2024 Multifamily Outlook: Part 1

As we wind down a difficult year for commercial real estate, it’s time to look toward 2024. Over the coming weeks, we will walk through key components of Net Operating Income, beginning this week with rent growth.

Rent Growth

After record rent growth in 2021 and 2022, rents dropped rapidly in 2023, not only in DFW, but across the country. When we hear declining rent growth, especially during time of high inflation, our natural presumption is that rents became too expensive, and the market is adjusting back toward affordability. That is not the primary reason, however, for rent growth slowing. It has been a function of supply.

Component 1: Supply and Demand

In 2020, developers paused new development and supply that was to be delivered was delayed. Combined with pent up demand (less move-ins and move-outs in 2020) and population growth, rents skyrocketed once the economy “reopened.”

Naturally, to catch up with this demand, developers began construction in record amounts. Much of that has been delivered in 2023, with more to come in 2024. In fact, 2023 will be a record number of completions, and it’s already the highest number of units delivered in the last decade:

This level of new supply is the driver for the softening of rent growth. The good news is that this new supply has also been absorbed. New supply is needed to account for the continued population growth. In fact, completions when cast as a total percentage of the apartment housing stock casts a different picture:

Employment growth is strong, especially in sectors important to Class B and C renters. Annual job growth of 4.4% is about 2 percentage points above the national average. Construction and Other Services (generally, non-food and hospitality services) stand out with annual employment growth of 9.5% and 10.1%, respectively. The strength of the employment base will keep the glut of supply from having a materially negative affect on rent levels, as shown in the chart below:

Job growth continues to outpace supply growth. Even at these high levels of construction, there is no sign of “over supply” — it’s merely meeting demand. Using these same adjustments when applied to the entire DFW employment base, we can see why there are yet still more apartments under construction today:

This estimation indicates supply is still short, an important point in forward-looking rent growth projection. Because of high interest rates and general economic uncertainty, new construction starts have slowed substantially.

Nationally, in 2022, monthly starts were topping 60,000 new units. As of August 2023, monthly starts have dwindled to just over 20,000 units (per RealPage Analytics). This decline will have a large effect in 2025 and 2026 deliveries, suggesting an ease in future supply.

In 2024, however, new supply is expected to be sizable, likely similar to 2023, though some may pause construction dealing with the burden of interest costs and lender difficulties.

Component 2: Renter Income

Affordability will always be a question for renters. Nationally, DFW and Houston remain the most affordable of the ten largest metro areas: At an average of $1,553/unit, DFW compares favorably to similar sized markets Chicago ($1,884), Washington DC ($2,049), Atlanta ($1,717), and the national average ($1,716). This is an important factor for long-term economic growth and an important reason so much out-of-market capital is invested in DFW multifamily.

That affordability must make sense at the market level, too — tenants must still be able to afford prevailing rents. After about 18 months of rents outpacing wage growth (May 2021–December 2022), wages are again outpacing rent growth, and have been for nearly all of 2023, shown below:

Net wage growth will give tenants an increase in relative affordability over the next year. Expressed in terms of rent-to-income, renters began feeling the effects of rent increases in mid-to-late 2021 and have continued as growth has filtered through properties.

Now, as rents slow and wages outpace, we expect to see a reduction in rent-to-income ratios in 2024. The Dallas side of DFW has already seen this, with rent-to-income ratios peaking in mid-2022 at just over 30%. The ratio has declined to ~29% since, shown below:

The ratios above show the rent-to-income ratio for Class B and below, termed “Renters by Necessity” (data by Yardi Matrix). Just as it took time for ratios to increase after rents outpaced wages, so too will there be a lag in the ratio receding as wages outpace rents. A return to a mid-20% ratio will give tenants the ability to stomach “traditional” 3–4% annual increases.

Putting it all together

As we build a profile for 2024 rent growth, the last piece is the effect of differing asset classes. Yardi Matrix segments multifamily into two pools: Lifestyle renters (A+, A, A-, B+) and Renters by Necessity (B, B-, C+, C, C-). Because affordable multifamily development is largely cost prohibitive, almost all the new supply has been in the Lifestyle segment, shown below:

This has created diverging rent growth trends while the new supply trickles through the market. New class A developments are in much more competition than previous years. A concession battle has begun as these new deliveries begin lease-up. We all know concessions lower effective rents. But they also narrow the price differential between new and existing units in the class A realm.

For example, a tenant pays $2,000 for a class A unit in a 10-year-old apartment building and is up for renewal at $2,150. Next door, a new class A property is delivered, scheduled to lease at $2,400 per unit. To weather the competition, owners of the new development offer one month free. This concession lowers the effective rent from $2,400 to $2,200. What was an expensive $250 monthly increase is now just $50, allowing the tenant to move into the new building with ease. This is the primary reason that the Renter by Necessity category has outpaced Lifestyle rent growth over the last year, shown here:

Renter by Necessity housing has also outperformed because supply growth is much less. The only new supply to affordable housing is through the moving “down” of class B properties as they age. This stock will certainly transition toward affordability over time, but not nearly at the same pace as new class A supply. Some investors will see aging B properties as an opportunity for rent increases through renovation; other properties will suffer from lack of capital and engage a more working-class tenant.

The Final Call

DFW should maintain a 1–3% rent growth amount in 2024. The Renter by Necessity segment should slightly outperform the leasing-up class A assets. With supply and demand both strong, we expect the increase in tenant purchasing power (falling rent as a percentage of income) to aid in moderate rent increases. There are many variables that could cause the forecast to change, however.

To the upside, not all developments under construction today may see completion. Depleted interest reserves and lesser-than-projected current rents could cause some projects to not be delivered. If this happens while demand remains as strong as projected, rents may move higher.

To the downside, as-expected completions and weaker demand may keep rents stagnant. As we saw in 2020, demand can still dampen even when population growth is strong. Household formation can slow, generally through individual tenants deciding to room together to save costs and reduce overall absorption. There would need to be serious economic stimuli to affect demand in a meaningful way, though.

Perhaps most importantly, DFW is poised for strong rent growth in 2025, 2026, and beyond. We know completions will dwindle by then by virtue of construction slowing today. This is always the primary driver of rent growth. Slowing supply will press rents upward again and makes for a compelling reason to purchase property today to capture that growth.

Savvy underwriters will not make offers banking on this projection, but instead predict a normalized ~3% annual growth rate in future years. If property metrics are satisfactory at current market conditions, then owners will reap the reward for investing today.

Patrick Dunne
Leads property underwriting, economic analysis, debt structuring, and investment management.
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