The Retail Multi-family Real Estate Market: Upside Down or Right Side Up?

“To invest or not to invest, that is the question.”

Why are we re-purposing a Shakespearean quote in an article about multi-family investing? Read on – we’ll explain.

Let's rewind the clock to the halcyon 2017 to 2019 years. What a time that was! Interest rates were low, and the multi-family real estate market was hotter than the NYC pavements in July. And EVERYONE wanted to jump on the bandwagon. It was party time and then some! Then, a tiny virus named COVID-19 literally brought the world to a grinding halt.

As we stayed home, practiced social distancing, and tried not to give up hope – the Fed (i.e., the Federal Reserve System, America’s all-powerful central bank) raised the interest rate. Then, it raised the interest rate again. And again. While the exact number of times the Fed has raised interest rates in the past few years is sometimes a matter of debate, what is NOT under debate is this fact – interest rates have gone from a historic low of 0.08% to the current 5.33%, the highest they have been in two decades.

This brings us back to the question we asked at the beginning, “To invest or not to invest, that is the question.” Short answer – YES. We believe investing in retail multi-family real estate is both a lucrative and financially sound proposition.

Here are our top 3 reasons why retail multi-family investing is a very good idea.

1. Supply/Demand Ratio:

We believe that the demand for multi-family units will exceed current supply in the near future – in or around 2025. The supply challenges we face today may create the demand opportunities of tomorrow.

Here’s why:

• It is difficult to justify the complexity and expense of new construction with multifamily housing trading below estimated replacement cost.
• The costs of construction, labor, debt, and insurance rose sharply during the pandemic and have remained elevated.
• While growth in construction costs will moderate in the near future, we expect it to continue to outpace both the pre-pandemic trend and inflation. This is partly due both to a scarcity of skilled labor and competition with infrastructure and other large-scale projects for labor and materials.
• Commercial real estate and single-family home construction make up only about 40% of total construction spending, down from a peak of 57% in 2005. Meanwhile, banks that are overexposed to real estate lending and subject to new capital reserve regulations are unlikely to come off the sidelines, making capital for new development scarce and likely expensive.

Ergo, supply will outstrip demand, making this a lucrative investment opportunity! [Please see the graph below.]

• Last but certainly not least, mega-investors like Blackstone are leading the charge in retail multi-family real estate investment. Earlier this year (in April, 2024), Blackstone made a $10 billion dollar multi-family investment. Yes, a 10 billion dollar investment. That is certainly an encouraging statistic.

2. Deleveraging:

Unlike the office sector, multi-family fundamentals are solid. Consider what would happen to a multi-family property purchased in February 2024 at a 5.5% cap rate (a measure of the one-year yield on a property calculated by dividing NOI by asset value) with 50% leverage. Assume that NOI grows at a 3% CAGR. As interest rates come down, it might be possible to sell at a cap rate of 5.0% five years later, in 2029. That equates to an internal rate of return of roughly 14.5% over five years, which is attractive for a historically stable, in-demand asset class. Another very encouraging statistic to consider. Additional points to consider are:

• Same-store net operating income growth (comparing growth in the same building from year to year) for U.S. publicly traded REITS has been healthy in most core markets.
• Multi-family assets tend to be financed with fixed rate debt, and thus, the majority have maintained sufficient cash flow to meet their debt service.

3. Once-in-a-Decade Opportunity:

In contrast to the office sector, where many companies have shrunk their corporate footprints in response to work-from-home trends, multifamily occupancy has been stable and the secular trend is toward more demand, not less. Consider the facts:

• The structural shortage of housing in the United States and high mortgage rates are pricing many would-be homebuyers out of the market and pushing them to rent instead.
• Meanwhile, high construction costs make an influx of new residential housing beyond 2025 somewhat unlikely.
• The result is a once-in-a-decade opportunity for real estate equity investors. Is it complex? Possibly. Is it exciting and lucrative? Without a doubt!

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