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Multifamily Weathers Recessions Better Than Other CRE Types

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Multifamily Weathers Recessions Better Than Other CRE Types

Economists believe that the likelihood the U.S. economy will enter a recession is increasing, considering climbing interest rates and stalling business investment. Yet a recession is far from a sure thing at this juncture, and even if it does hit, it probably won’t be as severe as past recessions. All the same, as the possibility becomes more real, it’s pertinent to examine how various commercial real estate (CRE) investments perform in times of economic strain.

How Bad Is the Current Economic Climate?

This is the second consecutive quarter in which the gross domestic product (GDP) has contracted. By one common but unofficial definition, this means a recession has already arrived. Government spending has fallen, pulling down the GDP, but a larger factor at play is a steep drop-off in business and residential investment. Business investment is slowing under the weight of supply chain delays and higher prices, while residential investment is falling under the weight of rising unaffordability due to mortgage rates.

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Yet the labor market is still demonstrating quite a bit of strength – unemployment is very low at 3.6% according to the Bureau of Labor Statistics, and jobs are still plentiful. Strong wage growth and excess savings in recent quarters has kept the U.S. consumer healthy. In fact, the GDP reading showed U.S. consumption of goods and services increased this past quarter– but that growth has slowed from its brisk pace in previous quarters, possibly reflecting the impact of broad price inflation.

Meanwhile, the Federal Reserve is aggressively hiking interest rates in an attempt to cool elevated inflation and allow supply to catch up with demand. Interest rate hikes are causing investors to pull back as the cost of debt rises. Combined with recession fears, it’s natural that we would now see a “flight to safety” among investors looking to protect their capital amid choppy economic conditions.

The Performance of CRE in Past Recessions

All recessions are different and stem from different underlying causes. As a result, the impact of a recession on CRE varies according to the cause, duration and severity of the downturn.

For example, the recession of the early 1990s was triggered by rising interest rates and an oil price shock. According to a CONTI analysis of CoStar data, the office and retail sectors bore the brunt of that downturn due to the subsequent “jobless recovery” that tanked office-using employment and retail spending. Multifamily was the only major property type to experience positive rent growth during that period.

All property types experienced negative rent growth during the early-2000s tech bubble, but the office sector suffered the steepest losses as a result of the collapse of the dot-com bubble and the related decline in tech employment.

The Great Recession—the most severe downturn since the Depression—was triggered by a global financial crisis and was followed by a prolonged jobless recovery. All major CRE sectors experienced negative rent growth, with office leading the pack. The depth and severity of the Great Recession pushed many renters to move back in with family or double-up with roommates, causing a sharp decline in demand. However, the recovery in multifamily was relatively swift as compared to office and industrial.

The most recent pandemic-induced recession had a unique impact on CRE property types, with stay-at-home orders and generous government stimulus pushing up demand for housing and goods ordered online. As a result, rent growth was actually positive for industrial, multifamily and retail. Direct government lending to retailers that were forced to close for public health reasons ensured that the retail CRE sector was spared from significant rent losses. However, there was no such lifeline for the office sector as work-from-home became far more entrenched than many had initially assumed, giving tenants the upper hand in lease negotiations.

Of course, the U.S. is a large country with region-specific growth drivers. As such, the impact of a national downturn is experienced differently across real estate markets. Oil and gas markets were most exposed during the early-90s recession, whereas coastal tech-based markets were most exposed during the early-00s downturn. The Great Recession’s impacts were broad-based, but less severe impacts were seen in markets that avoided the worst of the subprime mortgage crisis.

It is CONTI’s position that multifamily real estate weathers change well because it’s a necessity – people need a place to live. Our analysis demonstrates that necessity-based CRE is far more resilient during economic downturns. Notably, though, technological advancements consistently alter what is and is not considered a necessity. Online shopping and the ability to effectively work from home are relatively new changes with significant implications for CRE performance. The one constant from this survey of recent downturns is the high exposure of office real estate to the vicissitudes of the labor market.

Multifamily, on the other hand, offers a number of benefits that contributes to the sector’s outperformance during recent recessions. Housing is a requirement, multifamily is a more affordable alternative to owning a home and the shorter duration of apartment leases allows owners to adapt to a changing environment faster than other property types. In the current economic environment, higher mortgage rates, inflation and home prices are pushing more and more would-be homeowners into multifamily, contributing to the outsized rent growth we have seen over the past few years. We see this trend continuing into our near-term forecasts.