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Sector Focus: Multifamily Momentum Showing Signs of Slowing

04/23/2013 | By Carisa Chappell

Sector Focus: Multifamily Momentum Showing Signs of Slowing
While multifamily REITs have enjoyed strong fundamentals, returns from the sector continue to lag behind the broader REIT market. Industry analysts are attributing the sector’s performance to investors’ concerns with competition from the single-family home market and a muddled employment picture.

Multifamily REITs have posted total returns of 3.9 percent for the year as of April 22, trailing the average 2013 gains of 12.4 percent for all equity REITs, according to data from the FTSE NAREIT U.S. Real Estate Index. In comparison, the S&P 500 has posted returns of 10.2 percent for the same time period. In 2012 multifamily REIT returns were 6.9 percent, compared to 19.7 percent for all equity REITs.  

“The markets have not been kind to multifamily REIT stockholders,” said Jim Stevens, analyst with research firm SNL Financial. Multifamily REITs’ lukewarm returns have come as projections for the growth in the sector’s funds from operations (FFO) have dropped.

Median FFO growth for 2012 in the multifamily sector was 16.5 percent, well above the 5.2 percent median FFO growth of the entire equity REIT sector, according to SNL data. However, that is expected to slow in 2013, with SNL projecting FFO growth for multifamily REITs of 7.5 percent, below the mark of 9 percent projected in the broader REIT market.

FFO growth projections and the current NAV discount for the sector suggest momentum is slowing down,” Stevens said. The multifamily sector ended March trading at a 9.2 percent discount to NAV. That was higher than the median for all equity REITs of 6.7 percent.

Additionally, Stevens said that if the unemployment rate maintains the slow improvement seen in the last year, demand for multifamily space is likely to decrease. Unemployment dropped from 8.2 percent in March 2012 to 7.6 percent in March 2013, according to data from the Bureau of Labor Statistics.

Housing Market Effects

Calvin Schnure, NAREIT’s vice president of research and industry information, speculated that many investors expect rent growth in the multifamily sector to decelerate as the single-family housing market rebounds. Single-family housing starts are projected to rise from 535,300 a year ago to 700,000 this year and reach 1 million by 2015, according to an April report from the Urban Land Institute. 

Yet, Stevens noted that the evidence that single-family homeownership and multifamily rental markets cannibalize revenue from one another isn’t definitive.

“There are historical examples of the two industries growing in harmony, as well as examples of them moving inversely,” he said.

Oversupply Concerns

Another important variable affecting the multifamily sector is the number of new apartment units being made available. Luis Mejia, CoStar’s director of multifamily research, said “the wild card in the equation” is a possible overbuilding of multifamily units, “especially if the combination of relatively easy financing and developers’ optimism, which is always there, continues to persist too long.”

CoStar is projecting that 140,000 new apartment units will be delivered in 2013, with more that 400,000 to come in the next three years. Mejia said some markets that recovered early in the real estate cycle, such as Dallas, Washington, Denver and Seattle, may see higher vacancy rates in 2013 as they become saturated with new units.

Given the significant increase in deliveries of multifamily buildings scheduled for 2013, if demand growth diminishes, Stevens said “the unit owners could find themselves in trouble.”