for home purchases, which recently topped 6% on 30-year fixed rates, will eliminate a segment of buyers who will now remain tethered to rentals.

To identify an appropriate cap rate to plug in for an apartment buyer, the operative analysis concerning inflation projections is: how long will it remain elevated and at what level? However, with the possible exception of Superman, no one has those answers. There are too many variables to factor in. That said, I continue to believe in the strength of rental housing over the long haul, but do expect inflation to start taking its toll in pricing across all real estate types, including the mighty apartment sector.

By niCK lieBerman