SAN FRANCISCO—While class-A multifamily is experiencing cyclically high levels of construction, supply for classes B and C remains fairly muted, according to Kroll Bond Rating Agency. This bodes well for the approximately $132.3 billion of multifamily loans that have been securitized since 2010 in 346 Freddie Mac K-Series transactions ($107.9 billion) and CMBS conduit transactions ($24.4 billion), as KBRA's analysis indicates that nearly 80% of the underlying collateral ($103.9 billion) is class B or class C.

According to the National Multifamily Housing Council, as new apartments have been completed, particularly in the class-A segment, the net positive demand-and-supply balance that had existed for some time has turned negative. Based on the July 2017 report, this is the seventh consecutive quarter of softening conditions for the market tightness index. The index this year has been at levels not seen since the Great Recession.

Post-crisis multifamily originations appear to be well insulated from oversupply and may continue to benefit from positive property fundamentals. There is always a concern, however, that class-A oversupply could trigger concessions and prompt some class-B renters to trade-up to higher rent units. However this may be mitigated as there is a 40% rent premium between the two segments at the national level ($1,734 high rent versus $1,235 workforce), says KBRA.

While the class-B/C supply and demand balance has been favorable at a national level, local market conditions vary. To further examine the dynamics within individual markets, KBRA utilized various data points including employment, housing affordability, domestic and international migration, as well as demographic composition. Along with these variables, it also looked at inventory and construction levels, as well as current and historical vacancy rates. The information was used to derive a ranking system based on these supply and demand factors for individual metropolitan statistical areas.

The 59 MSAs included in the study population had observable data points for all of the supply and demand factors. In total, collateral securing 5,428 underlying loans was present across the selected MSAs with a total unpaid principal balance of approximately $86 billion. Individual rankings were assigned to the MSAs based on relative market attractiveness using the individual supply and demand factors.

After stratifying the rankings, it was determined that about 34% of the aggregate securitized principal balance is in markets designated as “top tier” (six to eight positive attributes), easily outweighing the 7% in the “bottom tier” (two or fewer positive attributes). The majority (59%) fell somewhere in between, although 23% were part of the lowest ranked mid-tier. However, that's not to say that all class-B/C collateral will perform well, as Kroll's ranking system indicates that about 30% (rankings at three or below) of the MSAs with securitized collateral have a supply and demand mismatch. Furthermore, while the other 70% appear to be better positioned, this cycle is long in the tooth, and past performance isn't necessarily indicative of future results, says KBRA.

While multifamily conditions have been softening, the effects have varied by classification and market. Five of the top-tier MSAs included Colorado Springs, Los Angeles, Phoenix, San Francisco and Seattle. Common themes among the top-tier markets include strong job growth, particularly in the technology-heavy areas of San Francisco/San Jose and Seattle, which also have some of the least affordable home markets.

“The San Francisco metro is the second least affordable market based on the National Association of Realtors Index in the nation following San Jose, which helps to provide support for rental demand,” Larry Kay, senior director of KBRA, tells GlobeSt.com. “Job growth from industries such as technology and social media has been strong and also contributed to rental demand. The metro's unemployment rate of 3.4% is 100 basis points below national levels. However, with substantial supply, the metro vacancy rate has been rising. We expect that high rental demand should help to keep supply levels in check.”

Instant Insights /

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