While there has been a significant amount of attention in the commercial real estate industry focused on the challenges confronting the office sector —particularly in light of evolving economic and market conditions—it’s crucial not to overlook challenges facing other real estate sectors. Multifamily is poised to encounter its own set of formidable obstacles throughout 2024.

Despite the anticipation surrounding potential downward shifts in interest rates, multifamily may be facing one the most arduous years since the onset of the COVID-19 pandemic.

There are persistent issues in multifamily real estate, including:

  • elevated interest rates
  • continued escalation in construction costs as well as rising operating costs
  • the influx of new supply resulting in flat or in some cases, even declining rents

These three trends within the multifamily sector have created a complex landscape that demands careful attention and strategic planning.

Elevated interest rates

During the COVID-19 pandemic, many investors relied on floating-rate loans and optimistic financial projections.

Floating-rate loans offered these investors lower initial interest rates compared to fixed-rate loans, allowing them to benefit from lower borrowing costs, especially during periods of low interest rates. Some of these investors may have also been drawn to floating-rate loans as the lower initial debt service frees up capital for property upgrades, enhancing the potential return on investment.

That being said, floating-rate loans carry the risk of interest rate fluctuations, which could lead to increased borrowing costs if interest rates rise—which, of course, they have.

From the third quarter of 2023 through the end of 2025, many multifamily loans will reach maturity. According to analysis from Newmark, 36% of these securitized multifamily debt maturities have a debt service covenant ratio (DSCR) of 1.25x, maturities that will struggle to refinance.

Although delinquencies have remained lower thus far in multifamily when compared to other property types, loan performance metrics reveal significant gaps between expected and actual performance. Some regions, particularly the South Atlantic and parts of the South-Central U.S., are at higher risk of defaults. Growth in those regions has been surging due to population increases and demand for affordable housing but developers overbuilt significantly in excess of demand

Troubled assets in the multifamily sector are an increasing cause for concern. As pressure mounts on banks to offload troubled loans, “rescue capital” funds have emerged to recapitalize struggling projects.

ACRE, a New York-based private equity fund manager, raised $400 million for a rescue capital fund to provide preferred equity loans to multifamily real estate to cover financing gaps.

Despite the proliferation of rescue capital funds, uncertainties remain. The risks associated with recapitalizing deals include higher construction costs and supply-chain delays, as well as declining asset values—it remains to be seen how this will develop in the coming quarters.

Escalating Costs

Since the onset of the COVID-19 pandemic, the multifamily industry has grappled with a persistent challenge: escalating construction costs. This trend, which shows no signs of abating, has emerged as a significant concern for developers and investors alike.

Construction costs have surged at a rate that surpasses general inflationary trends, presenting immediate and pressing issues for ongoing and upcoming projects. The primary drivers behind this upward trajectory are the notable increases in both labor and materials costs. Skilled labor, in particular, is in high demand, leading to wage hikes and consequently contributing to the overall escalation in construction expenditures.

Similarly, the prices of construction materials, ranging from lumber to steel and beyond, have soared, further exacerbating the cost burden on multifamily development projects. As a result, developers are facing unprecedented challenges in balancing budgetary constraints with the imperative to deliver high-quality, cost-effective housing solutions in a fiercely competitive market landscape.

Operating costs are increasing as well. According to Yardi Matrix’s 2024 Multifamily Outlook the average multifamily expense per unit saw a 9.3% increase on a trailing 12-month basis through midyear 2023, driven primarily by spikes in insurance costs.

Multifamily operators are facing additional cost hikes in labor, marketing, repairs, and maintenance. To navigate these challenges, operators are prioritizing cost-cutting, operating efficiency, and maintaining occupancy.

Stagnating Rents

Despite the aforementioned issues, the multifamily housing sector is witnessing an unprecedented surge in construction activity, with a staggering number of units currently in various stages of development to meet rapid population growth in sunbelt markets as well as heightened demand for affordable housing . According to analysis by Fannie Mae, 500,000 new multifamily units were completed in 2023 and are being marketed for lease during the course of 2024.

This influx of supply, while reflective of robust development efforts, is poised to introduce significant challenges to the market dynamics, particularly in certain regions characterized by oversaturation. The result? Stagnating, or in certain cases, declining rents.

For landlords and property managers in growing markets like Texas, Florida, and North Carolina, as well as the cities of Denver and Phoenix where overbuilding has occurred, navigating this landscape demands a strategic approach to pricing and positioning properties to remain competitive amidst heightened market competition.

2024 may be a tumultuous year for multifamily real estate. The aforementioned issues may cause a further decline in asset values across the industry—investors, owners and their lenders should practice caution in light of these prevailing market conditions.

Contact Mark Podgainy at mpodgainy@getzlerhenrich.com or 212-697-2400.