US Real Estate Market Update April 2022

US Macroeconomy

As per the Commerce Department, USA’s GDP unexpectedly declined at a 1.4% on an annualized basis in the Q1 CY2022, marking an abrupt reversal for an economy coming off its best performance since 1984. The negative growth rate missed even the subdued Dow Jones estimate of a 1% gain for the quarter, even though the initial estimate for Q1 was the worst since the pandemic-induced recession in 2020.

Seventy-five basis points is the new Fifty basis points. A relentlessly hawkish Federal Reserve is ramping up market expectations for big interest rate hikes that would have been considered unthinkable and market crippling just two months ago. As per Nomura, the Fed may hike the Fed funds rate by 75 basis points in coming rate review meetings, depending on fresh economic data, after a 50 basis point rise in May. Even without a 75 basis points hike, analysts expect the rate will rise up to ~2.0 - 2.5%, a phenomenal amount of tightening given that the Fed was still easing by buying assets as recently as March in this year.

These tightening measures have led to many market experts worrying about a recession. Macroeconomists at Goldman Sachs sees about a 35% chance of negative growth a year from now and Deutsche Bank sees the chance of a recession hitting the economy in late 2023 and early 2024.

?Real Estate Market

U.S. housing affordability in March fell to near all-time lows as home prices and mortgage rates continued to surge, in the wake of the highest consumer price inflation in four decades. Specifically, home prices in March appreciated at an annualized rate of 19.9%, down from February's upwardly revised 20.1%, but still standing at near its highest on record, according to Black Knight's Mortgage Monitor.

While this may not be a great news for homebuyers, for the existing homeowners the situation is quite different. Nine out of Ten American mortgages carry an interest rate of less than 5%, the level at which most new 30-year fixed-rate mortgages are now being underwritten, so there is a huge incentive for current homeowners to continue with their existing low-rate mortgages. This explains why current homeowners are unwilling to sell, even with record high home prices in many submarkets, further straining supply in the market.

The rising interest rates will impact the free cashflows of the multifamily and other rent yield focused real estate investments, due to a higher interest component outgo.

Markets like Miami, Austin, and Phoenix continue to lead the rental growth pack, but even markets like Detroit saw double-digit rent increases during the past year. Just two of the Fifty most-populous metro areas saw rents fall from a year earlier.

In aggregate, higher interest rates and normalized net operating income trends following Covid-19-driven financial choppiness, should combine to push market cap rates moderately.

During past 3-4 years, a lot of multifamily investments have benefited from rent growth and cap rate compression, which led to better investor return outcomes than original underwriting. We are also seeing investment managers increasingly adjusting their underwriting to take into account steady increase in interest rates and cap rate expansion. While, this is expected to taper the expected return curve we believe it is a healthy development for the multifamily asset class as the markets return to a "orderly" growth phase.

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