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Berkadia Research Predicts Slowdown in Investment Sales Activity, Renewed Focus on Major Metros for Multifamily Sector

The annual Berkadia Powerhouse Poll Outlook found some major shifts in expectations for multifamily investment in 2023.

A January 2023 Powerhouse Poll Outlook survey of investment sales brokers and mortgage bankers conducted by Berkadia found that its professionals expect some challenges ahead for the U.S. multifamily sector. In spite of that, the respondents indicated the sector will continue to show a decent amount of resilience.

Fifty-four percent believe that rising interest rates and inflation will have an “extremely” pronounced impact on investment sales activity in 2023, and 45% expect a “moderate” impact on sales deals.

Yet, at the same time, 59% of Berkadia respondents said that renter demand for apartments will continue to outstrip available supply this year, while 30% expect supply to outstrip demand and 11% are unsure of how the equation will play out.

The results showed that more than half of Berkadia survey respondents (51%) expect the U.S. will experience a recession over the next 12 months and an additional 36% believe the country is already in a recession.

The annual poll was conducted online in December 2022 and January 2023 and distributed across 70 Berkadia offices located throughout the United States. Respondents included 57 investment sales advisors and 87 mortgage bankers.

In spite of expectations for solid performance on property fundamentals in the multifamily sector, the lingering uncertainty around the larger U.S. economic environment is leaving many investors feeling hesitant about engaging in new acquisitions right now, according to Ernie Katai, executive vice president and head of production at Berkadia. The potential for a recession remains on people’s minds. Katai also brought up the example of the 10-year Treasury rate unexpectedly shooting up to over 4.0 percent last fall, after hovering somewhere between 2-plus and 3-plus percent for most of the summer 2022.

“We went to 4.4% Treasury and the world kind of stopped,” said Katai. “And we are still dealing with that. The uncertainty is just creating gridlock for the moment, and it’s going to take a couple of people or institutions to start transacting because it’s pretty much a herd mentality in this business.”

In 2022, multifamily investment sales volume in the U.S. declined by 17% year-over-year, to $294.1 billion, according to research firm MSCI Real Assets. In the fourth quarter of 2022, multifamily investment sales declined by 69% compared to the same period in 2021, to $50.4 billion.

Where cap rates might be heading

Two-thirds of respondents (67%) expect that cap rates on multifamily assets will rise in 2023, while 25% expect cap rates to compress, and 8% said they will stay the same. An overwhelming majority (92%) expect to see an increase in distressed opportunities this year.

“People are in situations where in the last couple of years, they paid high prices, low cap rates for properties,” said Katai. “They might have overpaid, but they don’t want to admit that error.” For the moment, the distress that might be in the market has not become visible. However, additional interest rate hikes or clear signs of a recession could change that. Meanwhile, “well-capitalized people are sort of hanging around there and saying: ‘We know there are some [investors] who are not going to be able to write those equity checks,’” Katai added.

This is happening at a time when multifamily rent growth expectations for the year are much more modest than in 2022 or 2021. Fifty-one percent of respondents said that investors are underwriting rent growth of 2% to 3% in 2023, and 21% said they are underwriting rent growth of 3 to 4%. Fifteen percent said that rent growth of about 1% to 2% is being underwritten and 10% indicated flat to negative growth in investor underwriting. Only 3% of respondents said investors are underwriting rent growth of 4% or greater.

Meanwhile, the expectations for cap rate expansion also vary by region. While a majority of respondents based in the Mid-Atlantic and the Northeast expect multifamily cap rates in their market to move up by between 50 and 75 basis points and almost no one expects them to increase by more than 100 basis points, more than a quarter (27.27%) of respondents in the Northwest expect such a jump. The figure is similar in the Midwest at 26.32%. A slight majority of respondents in the Southwest, on the other hand (52%) expect cap rates in their region to rise by only 25 to 50 basis points in 2023.

The difference might partly have to do with debates over eviction bans in the Northwest, where an apartment building that is 95% occupied physically might be 60% occupied economically as some tenants are still not paying rent, noted Katai. “That is not going to interest a lot of people in transacting at this time,” he said. “You are starting to see some of those eviction moratoriums expire and it’s going to become a political football.”

Investment preferences

Under current market conditions, survey respondents expect multifamily investors to focus the most on class-A and class-B properties in major metropolitan areas and secondary markets.

The speed with which preference for multifamily properties in major urban markets returned has surprised Katai, after the pandemic shuffled interest toward the suburbs. “The last couple of years, we saw a big push to suburban locations,” he said. “And yet, looking at what the survey shows, the metro markets are back to number one. But it’s pretty reflective of the fact that people are coming back to urban environments, whether they have to be in the office one day a week, or two, or three.”

True affordable housing (financed with LIHTC credits, for example) will also likely remain popular with investors, Berkadia respondents predicted, with single-family rentals and workforce housing coming in fourth and fifth on the list of preferences.

On the other hand, seniors housing, student housing and manufactured housing ranked toward the bottom for the amount of investor interest they are expected to attract in the coming year.

These preferences will be also impacted to an extent by which region of the country investors will be looking at, survey participants indicated. For example, class-A properties should be in highest demand in the Mid-Atlantic region, as well as in the Southeast, Southwest, Midwest and Northeast. On the other hand, class-B housing is expected to be the most popular property type in the Northwest and single-family rentals and build-to-rent communities will likely attract a fair share of investor interest in the Southwest, the Rocky Mountain region and the Southeast. Workforce housing, meanwhile, is expected to see the strongest interest in the Northeast, Rocky Mountains and the Northwest.

Survey responders also expect rising interest rates and inflationary pressures to show the strongest impact on investment sales activity in the Northwest, followed by the Southeast and the Southwest. The expectation is that they will have the least impact on deal activity in the Northeast.

Those results correlate fairly closely with where survey responders have already seen a decline in transaction activity. The Midwest and Southeast have reportedly seen sharp declines in transaction activity recently, while the Northwest also saw a moderate decrease. The Northeast, on the other hand, seems to have seen only a moderate decline to no change in transaction activity, and some survey respondents indicated that the Mid-Atlantic region was experiencing a moderate increase.

Twenty-five percent of respondents based in the Mid-Atlantic region also indicated they were still seeing investors primarily showing interest in acquiring properties, along with a smaller percentage of respondents based in the Northeast, the Southwest, the Southeast and Midwest.

Respondents in the Northwest and in the Rocky Mountains region, on the other hand, indicated that investors in their region are mostly holding off on engaging in new transactions, and those that do, are focusing primarily on recapitalizing existing assets. That said, some respondents based in the Rocky Mountains also indicated they are seeing investors focusing on acquiring new properties. Disposing of existing properties was also reported as a primary strategy for investors by some respondents based in the Midwest and the Southeast.

Capital sources

Survey responders indicated that in the year ahead they expect to see the highest level of acquisition activity from private investors, including 1031 exchange buyers, followed by institutional investors, private/non-traded REITs, publicly-traded REITs and finally, cross-border investors.

At the same time, they expect institutional investors to engage the most in disposing of properties, followed by private investors, private/non-traded REITs, publicly-traded REITs and then cross-border investors.

“I think the private market is liquid, and they are potentially much more of a long-term holder,” said Katai. “There are some opportunities right now where you are able to buy under replacement cost and that’s always interesting. So, I think a lot of the private buyers [could be out in the market].”

Institutional investors, on the other hand, are often constrained by timing such as having to close a fund or distribute returns at a particular date. Unlike private buyers, “they have an expiration date, and so that’s why you see that result in the poll.”

For institutional investors specifically, opportunities involving green real estate and debt are expected to be the most attractive this year. Opportunistic investment/ground-up development and affordable housing also ranked relatively high, while core and core plus strategies came in last.

Over the next one to two years, 26% of respondents pinpointed distressed opportunities as being the most attractive to institutional investors, 21% picked long-term investments, 19% chose single-family rentals and built-to-rent and 10% named recapitalization. Less than 10% picked portfolio investments, mixed-use, affordable housing, ESG strategies and renovation/rehabilitation.

Most debt capital for multifamily investment in 2023 will likely come from government-sponsored entities, according to survey responders, with banks and life companies in a somewhat distant second and third place, then the U.S. Department of Housing and Urban Development and then private debt funds in the last place.

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