VALUED INSIGHTS

Invaluable Valuation Knowledge for the Real Estate Stakeholder

SERIES:
Opportunities And Challenges
In The U.S. Multifamily Market
CHAPTER
  1. Supply And Demand In The Rental Market
    (Published: July 22, 2024)

  2. Understanding Multi-Family Housing Metrics (Available: July 29, 2024)

  3. Key Supply and Demand Indicators for Apartment Investors
    (Available: August 5, 2024)

  4. The Economics of Build-to-Rent Projects
    (Available:August 12, 2024)

  5. Analyzing Regional Apartment Market Trends (Available: August 19, 2024)

  6. Forecasting Demand for Multi-Family Units (Available: August 26, 2024)

  7. The Impact of Economic Cycles on Apartment Markets (Available: September 2, 2024)

SERIES:
Opportunities And Challenges
In The U.S. Multifamily Market
CHAPTER:

The Impact of Economic Cycles on Apartment Markets

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Author: Jason D. Beakley, Certified General Appraiser
Published: September 2, 2024

Economic cycles play a crucial role in shaping the performance and dynamics of apartment markets. As a commercial real estate professional focused on the multifamily sector, understanding how these cycles influence supply, demand, and overall market conditions is essential for making informed investment decisions and developing effective strategies. Economic cycles, also known as business cycles, consist of four main phases: expansion, peak, contraction (or recession), and trough. Each of these phases has distinct characteristics that impact the apartment market in different ways.

Expansion Phase

During the expansion phase, the economy is growing, and this growth typically has positive effects on the apartment market.

Jason D. Beakley
CERTIFIED GENERAL APPRAISER
Director
+1-480-440-2842 EXT 09

As employment rates rise and incomes grow, more people can afford to rent apartments, leading to increased demand. This surge in demand often results in higher occupancy rates and rising rents. The favorable economic conditions during expansion also tend to spur new apartment construction, as developers find it easier to secure financing and initiate projects when the market outlook is positive.

One of the most notable impacts of the expansion phase on the apartment market is the appreciation of property values. With strong demand and improving market fundamentals, apartment properties often see significant increases in value. This appreciation can create opportunities for investors to realize substantial returns, either through property sales or refinancing.

Key impacts of the expansion phase:

  • Increased demand leading to higher occupancy rates
  • Rising rents due to strong market conditions
  • New development activity to meet growing demand
  • Appreciation of apartment property values

Peak Phase

The peak phase represents the highest point of economic growth before a downturn begins. In the apartment market, this phase often exhibits maximum occupancy rates, with strong competition among renters for available units. While rents are typically at their highest during this phase, the rate of growth may begin to slow as affordability concerns emerge. This plateau in rent growth can be an early indicator that the market is reaching its peak.

During the peak phase, investment activity in the multifamily sector often intensifies. Investors may become more active in acquiring properties, seeking to capitalize on the strong market conditions. However, this increased competition for assets can lead to compressed cap rates and potentially overvalued properties. Savvy investors and operators should be cautious during this phase, as the risk of overpaying for assets increases when the market is at its peak.

Contraction (Recession) Phase

During economic contractions or recessions, the apartment market faces several challenges that can significantly impact performance. Job losses and income reductions can lead to decreased demand for apartments, potentially resulting in higher vacancy rates. To maintain occupancy levels, property managers may need to offer rent concessions or reduce asking rents, which can negatively affect property income and valuations.

The development landscape also changes dramatically during a contraction. New apartment construction often slows or halts as financing becomes more difficult to obtain and market conditions become less favorable. This slowdown in new supply can actually benefit existing properties in the long run by limiting competition, but in the short term, it reflects the overall weakness in the market.

Property values may decline during a contraction as market fundamentals weaken and investor sentiment becomes more cautious. This depreciation can create challenges for owners looking to refinance or sell their properties, but it can also present opportunities for well-capitalized investors to acquire assets at discounted prices.

Key challenges during the contraction phase:

  • Reduced demand leading to higher vacancy rates
  • Pressure on rents, potentially requiring concessions
  • Slowdown or halt in new development activity
  • Potential depreciation of property values

Trough Phase

The trough phase represents the lowest point of the economic cycle before recovery begins. In the apartment market, this phase can present both challenges and opportunities. As the economy begins to bottom out, occupancy rates may start to stabilize, albeit at lower levels than during the peak. This stabilization can provide a foundation for recovery, but it may take time for rents and property values to rebound.

One of the most significant opportunities during the trough phase is for value-add investors. These investors may find opportunities to acquire distressed properties at discounted prices, with the potential for significant upside as the market recovers. By implementing strategic improvements and repositioning assets, these investors can capitalize on the eventual market upswing.

As the economy begins to recover from the trough, pent-up demand from households that delayed moves or formation during the recession may start to materialize. This release of pent-up demand can be a catalyst for market recovery, driving improvements in occupancy rates and eventually leading to rent growth.

Strategies for Navigating Economic Cycles

To successfully navigate economic cycles in the apartment market, multifamily professionals should consider implementing a range of strategies. Diversification is key, both in terms of geographic markets and property types. Investing in markets with diverse economic bases can help mitigate the impact of industry-specific downturns. Similarly, maintaining a mix of property types (e.g., Class A, B, and C apartments) can provide resilience across different economic conditions.

Focusing on fundamentals is crucial throughout all phases of the economic cycle. Properties with strong locations and sustainable cash flows are better positioned to weather economic fluctuations. Additionally, maintaining flexibility in operations and investment strategies can help adapt to changing market conditions. This might include adjustable unit mixes, amenity offerings, or the ability to quickly implement value-add improvements when opportunities arise.

While short-term fluctuations are inevitable, it’s important to maintain a long-term perspective. The multifamily sector has historically demonstrated resilience over long-term economic cycles, and patient investors who can weather short-term volatility often realize significant returns over time.

Key strategies for navigating economic cycles:

  • Diversify investments across markets and property types
  • Focus on properties with strong fundamentals and sustainable cash flows
  • Maintain operational and strategic flexibility
  • Adopt a long-term investment perspective
  • Continuously monitor economic indicators and market trends

In conclusion, understanding the impact of economic cycles on apartment markets is crucial for success in the multifamily real estate sector. By recognizing the characteristics of each phase and implementing appropriate strategies, investors and operators can position themselves to capitalize on opportunities and mitigate risks throughout the economic cycle. As we move forward in 2024 and beyond, staying attuned to economic indicators and market trends will be essential for navigating the ever-changing landscape of the apartment market.