With the official end of the health emergency in May, it would be natural to assume that multifamily assets are operating in a much-improved environment versus three years ago, when policy responses to the pandemic locked down the economy, curtailed new applications, restricted tours and halted evictions.
That’s especially true because once shutdowns loosened, robust renter demand for apartments drove double-digit rent increases in late 2021 and early 2022.
But it could be argued that multifamily property managers face as tough an operating environment today as they did in 2020 — or even tougher. Amid labor shortages, inflation, higher insurance costs and property taxes, and stingier lending, property managers are adjusting to leaner budgets and staffing. Renter fraud is on the rise, too (see sidebar). In some cases, the challenges are translating into deferred capital improvements and reined-in spending on special events for residents, say observers.
Draper and Kramer, an owner and operator of some 6,000 Class A and luxury units in Chicago, Dallas, Phoenix and St. Louis, is closely watching asset performance and trying to wring out as much savings as possible, says Bill Van Senus III, assistant vice president and regional property manager for the company.
“Every expense and every line item are definitely being looked at with a little bit higher scrutiny,” he adds. “We are also refocusing ourselves on customer service and resident retention. These days, attracting and retaining tenants is a game of who can out-wow the competition.”
Insurance Spike
Of all the expense increases, some of the most severe revolve around property insurance. Historically, insurance costs have climbed approximately 2 to 4 percent annually.
But Hub International, a Chicago-based global insurance broker and financial services firm, predicts that apartment insurance rates will jump 20 to 50 percent this year, depending on an asset’s exposure to natural disaster risk. Multifamily property insurance typically covers physical building damage.
The higher rates are due to many insurance companies exiting the multifamily space amid catastrophic losses resulting from Hurricane Ian and similar weather events, observes Stephen Mitchell, an executive vice president with Asset Living, a Houston-based property manager of some 203,000 apartment and student, military and seniors housing units across the country. Hurricane Ian, a Category 5 hurricane, struck southwest Florida in late September 2022 and caused more than $112 billion in damage, according to the National Hurricane Center Tropical Cyclone Report issued in April.
Meanwhile, municipalities have increased property taxes substantially over the past 12 months or so as double-digit rent increases across many properties in 2021 and 2022 drove up net operating income, which helped fuel rising property values, says Chris Finlay, CEO of Middleburg Communities, a Dallas-based multifamily developer and operator of 5,000 units in the Southeast and mid-Atlantic. It’s only natural that the tax man wants his fair share.
“We’ve seen significant increases in property taxes as well as unprecedented increases in property insurance costs,” he reports. “The natural response from an owner and investor is to find ways to continue to create value for residents on the things that they can control.”
To a large degree, that comes down to leveraging technology as well as on-site management teams to maximize productivity, Finlay adds. “You can’t cut down on maintenance, and you can’t cut down on contract services for things like landscaping and pool care,” he continues. “But you can cut down on resident turnover.”
While the tax and insurance hikes are squeezing operating margins of most if not all operators, they are exceptionally painful on recent apartment buyers who overpaid for assets in so-called “negative leverage” deals, in which the cost of debt exceeds the investor’s initial yield on an acquisition.
Negative-leverage buyers wagered that continued rental rate increases would eventually provide enough income to put the income statement in the black. Rent growth has recently slowed across markets, however. What’s more, most of those multifamily buyers used floating-rate bridge loans to finance the acquisitions and failed to anticipate interest rates spiking over the past year.
“Interest rates moved up, property taxes have gone up way more than expected, and insurance costs have gone up more than expected — it’s a triple hit,” Mitchell explains. For some negative-leverage buyers who have seen decent rent growth, the rising expenses mean that they are stuck in “an equally negative position or one that has become more complicated,” he adds.
Demand Persists
The operating atmosphere isn’t all gloomy. Record high home prices continue to funnel people into rental apartments, a sector that has been undersupplied by 600,000 units since the financial crisis slowed building, according to the National Multifamily Housing Council (NMHC), a trade group based in Washington, D.C.
Renter demand also rebounded in the first quarter of 2023. While 1,900 more units were vacated than leased, the number still represented a big improvement over the negative absorption of 14,000 units in the fourth quarter of 2022, according to CBRE. The brokerage giant’s prediction that absorption would turn positive in the second quarter of this year came to fruition as 70,200 units were leased. That represented the most significant quarterly demand since early 2022, CBRE reports.
“Multifamily is well-positioned in the current environment to continue to provide solid returns for investors,” declares Avery Solomon, a senior managing director with Cushman & Wakefield, which manages more than 178,000 units nationwide. “With the rise of home prices as well as interest rates nationally, we see opportunity in all multifamily asset classes in the major metros.”
But the prospect of an economic slowdown and an abundance of development still threaten to undercut occupancy. More than 1 million apartment units are under construction in the United States, pointed out Greg Willett, a multifamily specialist with Institutional Property Advisors, during an event hosted by NMHC in April. Developers are expected to deliver about 400,000 units this year, an amount that’s likely to exceed demand, he added.
In some markets, such as Phoenix, Denver and Atlanta, the combination of slowing household formation and new supply is weighing on rent growth, states Mitchell. Whether that’s a short-term trend exclusive to specific markets or a more fundamental shift that will spread to other cities remains to be seen.
“It’s market to market,” he adds. “We’re beginning to see some classic concessions again in some markets — free rent in the one-to-two-month range.”
Bonaventure, an owner and operator of 6,000 units in 32 apartment communities primarily in the Mid-Atlantic and Southeast, continues to see strong property fundamentals and income growth in its markets despite an uptick in new construction, says Dwight Dunton, founder and CEO of the firm. Bonaventure also has built its portfolio with fixed-rate debt, he adds, which is giving it an edge over competitors who tapped floating-rate loans.
“The stability of our financing position gives us the flexibility to continue putting capital to work on planned CapEx and marketing events while other property owners may have to delay projects as their interest payments rise,” Dunton remarks. “The capital markets have had limited impact on property-level needs for us.”
Regulatory Creep
Arguably the biggest challenge that the multifamily sector faced during the pandemic was the inability to evict tenants who did not pay rent. The good news is that those eviction moratoriums have all but ended.
In some cases, as Equity Residential highlighted in its first-quarter earnings release, delinquent tenants are beginning to pay rent or move out quicker than initially expected. That’s true even in California, where some jurisdictions had extended eviction bans into the summer.
It can still take several months to evict tenants, however. Not only does a backlog of cases plague courts — a trend generally most pronounced in tenant-friendly jurisdictions like Atlanta and Chicago — but the 30-day eviction notice that Congress established in the $2.2 trillion Coronavirus Aid, Relief and Economic Security (CARES) Act during the pandemic also remains in place for properties backed by federal housing programs, including Fannie Mae and Freddie Mac mortgages.
By comparison, the state of Illinois required a five-day eviction notice for non-payment of rent prior to the pandemic, shares John Kennedy, executive vice president of operations with Evergreen Real Estate Group, a Chicago-based owner and operator of 11,000 primarily affordable housing units in the Midwest and Southeast. Evergreen also is expanding in the Northeast and West.
“Thirty days is a long time, especially if you have a number of residents who are taking advantage of the rule,” he asserts. “Our staff works very hard with residents to find an alternative solution because it’s our preference not to evict people. But it has been much more difficult to collect rent.” Plus, Kennedy continues, the end of pandemic-related rental assistance will likely drive rent delinquencies higher.
The National Apartment Association (NAA) notes that a CARES Act drafting error allowed the 30day notice rule to remain in place for too long. Legislation introduced in Congress earlier this year and supported by the association would vacate the requirement, according to an NAA spokesperson.
The eviction delay places more pressure on affordable housing property managers. In addition to their daily duties of maximizing occupancy, collecting rent and performing maintenance, for example, they are tasked with tracking and enforcing income restrictions in projects financed with low-income housing tax credits or public aid.
“I’ve been doing this for about 30 years, and the industry has become much more complex,” emphasizes Kennedy. “You’ve got different agencies looking at your paperwork and conducting audits, so it’s an ongoing challenge to maintain high standards and meet expectations.”
Managers of market-rate properties may also eventually encounter more federal and state government encroachment into their day-today operations. The Biden administration has introduced a “Blueprint for a Renters Bill of Rights” to advocate for rental affordability and strengthen renter protection.
While it is being advertised as mere fair housing “principles” and not formal policy, among other initiatives, the paper directs eight federal agencies to scrutinize apartment operations, says Solomon, who is based in the Washington, D.C., area.
Topics of interest include tenant screening procedures, credit reporting agencies and security deposit sizing. “Perhaps it is well intended,” Solomon adds. “But this shift to federal oversight will have a negative impact on the quality and quantity of rental housing at an affordable rent.”
Scarce Labor Adjustments
What the proposed bill of rights does not address is how labor shortages are affecting rental housing. Finding workers is an ongoing multifamily property management headache that rivals inflating expenses and higher interest rates. “We have experienced difficulty with sourcing the perfect-fitting team member amidst a tight labor market,” states Jamin Harkness, president of The Life Properties, an Atlanta-based manager of more than 16,000 workforce housing and naturally occurring affordable units in Texas, the Southeast and Midwest.
“Prior to the pandemic, it was harder to get top talent to leave their previous companies, whereas today there is a bidding war for top talent.”
As a result, the company is enhancing leadership training, benefits and work-life balance programs, says Harkness, whose firm is affiliated with value-add investor Olive Tree Holdings.
Property managers are also increasingly turning to technology to do more with less.
Middleburg, for example, has implemented artificial intelligence (AI) to field inquiries and schedule tours, many of which are self-guided. “It’s still early with this technology, but it is actually outperforming calls answered by humans. It’s shocking to me,” says Finlay. “It fields questions and can get people on-site. And if we can get people on-site, we have very good success in getting signed leases.”
One way that some owners are approaching the labor shortage is to try and reduce on-site personnel and marketing programs, says Mitchell. But by removing a full-time person from the office, managers have one less person who can interact with tenants and keep them connected to the community. What’s more, he says, reducing marketing budgets risks losing traffic.
“If you drop below a certain level of competency or spending on marketing, it just creates a death spiral,” he cautions. “You might be able to save a little cash flow today, but it could be to the detriment of a lot of cash flow tomorrow.”
— By Joe Gose. This article originally appeared in the Sept/Oct issue of Midwest Multifamily & Affordable Housing Business.