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Here's a riddle for you: How do you set the rent for an apartment building when wage growth is relatively stagnant? You don't want to overprice and experience a higher-than-necessary vacancy rate. On the other hand, renting for many has become the only game in town. At 63.4%, US homeownership is at its lowest point in this country since 1967, a startling figure released by the US Census Bureau earlier this year. Vacancies aren't a considerable problem; any number of statistic providers from Reis to Axiometrics to the aforementioned Census Bureau will tell you that rental vacancy rates are very low. Indeed, in that same report, the Census Bureau also reported that the rental vacancy rates were 6.8% in the second quarter of 2015, a 30-year low.

Maybe this isn't such a riddle after all.

 And then there's this: institutional demand for multifamily properties is strong, so strong that in some cities such as Washington, DC, New York City and San Francisco, other investors have stopped looking. Institutional players are not only drawn to the nonstop increase in rents, but also like urban properties' appeal to millennials, who if they can't rent in cities, would rather live with mom and dad than get their own place in the affordable outskirts.

And actually many millennials do opt to live with mom and dad, the call of the urban core notwithstanding, instead of moving out. This was not supposed to happen. After the Great Recession ended, we were all assured that the young people would start forming their own households, buying furniture and cars and renting apartments. Some are, but many are not, as noted by Pew Research Center after analyzing the US Census Bureau data this summer.

It found that improvements in the labor market have not led to more Millennials living apart from their families. In fact, Pew said, the nation's 18- to 34-year-olds are less likely to be living independently of their families and establishing their own households today than they were in the depths of the Great Recession. This is how Pew explains it: In terms of sheer numbers, there are more young adults today than there were when the recession hit—the 18- to 34-year-old population has grown by nearly three million since 2007. But the number heading their own households has not increased. In the first third of 2015, about 42.2 million 18- to 34-year-olds lived independently of their families. In 2007, before the recession began, about 42.7 million young adults lived independently.

Fortunately, their parents might wind up saving us all. A recent analysis by the Urban Institute predicts that senior renters will reach 12.2 million by 2030, more than double the 5.8 million in 2010. Where will they go? Some, perhaps many, will opt for into seniors housing or nursing homes. But the younger and more mobile seniors have expressed clear preferences for living out their retirement years in the heart of a city, going to plays and museums, visiting friends—basically all the activities they couldn't do when their kids were young and, later, living in their basements.

Putting aside the theories about urban seniors and homebody Millennials, the fundamentals still tell a solid story, right? Tight supply and high demand have characterized the apartment asset class for years now.

As it happens, in Q2 of this year Reis was a bit surprised when the 90,000 to 100,000 expected apartment units that were scheduled to come on line didn't. They were postponed to the third quarter, according to a video by chief economist Victor Calanog posted to the Reis website. Only 46,000 units came on line in the second quarter, meaning the sector experienced a healthy absorption rate.

As for the rest of the year, those missing units are so far still scheduled to go live, Calanog said. In fact, he said, based on recent interviews with developers, Reis expects more than 200,000 units to come on line this year. “There will be a large number of apartment properties opening their doors in the third quarter and we are expecting vacancy rates to rise slightly.”

So it goes. 

The Many Factors That Make the Case for Multifamily

Are you dizzy yet? Because, if not, there's more. There are many, many factors and trends, ranging from economic to demographic to societal, that shape the apartment asset class.

This, of course, has always been so, but these trends are being minutely examined and rehashed more than ever these days as investors and property owners try to discern if this is the year that multifamily will peak and then start its inevitable climb down. Or, it could be next year.

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The commercial real estate cycle is slowing, of that there is little doubt. Commercial lender sentiment has become more conservative, even anxious. Credit is tightening already; there is almost no need for the Federal Reserve Bank to go through the formalities. This is true for the apartment asset class as well.

In July, for example, the National Multifamily Housing Council Quarterly Survey of Apartment Market Conditions came out with a surprising and considerably dimmer view of multifamily mortgage borrowing than it saw three months prior.

The survey's debt financing index declined from 60 in late April to 35 in July. A reading below 50 indicates that borrowing conditions are worsening; the council noted it was the first time the debt financing index has fallen below 50 since January 2014. Mark Obrinsky, NMHC's SVP of research and chief economist, points out, “The decline in the debt financing index is significant.”

There are other signs that the apartment cycle is not so immune to the ebb and flow of market forces.

It was noted recently that rents in the suburbs started to rise faster than the urban cores, a seemingly inexplicable trend until it was dissected by Axiometrics, which then explained that immediately after the recession ended, demand for apartments in the urban cores increased, leading to growth in both rents and supply.

Then, beginning in 2012, supply really started to flow in Downtown submarkets. Occupancies went down as did rent growth rates. By the end of 2013, the market had worked its usual magic: rent growth in city centers was muted while suburban rent growth started to climb.

“As the urban core supply was absorbed, rents began going up in '15,” the company wrote in a blog post. “Axiometrics anticipates this trend will continue into 2016.“

Historic Investment Levels

None of this is to say that the multifamily asset class' run is over for this cycle. Not by a long shot.

CBRE recently reported that investment in US multifamily reached $127 billion for the 12-month period between Q2 2014 to Q2 2015—the highest four-quarter total in history and growth of 36% over the 12-month period and 27% of the total $110 billion invested in US commercial real estate during the quarter. The total surpasses the mid-2000s peak of $100 billion achieved in the year ending Q2 2006.

For real life illustration on a grand scale, only has to look at the $1.1-billion multifamily investment fund launched this summer by the Miami-based homebuilder Lennar to understand that this cycle this has a long runway ahead. The fund, called the Lennar Multifamily Venture, is an equity play between Lennar Multifamily Communities and global sovereign and institutional investors targeting class A multifamily development assets in 25 top metropolitan markets in the United States.

Its strategy is “develop-to-core,” meaning the fund will build multifamily communities and then hold them in a portfolio long term for cash flow. LMV will focus on the top growth and gateway markets in the US—otherwise known as supply-constrained markets.

Besides the clear vote of confidence in the multifamily market, the fund is important to Lennar for other reasons, as president Rick Beckwitt said. “This new fund will transition Lennar Multifamily Venture into a cash flow producer, benefiting from the combination of recurring rental income and management fees throughout the life of the portfolio,” he said. “Having a portfolio of new vintage communities should create excellent upside for our shareholders over the long-term.”

The Longstanding Case for Multifamily

Beckwitt's statement, made when the fund was announced this summer, is the essence of the multifamily business case and it still, for all the quirks and shifts and nuances described in the beginning of the article, this business case is a highly viable one.

Indeed, to be successful in multifamily one has to tune out a lot of the noise, David Birnbaum, the CEO of Englewood, CO-based Griffis Residential, says. “It doesn't matter in the least where you are in the cycle,” he relates. “There is never a 'perfect' time to invest, or a 'worst' time to invest. This decision always requires caution and selectivity.”

The company's investment philosophy instead, is to create value independent of market cycles, he explains. “We are in it for the long term, and if there are headwinds we feel we can get through.” The multifamily asset class is fortunate in that its cycle tends to be short-lived during the down parts, Birnbaum adds. “As long as you built your balance sheet for the long term, you should be okay.”

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Still, that doesn't mean companies can throw caution to the wind or blithely invest in a high-cost, high-priced market like, say, Washington, DC just because it is active.

This is where careful underwriting comes in, he says—and yes, a close awareness of local rent trends and other fundamentals.

The company looks at such things as reasonable expectations for rent growth, what can be done to create value through its management and a capital improvement program and any relevant examples in its portfolio. It might work backward from the debt it could take on to acquire a building—that is, figuring out how much a rent would have to fall for the company to have difficulty meeting the debt servicing. From all of these calculations, Birnbaum says, “we have a good sense of how much we can really grow rent.”

The local market's health is also an important factor. Right now Griffis is focusing on markets with strong economics and strong productivity growth. In January, the company acquired Westminster Center in the Denver market for $168,000 per unit and is now underway with renovations.

It likes this property because Westminster is between Denver and Boulder and that part of the metro area has experienced a great deal of job growth, Birnbaum says.

Also, it was able to purchase the property at a significant discount to replacement cost. “We think over the next three years it will prove to be a 30% to 50% discount to replacement cost,” Birnbaum says.

Raleigh, NC is another apartment market favored by investors for its long runway for growth. This summer Los Angeles-based Lowe Enterprises Investors, in a joint venture with a foreign investment client, acquired the Hamilton Ridge Apartments, a 178-unit apartment community in the Crabtree Valley area of the city.

It is no longer targeting assets in New York City or Washington, DC, says Andy Sands, SVP of Lowe Enterprises Investors. The best value can be had in Raleigh, as well as Atlanta and Denver.

Hamilton Ridge is not Lowe's first investment in Raleigh, but its second, he says. “We are generally focused on top-tier areas but we have found good opportunities in secondary markets—cities that have appealing characteristics including huge population growth and a growing employer base.” Raleigh was ranked first or second in terms of growth nationally from US Census Bureau, Sands adds.

Foreign investors such as the one Lowe partnered with do tend to prefer the top-tier markets, but they have come to understand that these cities have been picked over, Sands says.

As a result they, as well as Lowe for that matter, have broadened the list of markets in which to invest. In this particular deal, especially because Hamilton Ridge was a value-add play, the foreign partner was more comfortable in a secondary market because it had a domestic company as a partner, according to Sands.

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But even as investors climb down the ladder of attractive markets, they are finding similar problems. Namely, the level of construction in some secondary cities, a list that arguably could include Seattle, is becoming a concern. In Seattle, for example, “cranes are everywhere. It is a great place to live, terrific demographics and job growth but I do think supply is going to be a problem down the road.”

He is starting to have similar worries about Denver as well. “It's a matter of time before there is too much supply,” Sands says.

Yet it's hard to make that argument argue in these cities now, he admits. Job growth is strong, demand is tremendous and vacancies are low. “But research points to rising vacancy rates in the coming years.”

In short, the same multifamily risks are everywhere, Sands says—but some cities are further along in the cycle than others.

A Unique Period

Or maybe not. There is a school of thought that multifamily has entered a unique phase in which past history provides little guidance.

That is how Ella Neyland, president of Steadfast Apartment REIT, explains much of what is happening in the industry right now. “The way I look at it, now is a very good time for the apartment industry mainly because of the shifts in people's lifestyles and their stagnant paychecks.”

It may be a cliché but the numbers back it up, she says: “we really are becoming a nation of renters.”

Millennials are renters—not just of homes but everything from clothes to cars to pets, she says. The baby boomer generation is also becoming renters. “I see it in my own circle of friends—the children have left and you want something low maintenance.”

Meanwhile, jobs are coming back but paychecks aren't what they used to be, Neyland observes. “The average paycheck is 23% lower than before the recession.”

All of which means apartment owners have to rethink their own fundamentals about construction, rents, maintenance and new development. And so we go round and round with the questions, including this article. How do you set the rent for an apartment building when wage growth is relatively stagnant?