This is part three of a four-part series on multifamily bank lending
In the first of our four-part series on bank multifamily lending, we highlighted the remarkable growth in multifamily loans issued by commercial banks. Among all bank lending categories, none has grown faster than multifamily over the past six years. Multifamily as a share of overall lending has surged to a 20-year high. In the second part, we outlined how most of the megabanks have sat on the sidelines of this wave. Instead, it’s banks outside the nation’s top 35 by asset size.
Given the rapid growth in multifamily lending on the tails of a major recession, it’s appropriate to ask the obvious question: Is multifamily reaching a bubble?
To answer that question, let’s first look at apartment fundamentals and demand drivers. Then we’ll compare some of the missed warning signs from the single-family bust with today’s multifamily market.
Apartment fundamentals recovered quickly from the last recession, as 2010-2012 marked one of the best periods on record for the industry in terms of NOI growth – fueled by big gains in both occupancy and rents, aided by very limited new supply. Since then, new supply has ramped up. Already, as of Q2 2014, new supply levels on a trailing 12-month basis are at decade highs. Yet demand for apartments remains robust, tracking above supply. So occupancy hit a seven-year high of 95.7% in Q2 2014. Same-store rents for new leases jumped 3.5% year-over-year – a strong performance, albeit below the 2011 peak of 4.8%.
What’s driving the hot streak, and is it sustainable? One popular viewpoint is that the foreclosure crisis drove millions of people out of single-family homes and into apartments – a short-term, unsustainable lift for apartments. But the data doesn’t support that theory. Foreclosures turned single-family owners into single-family renters. And while the crisis did slow the tide of first-time homebuyers, there’s plenty of evidence suggesting a large swath of today’s young adults – even without the foreclosure mess or elevated underwriting standards – would still wait longer to buy homes due to the “prolonged adolescence” phenomenon. They are waiting longer to get married. Once married, they wait longer to have kids. Both provide an impetus for purchasing homes.
So, demographics – not the foreclosure crisis – have been the key driver behind the apartment industry’s success. The U.S. is seeing its highest growth rate in 20- and 30-somethings since the Baby Boom, and population trends clearly show significant growth through the next decade – fueling a steady demand stream for apartments, even as the oldest Millennials start to buy homes (and they will) in greater numbers. Interestingly, “prolonged adolescence” isn’t just delaying home purchase. It’s also delayed apartment lease signings for some young adults. Pew Research Center estimates there were 21.6 million young adults (18- to 31-year-olds) living in their parents’ homes in 2012, up 3.1 million from 2007. For them, the most logical next step is to rent an apartment … meaning there’s still plenty of pent-up apartment demand.
Simply put: Lots of young adults are renting apartments today, and more of them are coming. And these young adults are better equipped to support rent hikes than most realize. Millennials are widely portrayed as underemployed and poorly paid, but the data doesn’t support that view – not for the generation as a whole, at least. The Pew Research Center recently did the most extensive study to date on Millennials. One surprise finding: Millennial households command greater incomes than did previous generations at the same age (adjusted for inflation). Digging deeper, Pew found a disparity: All the income growth is coming among those with college degrees. Incomes for young adults without college degrees have dropped off. That disparity has obvious implications for apartment investors and lenders.
Do demographic trends inspire confidence multifamily isn’t bubbling? At minimum, it offers a contrast from the single-family bubble. You could make the case that demographics would have slowed home-buying even absent the foreclosure crisis or the issue of prolonged adolescence. By the mid-2000s, Gen X’ers had become the primary generation of age for first-time home purchases. The problem? Gen X is a comparatively small bunch, with only 40 million or so of them, sandwiched between two huge groups each more than two times bigger: Baby Boomers and Millennials. Artificial stimulants (low down-payment requirements, diminished credit standards, etc.) helped prop up demand, but only temporarily.
Beyond demographics, it’s worth comparing the conditions that led to single-family’s busted bubble of 2008 and those of today’s multifamily market.
- In the mid-2000s, banks lowered lending standards to compete with each other and to feed the GSEs’ demand for single-family loans. For multifamily, banks are generally getting attractive terms – in part, ironically, due to less involvement of late from the GSEs.
- Loan-to-value ratios are typically around 70% in multifamily, so borrowers have a lot more skin in the game, and prices haven’t shot up near to the degree seen in single-family – not yet, anyway. This means multifamily values/prices would have to plunge further than in 2008-2009 before a bank’s investment becomes exposed.
- It was the lack of skin in the game that drove the nonperformance rate of first liens for 1-4 family homes (which is predominantly single-family) held by banks up to a peak of 10.1% in Q1 2010. That’s more than double multifamily’s peak nonperforming bank loan rate.
- Unquestionably, loose lending requirements served as a major driver of the single-family bubble – inflating homeownership to historic highs. The apartment industry doesn’t have a comparable driver you might deem as artificial. And even if one existed, apartments can remove delinquent tenants quickly due to the nature of a lease term.
- Even with the recent growth spurt, multifamily still represents a much smaller share of bank balance sheets than single-family ever did. Plus, banks today are much better capitalized with higher liquidity.
There is one more important comparison to make between single-family in the mid-2000s versus multifamily today – construction. The sharp rise in multifamily development has made headlines and inspired some to start crying “bubble.” But what does that data show?
While multifamily construction has surged upward, it’s still well below levels seen in the 1980s, 1970s and 1960s. And it’s highly unlikely to return to those levels. Single-family construction, by comparison, fed the bubble by shattering all kinds of records in the mid-2000s. Additionally, both Fannie Mae and Freddie Mac have published research suggesting current apartment construction volumes are actually insufficient to meet demand. (We’d suggest a more nuanced view on construction, which we’ll touch on in Part 4 of this series.)
All that being said, we should acknowledge that the apartment market is almost certainly past the peak for this cycle. That’s true of NOI growth (there’s less room to grow occupancy today, requiring bigger rent hikes to sustain NOI growth levels), loan yields (the marketplace is becoming more competitive) and cap rates (ditto). Early in the recovery, apartments were so hot that pretty much any deal was a good one. Today, as yields are normalizing, strategy is becoming more important.
Is multifamily housing near bubble status? The data says no, but … it’d be wise to watch for flashing yellow lights. How should multifamily lending strategies evolve? We’ll also explore that question in Part 4 of our series.
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