The Crisis In Housing, Part 2: The Multifamily Conundrum

Several recent data studies by leading housing market analytics firms are showing the state of U.S. rental housing as being in something of an existential crisis.

Realtor.com, a division of News Corp’s NWSNWSA subsidiary Move Inc., reported the U.S. median rental price in February was $1,792, up 17.1% year-over-year and a new high. February also marked the seventh consecutive month when rents spiked by double-digit percentages.

Among unit sizes, studio rents increased at the fastest annual pace, up 17.1% (+$215) to a median of $1,474. Larger unit rents posted double-digit gains over February, with one-bedrooms up 16.4% (+$232) to $1,648 and two-bedrooms up 16.2% ($278) to $2,002.

As a result of these increases, Americans living in rental units spent 30% of their monthly budgets in February on housing costs — this percentage was higher in 14 of the 50 largest metro areas. And that, to put it mildly, is a problem.

“Whether it's rent or mortgage payments, the general rule of thumb is to keep monthly housing costs to less than 30% of your income,” warned Realtor.com Chief Economist Danielle Hale. “And with rents surging nationwide, February data indicates that many renters' budgets may be stretched beyond the affordability limit.”

Separately, data published by Zumper determined the national rent growth during the first three months of 2022 was outpacing 2021’s rent growth. In Zumper’s March data, the nationwide median one-bedroom rental price hit an all-time high at $1,400, a 2.5% increase for the year so far that was also ahead of the 1.9% growth at this time one year ago.

“That rent growth in 2022 is outpacing 2021 is a sobering thought, given that 2021 likely experienced the most rent growth of any year in a generation,” said Jeff Andrews, a writer/editor for Zumper. “But for context, the most rapid period of growth in 2021 came from May to October, when the median one-bed rent rose by a shocking 9.7% in just six months. It’s an extremely high bar for 2022 to keep pace with, even if the year has gotten off to a hotter start.”

In Search Of Vacancies: While rental housing has become more expensive, an increasing number of people are scrambling to secure units. Data released earlier this month by RentCafe found a 10% year-over-year increase in apartment applications, from 2.9 million in 2020 to 3.2 million in 2021, with the greatest share of this activity (27%) driven by the Gen Z demographic.

Not unlike the problem facing homeowners, the balance between supply and demand is out of kilter.

“If you look at vacancy rates across rental housing and homeownership housing, they're at extremely tight levels,” said Jamie Woodwell, vice president in the research and economics group at the Mortgage Bankers Association (MBA). “So, the entire U.S. housing stock is essentially full right now, and that overall lack of supply of units is what we see driving home price appreciation as well as increases in rents. And what that leads to is the need for more development.”

“We're at a place right now where we've got more multifamily units under construction than we have at any time since the mid-70s,” Woodwell added. “A very strong pipeline of multifamily units currently being built. We expect to continue to see strong activity in terms of multifamily starts, but it might not stay at these high levels.”

As for the projects underway or being completed, Woodwell pointed out that “when new construction is built, because it's new it tends to be at a higher price point than some of the units that may be existing in a market.” This observation was shared by Jake Clopton, president of the Chicago-based commercial mortgage brokerage Clopton Capital and a Benzinga contributor.

“For the guys that are building multifamily, I'm seeing them building the higher-end stuff,” Clopton said. “Construction costs are so expensive that if they're building today, they're typically having to build for higher-end rental units to make it worthwhile.”

Clopton added that another aspect of multifamily housing he’s increasingly witnessing are “build-to-rent single-family home communities that are more in the affordable space. Sometimes they are parceled out into separate parcels, and sometimes they're also one parcel.”

Clopton observed the main problems facing multifamily developers were twofold. First, there are the double-barreled disruptions created by rising costs and a haphazard supply chain.

“It's much more expensive to build today,” he said. “And not only is it more expensive, but I've got borrowers that are in mid-construction and they can't get deliveries on doors. There was one guy who said, ‘Listen, this building's completely done — I just don't have any doors.’ It's weird, some of the materials are so backlogged that it's taking longer to build stuff — and the longer it takes to do anything, the more it costs.”

Tied Tight In Red Tape: The second problem that Clopton raised was dealing with local governments to get the green light on projects.

“It's difficult to get approvals,” he explained. “I've got this one manufactured housing developer in Florida man who has been trying to get permits for a year. I've had some guys tell me it's taking longer to get approvals at the local government level.”

Dr. Anthony B. Sanders, distinguished professor of real estate finance at George Mason University and former director and former head of asset-backed and mortgage-backed securities research at Deutsche Bank AG DB, agreed that many local governments seem to be working against multifamily developers rather than trying to encourage them to build rental housing.

“There are a lot of municipal zoning policies about where you can and cannot build multifamily developments, what can be built and how much has to be set aside for below market rate units,” he said. “If you go to various cities like Los Angeles, there is the NIMBY model — not in my backyard. Nobody wants Section 8 housing for the lower-income households to be near them, so they actually prohibit construction of multifamily housing in certain areas. And this is occurring all across the country.”

Dr. Sanders recalled that the “Obama administration actually wanted to see if they could nationalize zoning laws, which did not go very well with state and municipalities that wanted to maintain control.” Instead, he pointed out, local governments began offering developers a choice: they could either set aside a percentage of units in a multifamily development for below-market rate rentals or pay a fee to omit the set-aside less-expensive units from the property.

John Glassock, professor of finance and director of the University of Connecticut Center for Real Estate and Urban Economic Studies, believed that choice was being forced on developers because of a history of poor planning by many local governments.

“If the cities would let the market build more housing, they would never have to do that,” he said. “The only reason they're having to get money from somebody to try to put in affordable housing is because they didn't let enough builders build enough apartments and enough housing in the first place. They cause that problem by their zoning and their land use controls.”

However, Glassock noted government cannot be blamed for preventing all new multifamily housing.

“Now let me be fair, a lot of citizens don't want more housing built,” he said. “Because if you don't get more housing built, their house price will go up. And once you get in this game, it's kind of a Ponzi scheme — you don't want more housing built because you want to make more money on the house that you've already bought. But that's really not fair to society.”

Real Estate Reinvented: One possible strategy for growing the quantity of rental housing has been the repurposing of commercial properties including office buildings, hotels, malls and industrial facilities into housing. But not every old property can be easily transitioned into a residential space.

RentCafe reported more than 32,000 apartment conversions occurred in 2020 and 2021, with the majority involving former office buildings. Washington, D.C., saw the most conversions, with nearly 1,100 units created from three ex-office buildings, followed by Chicago with 1,020 converted apartments in former office buildings.

RentCafe also tracked an additional 306 future redevelopment projects that have been announced, which will create more than 52,700 housing units.

“On the one hand, if a property is well located, then it can probably switch uses relatively easy,” said MBA’s Woodwell. “But the challenge is that oftentimes the structure itself may not be amenable to quickly or easily change from one purpose to another. I think there is certainly an interest from folks to do that, but it's often easier said than done.”

But Clopton stated he was not receiving inquiries from borrowers seeking financing to pursue that strategy.

“The most I'm seeing is like maybe a retail unit somewhere in the mix,” he said. “I'm not seeing any office. What I'm seeing is pure habitational.”

The Low-Income Housing Question: Within the rental housing environment, the more financially vulnerable members of society have traditionally struggled to find affordable housing during good times — and they've been struggling more in the pandemic era.

“What traditionally happens is that that new supply coming in at the top of the market helps push other units down in terms of price,” said Woodwell. “The process is usually referred to as filtering — that’s the way we tend to get affordable housing. Because the supply hasn't been keeping up with the demand, that filtering hasn't been working quite — you haven't seen as much volume filtering as you need to keep the market, as a whole, affordable.”

But that’s not to say that the lower-income households have been cast adrift in the housing market without a chance of finding an affordable haven. Woodwell observed there has been a “steady supply of new developments being driven by the Low-Income Housing Tax Credit (LIHTC), which is incredibly important to be bringing new affordable units and subsidized units online.”

The LIHTC was founded in 1986 and involves the federal government providing state and territorial governments with tax credits to subsidize the acquisition, construction, and rehabilitation of rental housing for low- and moderate-income tenants. Developers sell these credits to private investors to obtain funding, who can then claim the LIHTC for a 10-year period once the multifamily project is available for tenants. There are also 23 states that supplement the federal effort with tax breaks to developers of low-income housing.

There is a nationwide shortage of 7 million rental homes that are affordable to the lowest income households, according to recent data published by the Public and Affordable Housing Research Corporation and the National Low Income Housing Coalition. President Joe Biden’s Build Back Better plan includes a significant expansion of the LIHTC program designed to encourage more rental housing financing.

“If the BBB bill passes with the current LIHTC components intact, it will lead to a historic increase in production for the industry,” said Tony Bertoldi, co-president of CREA LLC, an Indianapolis-based LIHTC syndicator, in an interview with the trade journal Affordable Housing Finance. “As the bill comes into effect, we anticipate LIHTC pricing to fall as the supply of tax credits increases. This should bolster yields, increasing demand from existing economic investors and potentially drawing new investors into the market.”

However, that legislation is currently stalled in the U.S. Senate and is, as of this writing, showing little evidence of being revived or re-edited as a standalone bill designed to expand the LIHTC program.

Tomorrow: Part 3 in this series considers the widening gap between White and Black homeownership and the ongoing discrimination faced by many LGBTQ homebuyers and renters. Part 1 can be read here.

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