Authored by Jonathan Needell, President and Chief Investment Officer
December 15, 2021
The U.S. has entered a period of inflation that is impacting everything from gasoline to groceries. In fact, inflation rose 6.2% in October, one of the highest leaps in over 30 years.
In the real estate industry, multifamily property prices in particular, which were already increasing before inflation set in, are climbing, undeterred by the pandemic. As inflation continues, apartment asset valuations have the potential to rise even further in the coming months – particularly given this sector’s history of strength and stability.
This begs the question, “Can multifamily prices become too hot to handle?”
The general answer to this question is, “Yes.” The more nuanced answer is, “It depends.” In some areas of this sector, the market is likely to become overheated under inflationary conditions. In others, investors are more likely to find reasonably priced deals.
At Kairos Investment Management Company, we and our affiliates have invested in 19,000 multifamily units, which gives us a seasoned perspective on this segment of the market. Here are some of the factors we see putting upward pressure on multifamily prices during the current inflationary period and how they can be mitigated.
- Supply and demand
Low supply combined with high demand typically leads to price increases. According to Freddie Mac, the housing market shortage of about 2.5 million units before the pandemic increased to about 3.8 million units by the end of 2020. Despite a revving up of multifamily construction in recent months, demand continues to outweigh supply, putting upward pressure on replacement costs for the foreseeable future.
One solution for multifamily buyers concerned about overheated pricing is to research secondary and tertiary markets, where there tends to be less competition and asking prices are usually lower than in many of the primary markets. For example, some of the regions where our firm owns multifamily properties include Cary, North Carolina; Mesa, Arizona; Knoxville, Tennessee; and Draper, Utah. These markets and others have allowed us to capitalize on some of the dislocations and inefficiencies that are inherent in real estate investing.
- The labor market
The skilled labor shortage has been a headwind for residential construction for quite a while – some say as far back as the 2008 recession. In fact, with the National Association of Home Builders (NAHB) saying the number of new workers needed to keep up with demand is estimated to be 740,000 a year for next three years, construction of multifamily properties is likely to continue to be hampered for some time to come. Slower construction means slower delivery of supply, which leads to higher prices in areas where demand is great.
A decreased labor market also drives up the cost of labor, which results in higher prices for apartment communities. The cost increases exponentially in expensive primary markets, again making the case for seeking out assets in more affordable secondary and tertiary markets.
- Supply chain issues
Rising construction costs, exacerbated by the pandemic, have experienced an additional push upward by supply chain issues. The sheer difficulty of obtaining materials from overseas to build multifamily projects is driving up costs for these goods, which in turn leads to higher valuations for apartment properties.
In addition, Congress recently passed a $1 trillion infrastructure bill that will increase demand for concrete, steel, and wood at a time when these goods are already difficult to obtain, causing price increases and raising concerns about inflation.
Also, the combination of supply chain issues and rising material prices is driving up replacement costs for multifamily communities, which causes upward pressure on rents at newly developed communities.
Acquiring existing multifamily assets helps stakeholders circumvent the supply chain issues inherent in new construction. Finding a less-traveled niche among existing assets is another, which is one reason why KIMC is a disciplined lower-middle-market real estate investor that focuses on deals in between the institutional and individual investor categories.
Seeking out previously constructed multifamily properties in markets and categories where competition is diminished can significantly reduce the impact of supply chain woes on investments.
Inflation is likely to continue pushing multifamily asset prices higher over the next year or more. By understanding how supply and demand, the labor market, and supply chain issues could affect these prices, stakeholders can mitigate the impact of inflation on their multifamily portfolios.
*There are no guarantees that any specific investment strategy will be profitable or equal to past performance levels. All investment strategies have the potential for profit or loss. The views and opinions expressed in this article are solely my own.
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