Source: Fitch Ratings / #Apartments #Multifamily
NEW YORK, NY - Fitch expects the positive operating performance of the multifamily sector to continue during the next 12 months and to continue contributing significantly to the performance of real estate investment trusts (REITs) that invest in those properties. However, we increasingly see risks forming in the sector's acquisition underwriting in addition to its growing sensitivity to an increase in interest rates, future supply, changes to the GSEs, and most importantly, improvements in the single-family residential market.
Recent trends in underwriting suggest risks for the sector beyond the 12-month range. Some borrowers (predominantly unrated private owners and operators) and lenders have resumed pro forma underwriting that was popular during the heyday of the bull market. This type of underwriting depends on low interest rates at refinancing to maintain capital values. Rising interest rates or a failure to achieve underwriting assumptions due to pressures related to rental affordability could create the difficult refinancing conditions other property sectors encountered in 2008-2011.
Another long-term risk for the sector is potential changes to the GSEs. The political discussion around winding down Fannie Mae and Freddie Mac may increase after this November's election. Disruption in the liquidity they provide is unlikely to be completely absorbed by the traditional secured lenders, namely insurance companies, given their balance sheet constraints and concentration limits.
However, the positive operating performance is expected to continue as the current supply/demand imbalance remains in place for the short term. While supply remains low on both an absolute and relative basis, with 2011 deliveries trailing our estimate of the annual obsolescence factor, the long lead time created by the entitlement and construction and some continued (albeit moderating) hesitancy by lenders and principals to move further out on the risk spectrum into development should provide a clear window for 2012-2014 deliveries.
Even if the supply pipeline was more immediate, it would still be outweighed by demand. We estimate that every 25-basis-point decline in the home ownership rate adds approximately 275,000 households to the rental market. The home ownership rate for 2010 was 66.9%, down from 67.4% in 2009 and marked the sixth straight year of declines. Save for the implementation of an unforeseen plan (be it public or privately led) that meaningfully changes the dynamics of home ownership and the current headwinds, the conditions supporting multifamily demand will likely remain favorable until home prices rebound.