2024 Arcan Multifamily Market Update
Dear Partners and Friends,
We hope everyone had a terrific holiday season and new year. We are excited to report that the moment we have been waiting for has finally arrived: the new real estate cycle has begun. While we look at this new cycle with opportunity in mind, there is little question, however, that the industry is going to be dealing with the repercussions of the previous cycle for some time. Today’s landscape is quiet, and transactions remain scarce. It feels as if the entire multifamily market is joining together to mourn the loss of the last cycle, and that certainly seems appropriate. The period between 2010 and 2022 was a great time to invest in apartments. As the industry grieves the loss of the last cycle and anxiously copes with the reckoning required, we think that the 5 Stages of Grief is the most appropriate framework for analyzing the current market.
The first stage of the grieving process is DENIAL and that very much represents 2023. Interest rates climbed and operational challenges appeared broadly for the first time in a decade. Many investors, lenders, and operators buried their heads in the sand to hope for quick rate cuts or some other power to swoop in and save the day. Predictions abounded that the Fed would cut rates or the 10-year yield would somehow drop to near-pandemic era levels. Predictably, that did not happen and now time is running out (and for some, time already has run out). We are starting to see lenders and operators come to terms with troubled deals and recognize that dramatic rate cuts are not on the horizon. Denial also extends to the number of units still under construction. It is Arcan’s belief that many markets are overbuilt, and it will take time to lease up all the units under construction. This often results in increased vacancies and a decrease in rent. Indeed, that is the case today. Rents in Atlanta, for example, are down about 2.7% year-over-year and average vacancy is up to nearly 12%. In Q1 of 2023, more than 38,000 units were under construction in the Atlanta market. That number is closer to 30,000 units today. At current absorption levels (a little over 7,000 units in the last year) it will take about four years to lease the units that will be delivered in the next 24 months. Units under construction will need to drop precipitously to reach the equilibrium required for market rent growth to return in force. That will take time. It also hurts that most of this inventory is high-end class A. When construction costs are high developers are forced to build high-priced high-end units to achieve rents high enough to get an adequate return on your investment. This was very much the case in this cycle.
The challenge faced in 2023 obviously resulted in some ANGER as the Fed held firm in their inflation fight and consistently raised rates during the year. for real estate, working through these increases resulted in deals bleeding cash and shrinking capital accounts. Some lenders and operators are at odds with each other, and investors are squeamish as they are forced to determine (for the first time in a decade) which deals are successes and which are failures. We are also going to find more instances and accusations of fraud and mismanagement. While some bad behavior always exists, it is substantially less visible when everyone is making money.
Now that we are starting 2024, we have reached the BARGAINING stage. Market participants are pleading for the capital, interest rates and buyers required to get out of troubled deals. Most groups have recognized that maturing debt and expiring rate caps are coming due. There is a tremendous amount of capital prepared to buy (Blackstone is reporting $200B in dry powder for investment including a recent $30.4B real estate fund raise). Many buyers are optimistic and why shouldn’t they be? Multifamily fundamentals remain largely strong. The Atlanta market absorbed over 7,000 units in the last year and positive absorption is found in almost every Southeastern market Arcan tracks. The South is growing, and quickly. There are plenty of new residents moving to our markets in search of quality housing just not quite as many as developers had hoped. While some micro markets are in trouble due to an oversupply of new units, others are desperately in need of new affordable housing.
There remains a large bid-ask spread between what most buyers are willing to pay, and sellers are willing to accept. For the first time in almost 10 years, we expect the buyers to win this battle as the clock works against sellers. Refinancing seller’s maturing debt that was originated in the previous cycle’s low-interest rate environment will be expensive and proceeds likely to be lower than the original loan balance. This wave of maturities will force many sellers’ hands.
We expect the sum of these parts to result in a broad multifamily market DEPRESSION at some point in 2024. For some, it is already here. The rapid increase in rates has led to a plummeting number of transactions. Total multifamily investment volume in 2023 in the Atlanta market reached its lowest point since 2013. When you consider valuations have roughly doubled in that time frame, the real transaction volume is even lower. There is nothing yet on the horizon that would indicate the pace will increase in 2024. It is our expectation that we will see another slow year of transactions. Having said that, the pending workout of challenging deals and optimistic outlook towards rate reductions do present a light at the end of the tunnel. The big question remaining is: how long does this take? With fresh inflation data from December showing an increase back to the mid 3% range, rate cuts seem even further away.
It is our hope that ACCEPTANCE is closer than it appears, and we can start to get back to a normal market again in 2025. And by normal, we do not mean the post-pandemic boom of 2021-2022. The rent growth and transaction volume seen at a time of unprecedented easing of monetary policy appears to be a total anomaly. Looking back, with rents decreasing in many markets, it seems clear that a portion of the massive rent increases in 2021 and 2022 were not real. Ultimately, we expect rates to continue to be flat or down until such time as the rate increases of the pandemic are more normalized over the long term.
An overwhelming majority of Arcan’s competition is either completely out of the market or VERY selectively investing. What remains to be seen is how long the substantial amount capital raised to acquire assets will sit out waiting for either the right price or more distress. We at Arcan, however, think that there is ample opportunity to buy good deals today. While they may be fewer and farther between, they have started coming across our desk. Once the cycle of grief is completed, we believe that the multifamily market is poised for long-term outperformance.