In the not so distant future, history books will remember COVID-19 as the black swan event of 2020 that derailed the longest economic expansion in U.S. history and pushed the global economy into recession.

Given the many business closures and historic spike in unemployment, it is likely that a recession is already underway. One unanswered question is how severely the virus-related fallout will impact the multifamily market.

Prior to the COVID-19 outbreak, U.S. multifamily markets enjoyed roughly a decade of improving operating metrics and investment flows. Multifamily may be better positioned to weather a downturn relative to other commercial property types given the continued attention and support from the government and liquidity from government sponsored enterprises, including Fannie Mae, Freddie Mac and Ginnie Mae. However, many renters are on the front lines of mass layoffs and furloughs that have dealt a brutal blow to sectors such as hospitality, leisure, retail and manufacturing. As renters’ incomes decline or disappear altogether, multifamily property rental revenue, operating metrics, and overall valuation are at risk of deteriorating.

Owners & investors brace for impact

The main concern is that increased unemployment may result in tenants that simply don’t have the money to pay their rents. When enough renters do not pay their rent, a potential negative feedback loop can form:

  • Renter misses rent payment
  • Property owners have less revenue to cover expenses (mortgage payments, property maintenance / improvements)
  • Property value declines as net operating income falls, refinancing becomes more challenging / costly
  • Without cashflows to support it, the property quality may decline, making it less attractive to renters, investors / owners, and lenders

The situation is not helped by the fact that language contained in the $2 trillion Coronavirus Aid, Relief and Economic Security (CARES) Act and guidance from the National Multifamily Housing Council have encouraged owners to practice extraordinary tenant-friendly forgiveness of late and non-payment of rent.

Early data has shown a sharp spike in unemployment claims. In the week ending March 28, the advance figure for seasonally adjusted initial claims spiked to 6.6 million – double the 3.3 million reported from the previous weeks claims, according to the Department of Labor. To put that dramatic spike into context, total job growth for  all of 2019 was 2.1 million jobs. The business disruption is likely to be more acutely felt by small business. According to Homebase, the number of small businesses operating nationally dropped by 50% when comparing data from March 1 to March 29, while numbers were even higher at 60% in hard hit cities such as Las Vegas and San Francisco due to the reliance on tourism in those markets.

Historical property transaction data from Reonomy provides a snapshot of how values have trended over the last 17 years. Nationally, multifamily values have recovered to levels that preceded the Global Financial Crisis (GFC), with many large metropolitan statistical areas (MSAs) surpassing the prior peaks. National median multifamily property prices peaked at $94 per square foot (psf) in 2Q 2006, then dropped to $50 psf in 1Q 2011 (47% decline), before making the climb back up to $96 psf as of 4Q 2019.

 

Negatively impacted markets

Although the depth and duration of the COVID-19 impact is still uncertain, investors are trying to estimate the potential short- and long-term impacts to property fundamentals and valuations. Publicly traded REITs provide a glimpse of market valuation. REIT prices, like the broader market, are experiencing increased price volatility. Apartment REITs reported negative year-to-date returns of (24.3%) at the end of March, slightly below the (21.7%) for all equity REITs, but much better off than the hard hit sectors such as lodging (51.0%) and retail (47.2%), according to Nareit.

In the following section, we review six major multifamily markets and look at the prior recession as a guide of potential pricing impact.

San Francisco:

Following the GFC, the median price per square foot for multifamily properties in the San Francisco-Oakland-Hayward MSA fell by 64% from its high of $270/sf in 4Q 2005 to $97/sf in 1Q 2012. Since then, the median price has more than recovered, climbing to $415/sf – 154% above the prior peak – as of 4Q 2019. Prior to COVID-19, the San Francisco apartment market had been fueled by an exceptionally strong economy. Vacancies were among the lowest in the nation at 4.1% with only moderate levels of new supply in the pipeline, all of which had positioned the MSA as one of the top rated metros in the country for rent growth in the coming year, according to the Freddie Mac 2020 Outlook.

However, San Francisco was one of the first metros to issue widespread shelter-in-place orders. The mandate for the seven-county area went into effect March 17th with a negative impact on business disruption that quickly rippled through the economy. Between March 1 and March 31st, the number of hours worked by hourly employees dropped by 68% and the number of local business open declined by 56%, according to Homebase.

 

New York City:

During the GFC, the median price per square foot for multifamily properties in the New York-Newark-Jersey City MSA fell from its high of $178/sf in 2Q 2006 to $42/sf in 2Q 2011. Since then, the median price has recovered, $133/sf as of 4`Q 2019, but is still 26% below the prior peak. Growth in the tech sector, big name players such as Amazon, Google and Facebook, was fueling job creation and demand for rental housing. According to Marcus & Millichap, vacancies in the five boroughs were at a near 20-year low of 1.5% prior to COVID-19. Despite the nearly full occupancy, the city had passed controversial legislation that put some restrictions on owner’s ability to increase rents at some properties.

On March 20th, New York Gov. Cuomo issued an order for non-essential personnel to stay at home as the cases of COVID-19 infection in the city skyrocketed and the metro emerged as the epicenter for the disease in the U.S. Between March 1 and March 31st, the number of hours worked by hourly employees dropped by 75% and the number of local business open had declined by 61%, according to Homebase.

Boston:

During the GFC in 2008-09, the median price per square foot for multifamily properties in the Boston-Cambridge-Newton MSA fell from a high of $165/sf in 2Q 2005 to $66/sf in 1Q 2009. Since then, the median price has more than recovered, climbing 27% above the prior peak to reach $209/sf as of 4Q 2019. Boston’s multifamily market has ridden a strong tailwind from growth in the tech and biotech sectors specifically. Apartment vacancies remain tight at about 3%, according to Marcus & Millichap.

Massachusetts announced a statewide stay-at-home advisory for all unnecessary activities that became effective March 24th and will run until April 7. Between March 1 and March 31st, the number of hours worked by hourly employees dropped by 71% and the number of local business open had declined by 58%, according to Homebase.

 

Seattle:

During the GFC, the median price per square foot for multifamily properties in the Seattle-Tacoma-Bellevue MSA fell from a high of $160/sf in 2Q 2007 to $85/sf in 1Q 2013, a 47% drop. Since then, the median price has more than recovered, climbing 70% above the prior peak to reach $273/sf as of 4Q 2019. Seattle also has enjoyed strong job growth thanks to its booming tech sector. At the same time, vacancies have edged slightly higher amid a wave of new supply. According to Marcus & Millichap, vacancies increased to 4.3% following the completion of nearly 10,000 new units last year.

Washington state issued a temporary stay-at-home order for non-crucial activities that went into effect March 23 and will last through April 6th. Between March 1 and March 31st, the number of hours worked by hourly employees dropped by 61% and the number of local business open had declined by 48%, according to Homebase.

Austin:

During the GFC in 2008-09, the median price per square foot for multifamily properties in the Austin-Round Rock MSA fell from its high of $94/sf in 4Q 2007 to $57/sf in 1Q 2009. Since then, the median price has more than recovered, climbing 66% above the prior peak to reach $156/sf as of 4Q 2019. Austin’s apartment market has thrived on a booming tech sector and an influx of new residents. Vacancies started the year at 4.6%. However, the market may struggle to absorb a deluge of new construction with 9,200 units set to deliver this year, according to Marcus & Millichap.

Austin has a stay-at-home order that went into effect for the tri-county area on March 25th and extends through April 13. Between March 1 and March 31st, the number of hours worked by hourly employees dropped by 57% and the number of local business open had declined by 45%, according to Homebase.

Denver:

During the GFC in 2008-09, the median price per square foot for multifamily properties in the Austin-Round Rock MSA fell from its high of $110/sf in 1Q 2004 to $58/sf in 4Q 2008. Since then, the median price has more than recovered, climbing 92% above the prior peak to reach $211/sf as of 4Q 2019. The job market has actually been constrained by a tight labor supply with unemployment hovering at about 2.6%. Demand has been generally on pace with a steady influx of new supply in Denver. Vacancies at the start of the year were hovering at about 4.5% with 8,800 new units expected to be completed this year, according to Marcus & Millichap. Annual rent growth has exceeded 4% for the past two years.

Colorado issued a statewide stay-at-home order that went into effect March 19 and will run until April 11. Between March 1 and March 31st, the number of hours worked by hourly employees dropped by 58% and the number of local business open had declined by 50%, according to Homebase.

 

Using the past to gauge future pain

For multifamily owners and investors, it is still very much a fluid situation with stay-at-home and shelter-in-place orders in place that impact the majority of the country. It remains to be seen what toll COVID-19 will have on the multifamily market in terms of market fundamentals, property values, and ultimately, investment opportunities, pricing and cap rates going forward. It also is unclear whether all property types and markets will be affected equally. As the pandemic continues to play out, two of the biggest wild cards are how long the downturn will last and how quickly it will recover. While the current crisis and potential recession is different from the GFC, owners and investors alike can look to the past recession to better understand potential implications and impacts to their multifamily portfolio.