I found this article on The American Banker and knew I had to share it with all the modular home factories. While there are absolutely no indications that multifamily housing is about to reach it’s bursting point, American Banker is making the observation that banks will need to tighten lending requirements as this market slows. Modular home factory management would be wise to use caution over the next few years to make sure that the project they’re bidding on is fully funded before the first module is produced in the factory.
Is Multifamily Housing the Next Lending Bubble?
JAY PARSONS, The American Banker
SEP 18, 2014 10:00 am ET
The apartment industry is riding high these days. Sales
volumes are at peak levels. Prices have jumped to all-time highs.
Capitalization rates have dropped to long-time lows. And buoyed by strong
demand and easily accessible funding, apartment construction has surged to the
highest levels since the 1980s.
All these high-water marks suggest an obvious question: Is
multifamily housing reaching a bubble?
This question is especially important for banks because they
have quickly become major players in the multifamily business. Since the start
of 2013, banks have funded 82.5 cents of every new dollar, on net, loaned for
multifamily housing, based on data from the Federal Reserve. And since the
second quarter of 2008, multifamily loan volumes have ballooned 33% to an
all-time high of $281 billion on bank balance sheets, according to Federal
Deposit Insurance Corp. filings compiled by BankRegData.com. No other bank loan
category has grown faster over that time period; it’s not even close.
Multifamily now comprises 3.5% of all outstanding bank loans, the highest level
since 1992.
There are several theories as to what’s driving the
apartment industry’s hot streak — but first, let’s look at the fundamentals.
The apartment sector recovered quickly from the last
recession. The period between 2010 and 2012 was one of the best on record for
the industry in terms of net operating income growth. This growth was fueled by
big gains in both occupancy and rent prices and aided by very limited new
supply. Since then, new supply has ramped up. As of the second quarter of 2014,
new supply levels on a trailing 12-month basis are at decade highs. Yet demand
for apartments remains robust, tracking above supply. Occupancy hit a
seven-year high of 95.7% in the second quarter of this year.
So what’s behind the multifamily surge? One popular view is
that the foreclosure crisis drove millions of people out of single-family homes
and into apartments, creating a short-term, unsustainable lift for the sector.
But the data shows that foreclosures turned single-family owners into
single-family renters, not apartment inhabitants.
It’s true that the crisis slowed the tide of first-time
homebuyers. However, the evidence suggests that a large swath of today’s young
adults — even without the foreclosure mess or the resulting tighter
underwriting standards — would still wait longer to buy homes. Millennials’
so-called prolonged adolescence has them waiting longer to get married and to
have kids, both of which provide an impetus for purchasing homes.
In fact, demographics, rather than the foreclosure crisis,
has been the key driver behind the apartment industry’s success. The
its highest growth rate in the population of 20- and 30-somethings since the
baby boom. Population trends clearly show significant growth through the next
decade that will fuel a steady demand stream for apartments, even as the oldest
millennials start to buy homes in greater numbers.
Young adults’ prolonged adolescence isn’t just delaying home
purchases. It’s also delayed apartment lease signings for some young adults —
suggesting that there is still pent-up demand for apartments. The
31 lived in their parents’ homes in 2012, up 3.1 million from 2007. Once this
group leaves the nest, the next, most logical step will be to rent an
apartment.
Simply put, lots of young adults are renting apartments
today — and more of them are coming. Moreover, these young adults are better
equipped to deal with future rent hikes than many realize. Millennials are
widely portrayed as underemployed and poorly paid. But the data suggests that
is untrue for the generation as a whole. Millennial households command greater
inflation-adjusted incomes than previous generations did at the same age,
according to a recent study by the
income growth has come from young adults with college degrees, while income for
those without degrees has fallen.
Beyond demographics, it’s worth comparing the conditions
that led to the busted single-family bubble of 2008 to those of today’s
multifamily market.
The most obvious problem in the single-family bust was that
banks lowered lending standards during the mid-2000s, inflating homeownership
rates to historic — and artificial — highs. The fact that borrowers lacked
sufficient skin in the game drove the nonperformance rate of first liens for
single-family homes held by banks to a peak of 10.1% in the first quarter of
2010.
The apartment industry doesn’t have a comparable driver.
Banks today are generally getting attractive terms for multifamily loans, with
loan-to-value ratios typically around 70%. Moreover, the nature of lease terms
allows apartment owners to quickly remove delinquent tenants. And apartment
prices haven’t shot up to the degree seen in single-family homes in the run-up
to the crisis — not yet, anyway. Multifamily housing prices would have to
plunge even further than in 2008-2009 before a bank’s investment could become
exposed.
There is one more important comparison to make between
single-family homes in the mid-2000s and multifamily housing today:
construction.
The sharp rise in multifamily development has made headlines
and inspired some to start crying “bubble.” But the data shows that
while multifamily construction has surged upward, it’s still well below levels
seen in the 1980s, 1970s and 1960s. And it’s highly unlikely to return to those
levels. Single-family construction, by comparison, fed the bubble by shattering
all kinds of records in the mid-2000s. In fact, both Fannie Mae and Freddie Mac
have published research suggesting that current apartment construction volumes
are actually insufficient to meet demand — although those
proclamations warrant some nuance.
All that being said, the apartment market is almost
certainly past the peak for this cycle. There’s less room to grow occupancy
today, so bigger rent hikes would be required to sustain NOI growth levels. The
same is true of loan yields, since the marketplace is becoming more
competitive, and of cap rates. Early in the recovery, apartments were so hot
that pretty much any deal was a good one. Today, as yields are normalizing,
strategy is becoming more important.
While the multifamily housing is not near bubble status, it
would be wise to adapt to the changing cycle. The biggest risk to the
multifamily sector, like any sector, is the macroeconomic environment.
If the
economy weakens materially, multifamily is vulnerable. Banks can prepare
themselves for such an occurrence by narrowing their focus to specific market
segments that meet acceptable risk thresholds and by continually upgrading
underwriting techniques. At a market’s
point
backpedal — but to continually sharpen processes and adjust to changing
conditions.
Jay Parsons is the director of analytics and forecasts for
MPF Research, the market intelligence arm of RealPage, Inc., specializing in
the multifamily housing industry.
