In the realm of multifamily real estate, where market fluctuations and economic uncertainties often dictate the industry’s future, some players have an unwavering belief in its resilience and promise.
John Begley, vice president of real estate investments at CP Capital—a company that has been actively investing in multifamily real estate for nearly 35 years, across various economic cycles—is convinced that multifamily will continue to provide compelling investment opportunities going forward.
Even though the sector has experienced its fair share of ups and downs—including supply chain disruptions, a slowdown in transaction volume due to prolonged monetary tightening and decelerating rent growth—”there will always be the need for safe, quality housing,” as Begley puts it. Here’s what’s behind his optimism when it comes to the industry’s outlook.
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What positive trends are you seeing that make you feel so confident about the multifamily market’s return to normalcy?
Begley: Despite some turbulence in the market, multifamily is a necessity-based real estate sector which makes it one of the most stable real estate investments—especially compared to more volatile asset classes like office or retail which have been going through significant disruption. This year we’ve witnessed an inevitable pullback from the multifamily investment run-up we experienced immediately following the pandemic. Even though rent growth is decelerating, we are still seeing robust rental demand driven by the rising cost of homeownership, an aging housing stock and a persistent supply-demand imbalance in many markets across the country.
We are particularly bullish on suburban markets outside major metros, which have seen a boom over the past several years due to demographic shifts and changes in lifestyle trends like the rise of remote work. These markets are projected to see positive rent growth in the coming years in the range of 2 to 4 percent, which is in line with what we have seen historically. This strengthens our belief that the multifamily space will continue to provide compelling investment opportunities for years to come.
How has demand for Class A multifamily rental properties evolved over the past 12 months?
Begley: From our experience, demand for Class A apartments has receded from the market exuberance seen in 2021 and early 2022. With that being said, it is at a level consistent with historical norms and continues to support a favorable long-term outlook as U.S. employment remains strong and high home prices have many aspirational buyers renting for longer.
While we are seeing elevated new construction levels across the country, supply chain disruption, slow local government approvals and challenging debt markets have delayed or canceled many new Class A apartment communities, which may keep a heavy concentration of new apartments from delivering all at once. Multifamily demand also varies by market and even by submarket. For example, demand in pockets of Southern California appear to be weakening while apartments in the Northeast, Mid-Atlantic and Midwest are displaying promising rent growth, solid unit absorption, and healthy stabilized occupancy levels.
Please expand on the regions that are showing favorable multifamily fundamentals today. Which areas could see improvement?
Begley: Northeast and Mid-Atlantic suburbs are showing favorable multifamily fundamentals, largely driven by expensive homeownership costs, an aging housing stock, stable employment drivers, and very high barriers to entry.
We are also seeing some submarkets in the Southeast and Southwest that have experienced tremendous new apartment inventory expansion over the past cycle, and rightfully so. A business-friendly environment, beautiful weather, favorable income tax treatment, and a low cost of living have attracted troves of new residents. While we are confident the new apartment supply will eventually be absorbed, it’s likely some developers and investors may experience softening demand in the near term.
In some areas of growth markets, recently completed communities are experiencing muted rent growth while the overall industry is battling operating expense inflation related to sky-rocketing insurance premiums, higher marketing spending, and increased property personnel costs. These increasing operational costs, combined with rapidly expanding interest rates, may require new development projects to stabilize before generating positive cash flow or may lead to the need for additional cash infusions to bridge the gap.
Regardless of the recent slowdown in the current multifamily investment environment, the national housing shortage will continue to persist for the foreseeable future and suppressed new development activity is expected to further exacerbate the issue. We are active investors and remain believers in growth markets throughout the Sun Belt. A temporary influx of new apartment deliveries hasn’t changed our positive outlook on the region long-term.
Despite all these challenges, CP Capital is set to hit several milestones. Tell us more about these achievements.
Begley: CP Capital has hit a number of exciting milestones in the second half of this year, and we are poised to achieve several more across our portfolio before the year is out.
We currently have six projects under construction—representing over 2,000 units total—in submarkets of Washington, D.C.; Philadelphia; Austin, Texas; Charleston, S.C., Tampa, Fla., and Phoenix. Three of our recent developments outside Boston, Los Angeles and Nashville, Tenn., are actively in lease-up and nearing stabilization. Last month, we kicked off leasing at three new development projects in suburban Denver and Atlanta. We also recently completed the sale of The Monarch, a 236-unit, Class A property in the Chicago suburb of Des Plaines, Ill.
We believe our strong pipeline activity amid recent market uncertainty is indicative of the multifamily sector’s strong underlying fundamentals, and highlights the demand for high-quality rental housing in growing suburban markets across the country. It also underscores the success of CP Capital’s long-term strategy, our enduring relationships with top developers across the country, and our dedication to maximize investment performance.
In terms of portfolio expansion, we will continue to pursue investment opportunities in high-growth and high barrier-to-entry suburban markets with favorable population and employment demographics, alongside our best-in-class development partners.
What sets you apart from competition? How do you approach multifamily investment and development?
Begley: For over three decades, our mission has been to generate value for investors while having a positive impact on society…One of our main focuses has been investing in lower-density, surface-parked multifamily communities in infill locations. The sites are difficult to piece together and often come with some challenges that create high barriers to entry. Once complete, however, these projects benefit from a more economical construction build without underground or structured parking, allowing for a lower average monthly rent check compared to nearby higher-density, higher-cost builds.
In numerous cases, we have delivered a high quality, efficient product and outperformed our original underwriting by a wide margin. These projects often required us to demolish an existing, obsolete building or clean-up an underutilized land parcel, which also undoubtedly improves the surrounding neighborhood and local community while delivering attractive, risk-adjusted returns for our investors.
Market dynamics are constantly changing. Is your approach to multifamily investment today much different from the one you used a few years ago?
Begley: CP Capital has been actively investing in multifamily real estate for nearly 35 years across various economic cycles. While the investment landscape is always changing, there remains a need for safe, quality housing. We have generally employed the same strategy throughout our history although our geographic investment footprint has grown over the years to include new, established metros. Local housing shortages and our development partners have presented unique development opportunities in new markets across the country where we previously haven’t invested. These opportunities have added a greater level of diversification for our investors.
Another major market trend that we have adopted over the past couple years has been the inclusion of technology and forward-thinking, resident amenities in our properties. During the pandemic we started to see new communities incorporate pre-wired Wi-Fi for individual units, non-key secure access systems, EV charging stations, larger package lockers with cold storage, expansive dog parks, pickleball courts, larger coworking areas, and fitness on-demand programs. These new property features have continued to evolve with new technology and changes in renter preferences. It is now critical for new developments to feature some or all of these upgrades to remain competitive in the market. We make it a priority to discuss and evaluate all these features during our underwriting process.
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How do you manage risks associated with multifamily investment in this volatile economic environment?
Begley: In 2021, investors were eager to enter the multifamily development space due to low interest rates and extraordinary demand catalyzed by the pandemic. Today, construction delays from supply chain issues, new apartment deliveries and higher borrowing costs have burdened some investors that underwrote deals at multifamily’s recent peak performance without making conservative forward-looking assumptions in their pro formas. Over the years, we have established high underwriting standards and investment safeguards designed to mitigate potential investment risks regardless of where we are in the cycle. We underwrite exit cap rate expansion, additional escalation contingencies, conservative interest reserves, and longer delivery time frames.
Our investments are conservatively financed with longer, initial term construction loans and extensions to combat unforeseen delays. During the investment hold period, we work with our development partners to construct the highest-quality, cost-effective development project while exercising operational discipline, strategic asset management during the lease-ups, and maintaining an overall focus on maximizing investment performance. While it is near impossible to time the investment cycle precisely, we believe working to mitigate the downside risks allows us to navigate periods of market turbulence and transact when it best suits our investors and the partnership.
What are your expectations when it comes to multifamily investments? What could make sales activity across the industry pick up over the next few months?
Begley: We believe multifamily transaction volume will remain soft for the remainder of 2023 and into 2024, largely due to the impact of recent interest rate hikes and the uncertainty of where rates will settle in the near term. For buyers, 6 percent+ interest rates make purchasing properties with 4.75-5.50 percent cap rates difficult to justify, especially if the investor is unable to meaningfully grow net operating income to achieve positive leverage. Many would-be sellers are reluctant to part ways with their investments if they are falling short of the original business plan and are not being pressured by lenders or equity partners to sell.
We expect to see transaction activity pick up when existing loans that were locked in several years ago at low interest rates approach maturity or if the Fed declares victory in the war against inflation and cuts interest rates sooner than expected.
Unfortunately, we can’t predict the timing of either outcome with any confidence. Despite these uncertainties, U.S. housing formation, steady job growth, and a continual housing shortage will require new multifamily investment, regardless of where interest rates are.
On the new construction investment front, we are seeing construction costs pull back around 5 to 7 percent as new starts have halted. We expect a declining pipeline and pent-up demand to bolster multifamily fundamentals over the next two to four years. It’s likely that apartment developers and investors who break ground over the next 18 months will have limited competition and deliver into a more advantageous investment market in 2025 and beyond. More than three decades of multifamily investing through multiple economic cycles has taught us that the best time to invest is when investment volume craters and competition slows.
