How Multifamily Landlords Can Ride Out a Potential Recession

It seems all but certain to many economists that a recession is in our near future. Bloomberg economists recently forecast a higher probability of recession for all the time frames they study. One of their estimates went as far as to put the probability of falling into a recession by October 2023 at 100 percent.

The good news is that some analysts, including those at Morgan Stanley, say if a recession does happen, it’ll likely be shallower and less damaging to corporate earnings than past downturns. A big reason for this is that many past recessions have been credit-driven and caused by debt-related excesses, such as the financial crisis in 2007-2008. This time around, Morgan Stanley notes excess liquidity would trigger a recession, mainly caused by extreme levels of pandemic-related fiscal stimulus packages that contributed to inflation and drove financial speculation.

Even if the next recession is softer, it’ll still be at least somewhat painful, and it will certainly affect real estate. Compared to other asset classes, multifamily is well-positioned to withstand a downturn. Slowing construction will likely balance the industry’s supply and demand and help sustain the sector. Many would-be homeowners today are opting to rent instead of buy, with the average housing price about 44 percent more expensive than it was in 2019. This is driving increased, sustained demand for multifamily living.

Other good news for multifamily landlords is that rents are generally slower to respond to rising interest rates than in the single-family housing market. “Based on the past few recessions, the effect on multifamily performance may not begin until near or after the recession ends,” Moody’s Analytics wrote in a recent report. Low unemployment and a tight labor market may also help sustain multifamily demand. Household balance sheets are generally better than in previous downturns, even though disposable incomes are dwindling.

Moody’s noted that the housing affordability crisis playing out nationwide is causing a diminishing financial safety net that could drive some renters to find roommates, move in with family, and delay signing a new lease. However, Moody’s only expects a moderate vacancy increase and rent growth to simply decelerate in a mild recession. “A slight and short-lived dip into negative territory towards the end of the recession is possible, but a free fall is highly unlikely,” the report concludes.

A short-term revenue booster

This is all mostly good news for multifamily landlords, but proactive steps can still be taken to brace for a downturn. And there are also ways to ease the pain if a recession happens. Jeff Duerstock, Head of Sales at Spruce, a property management tech firm, said multifamily owners are now emphasizing resident retention more than ever. In the event of a recession, owners can also look at alternative income-generating options, such as short-term rentals. “The ability to fill even just a portion of an apartment building with short-term rentals helps reduce vacant inventory and maintain higher rents long-term on the remaining units,” Duerstock told me.

Short-term rental rates remain high, and most markets have a considerable appetite for the units. There are now approximately 23,000 multifamily units being used at the institutional level for short-term rentals nationwide, according to Cushman & Wakefield. There are many operating models for STRs that multifamily landlords could use. For example, short-term rental firms sign multi-year leases with apartment owners at or above market rates for blocks of units and then rent them out at a higher rate for short-term stays. In this asset-light model, the short-term rental firm effectively becomes a long-term tenant of the building itself.

Some multifamily landlords have seen higher short-term rates than they’d usually get for a traditional 12-month lease. According to one Cushman & Wakefield report, the short-term rates can be 30 to 50 percent more than conventional, longer leases, depending on the submarket. The old-school thinking is that everyone wants to sign a 12-month lease, but some landlords note that people move around more today. More landlords are open to having conversations about a three-month lease, especially if they get a premium on the shorter lengths.

Walk the (fine) line

Short-term rentals can boost revenue and maintain a steady cash flow during a downturn. Another area landlords can look to in dire economic times is reviewing property management budgets and looking at ways to trim the fat, although there’s a delicate balance with this. A turbulent market will have many owners looking to cut costs, but it’s essential to listen to residents and not cut services and amenities that are important to them.

Surveys and informal conversations with residents about their most valued amenities are crucial. Retaining tenants is more critical than ever during a downturn, so landlords will want to keep people happy, which may mean paying more to maintain prized amenities. Other expenses to cut back that may not jeopardize resident satisfaction could be re-negotiating vendor contracts and deferring non-essential repairs and maintenance.

Getting more precise about property management budget planning can also make a difference. Analyzing run data for building equipment is a relatively low-cost way to tighten a budget. This helps predict the lifespan of expensive equipment like HVAC systems and better factor in replacement and repair costs. Work order data can also be used to assess maintenance staffing levels.

All the data collected for budgets will have limited value if there is no context, though. To identify ways to improve, landlords and property managers can benchmark operating expenses against those of competitor portfolios. It’s considered best practice to use third-party data for benchmarking, like the IREM Income/Expense Analysis. The data from the Institute of Real Estate Management collects information from over 6,400 apartment properties in more than 80 US markets, including data for operating expenses, leasing expenses, maintenance and repairs, and utilities. Being able to compare your expenses and total income against peer buildings can help justify certain costs, operate more efficiently, and stay competitive with others in the industry.

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During a recession, multifamily landlords may also want to provide incentives to high-quality tenants, such as discounted rates for signing long-term leases. There’s no one-size-fits-all answer to providing rent payment flexibility or offering incentives, so each owner’s strategy will differ.

Rental rates hit the brakes

Perhaps the biggest decision landlords must make during a recession is whether to lower the rent. Setting rental rates is always a complicated calculus, and it’s something that gets trickier during a downturn. More tenants today are aware of rental costs, as evidenced by the nationwide push for rent control laws, so it’s essential to ensure rates stay within the competitive range. Staying informed on competitors’ rates in the area is always advised, although you may need to be careful in how you do that. The recent controversy and legal quagmire surrounding RealPage and its pricing software, YieldStar, means valuable data and software like this is more under the microscope nationwide.

During a downturn, it’s also best to be even more diligent than usual when performing background checks on potential residents. Carefully review credit reports, rental history, and proof of income. In the long term, you’re better off keeping a unit empty until you can find a quality resident instead of renting out immediately to someone who could become a problem.

The good news is that, despite worsening economic conditions, demand for rentals remains high. When interest rates are higher, more people are likely to become renters. And there’s much data and research to indicate that fewer Americans today can afford the dream of owning a home, for better or worse. Still, research suggests multifamily rents are moderating, and owners can’t keep pushing rapid increases indefinitely. The job market is still healthy (for now), but the impact of historic inflation levels is hurting bank accounts.

Rent prices nationwide are decelerating after a period of rapid increases. A recent Redfin report showed that the median US asking rent rose nine percent year-over-year in September to $2,002, the slowest increase since August 2021. September was the fourth straight month in which annual rent growth has slowed, and rates are increasing at half the pace they were six months ago. Redfin Deputy Chief Economist Taylor Marr said the rental market is “coming back down to earth” because economic uncertainty has ended the pandemic-related moving frenzy of 2020 and 2021. “We expect rent growth to slow further into 2023 as Americans continue to hunker down and more new rentals hit the market,” Marr said.

A recession seems inevitable to many in the economic forecasting business, but the multifamily industry may not need to worry too much. Historically, multifamily is one of the most reliable, recession-proof assets for real estate investors because it serves a basic need—everyone needs somewhere to live. And if the pandemic told us anything, it was that people will cut back on other expenses so they can pay the rent. A potential recession will still impact multifamily landlords, perhaps seeing higher vacancy rates and decelerating rent growth. There’s never a bad time to prepare for an economic downturn, and landlords may want to devise ways to ride out a potential recession now. A slowdown for the multifamily industry may happen eventually, and contingency plans may need to be established, but for now, a multifamily free fall seems unlikely.

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