One of commercial real estate’s top performers will need help to stay healthy
- Call 848-329-0752
Contributing Author, Investment Properties, Market Trends, Mortgage
Market cycles in the housing industry come and go. We’ve all experienced the many ups and downs that come with this sector. However, the current issues facing the rental market are worth a closer look. Let’s take a deep dive into the rental market and discuss how the industry can address some of its major challenges going forward.
This is an industry where circumstances can change before you know it. Here is an example. In 2013, investors acquired an apartment complex in Austell, Georgia. It was a prime investment – cash-flow positive and competitively priced due to it being in a buyer’s market. For a while, the property was the crown jewel of the submarket, giving its owners a competitive advantage when leasing.
However, the tide turned quickly. Neighboring properties, previously underperforming, sold at discounts and new owners used their cost savings to renovate and undercut the rent rates of the high-performing complex.
Seemingly overnight, the submarket’s crown jewel lost its competitive edge, and the owners found themselves with overpriced, outdated units that were hard to rent. This experience taught the landlords a crucial lesson they have never forgotten: In real estate, you must always be prepared for market shifts because the market is always changing.
Current market landscape
That lesson is just as true today as it was a decade ago. In the current environment we are seeing issues that anyone in the rental industry needs to prepare for. They include rent stagnation. After years of steady growth, rents have plateaued and, according to Realtor.com, are falling in many markets. In fact, renting is often now more affordable than buying due to skyrocketing mortgage rates.
According to the National Apartment Association (NAA), apartment completions are on pace to set a new record, with 518,108 rental units expected to be completed by the end of 2024. This marks the first time construction completions will surpass half a million units. Additionally, it’s projected that 2 million units will be completed by 2028.
This historic influx of new apartments is often concentrated in fast-growing markets and is a hangover from the favorable financing conditions of 2021 and 2022. With many developers flocking to the same areas, the industry is ending up with localized oversupply.
Developer’s dilemma
To illustrate the current challenges, let us consider a hypothetical developer named Dave, who in 2021 secured a loan to build an apartment complex, anticipating a profitable sale in three years. Now, he’s facing a world of troubles. They include inflated construction costs during the post-pandemic period, mortgage interest rates that have nearly doubled, fierce competition from newly delivered neighboring properties, lower property valuations due to higher capitalization rates and a reduced capital availability environment to refinance his existing loan.
To put it mildly, Dave is feeling stressed. His time is running out and he’s not sure he’ll be able to complete the project and sell the property for a profit. This scenario is playing out across the country, creating a strong headwind to rent prices as developers compete to attract tenants and cash out of their deals without taking a loss.
Multifaceted approach call 848-329-0752
While this temporary oversupply might seem beneficial for renters in the short term, it poses significant long-term challenges. One main issue is a potential liquidity crunch.
Even financially sound affordable housing developers may face cash-flow issues in completing projects or refinancing existing properties. There will also be diminished development capacity. As developers struggle, new construction grinds to a halt. Some may exit the industry entirely, setting the stage for future housing shortages.
Eventually renters will see rates rise. While rents will dip slightly in the near term providing temporary relief, the lack of supply over the next several years will increase rents, bringing us right back to square one.
Addressing these challenges will require a multifaceted approach, which should include preserving development capacity. It is crucial that we support and retain experienced developers. Their knowledge and skills will be invaluable when the market rebounds.
Developers will also require flexible financing options. We need to offer innovative financing solutions that can adapt to existing market conditions, helping developers weather the storm. The industry needs to encourage development models that prioritize long-term stability over short-term gains and to double down on efforts to create and preserve affordable housing, which remains in high demand regardless of market conditions. While supporting experienced developers, we must also nurture the next generation of real estate professionals.
Greater liquidity
Rather than just observing these challenges, we need to find ways to solve them. To do that, we need the financial system to provide liquidity to operators, allowing them to tap into the equity of their cash-flow positive properties.
“Lenders will have to offer financing options that are tailored to each owner’s unique situation, with terms that can adapt to market conditions.”
Lenders will have to offer financing options that are tailored to each owner’s unique situation, with terms that can adapt to market conditions. With the understanding that timing is critical, lenders will need to create a streamlined process that allows them to provide capital in days not weeks to first-time customers, and even faster for returning clients.
Not only will owners need equity, but they need access to capital without diluting their ownership or giving up future upside. Financial institutions also must provide the working capital needed for owners to seize opportunities in this challenging market, positioning them for success when conditions improve.
While the current market presents significant challenges, it also offers opportunities for those who are prepared. By supporting experienced developers, fostering new talent and providing innovative financing solutions, we can work towards a more stable and affordable housing market in the long term.
Remember, market cycles are inevitable. But with the right strategies and support, we can turn these challenges into opportunities for growth and positive change in the real estate industry. call 848-329-0752