Recession, and Multifamily Rentals

With the Federal Reserve raising interest rates to dampen inflation, many pundits are predicting that the U.S. will enter a recession soon. So what impact would that have on multifamily rental properties, especially ones in Colorado?

After all, multifamily investment rentals are one of the biggest drivers of the ongoing Colorado real estate boom. In Colorado Springs alone, multifamily rents have skyrocketed 17%, year-over-year as of Q3 2021.

Owing to this, new construction is scrambling to keep up with demand. People are pouring in from more expensive cities like New York, San Francisco, and even within Denver, where cost-cutting measures like negotiating down real estate commission or using innovative new home-trading startups like Reali, still aren’t enough to get them into a home.

The next post-recession landing will likely be a lot softer than 2008’s, and many experts are already calling it an economic “stabilization” rather than a full-on crash.

1. Multifamily rentals might weather the storm.

While the last recession was pretty tough on the multifamily rental market, a big portion of post-2008’s adversity came about because of bad loans — and the industry hasn’t repeated that mistake. The next post-recession landing will likely be a lot softer than 2008’s, and many experts are already calling it an economic “stabilization” rather than a full-on crash.

That’s not to say that rents won’t fall for a short time, or that vacancy rates won’t edge up. But it almost certainly won’t be a wipeout.

2. Multifamily rentals could continue to rise through a mild downturn.

Part of this sunny outlook, is because multifamily rentals are such great investments in the first place. Commercial real estate, as a whole, is so strong that it’s outperformed the stock market over the past 20 years. For example, if you had invested $150,000 in the S&P 500 on January 1, 2000, you’d have a little over $486,000 today. Not bad!

But that same $150,000, invested in commercial real estate, would be worth over $775,000. And in the commercial real estate sector, multifamily rentals are arguably the crown jewel of investments. Apartments have outperformed every other type of real estate investment over the past 40 years — a period that includes five recessions.

The upshot? While a recession might dent the growth of multifamily rentals, they might continue to punch far above their weight class.

3. We might see a repeat of 2008 (in some ways).

A close study of the last recession yields a few more encouraging insights. A report by the Center for Housing Studies based at Harvard University looked at the impact of 2008’s Great Recession on the multifamily housing market. Their findings could be relevant to today’s situation.

In 2008’s recession rent growth stalled, and property values declined — but renter incomes declined even more. This changed the composition of renter households so that a lot of rental demand temporarily shifted to single-family properties, or even unconventional single-room rentals, and away from large multifamily properties. Vacancy rates went up, but recovered after a year. Rents fell 4% the first year and then began to climb again. If we see a recession this year, a similar fast decline/fast recovery dynamic could play out.

However, large multifamily property values did take a bigger hit than single-family properties. They declined by 40%, compared to only 32% for single-family, before recovering quickly.

Something for today’s owners to keep in mind — make sure you have plenty of cash in reserve for operating expenses so you can maintain your investment properly.

4. Low supply and falling renter incomes could buoy the multifamily rental market.

Still, the multifamily market remained fundamentally strong post-2008 because of the low supply of new housing hitting the market (which is still the case today), and renter incomes falling more than rents. This is usually the case in modern recessions, which means that even in a downturn, landlords and owners still have a lot of leverage.

One of the biggest hazards in 2008 was that many cash-strapped owners couldn’t afford to keep up maintenance, which led to their properties deteriorating rapidly, along with an increase in tenant complaints and turnover. That’s something for today’s owners to keep in mind — make sure you have plenty of cash in reserve for operating expenses so you can maintain your investment properly.

5. Multifamily rentals may turn out to be nearly recession-proof.

While multifamily properties took a big hit in the last recession, they came out of it faster, and better, than most other classes of investments. Many experts today consider multifamily rentals to be nearly recession-proof.

Why? Well, multifamily properties are incredibly cost-effective when compared to the same amount of single, separate units. Maintenance costs are a fraction of what they’d be if you had to maintain multiple single-family properties, and the amount of rent earned per square foot is much higher than single-family rentals. In addition to that, they come with very minimal risk compared to single-family properties. In a multifamily rental, you may have a vacancy here and there but you’ll always have cash flowing in from the other units.

So what can owners of multifamily rental investment properties expect if the economy does fall into a recession in 2022 or 2023?

Based on past recessions, they’ll take a hit in the short-term, but recover very quickly, and at a faster rate than other types of real estate. Scant new construction will keep supply low, demand high, and lead to a fast price rebound. Renter incomes will fall more than rents, which is good for landlords and owners. Any uptick in vacancy rates will prove to be temporary.

Overall, their multifamily investments will come out of it stronger than before — a profile that’s fitting for what many are just now realizing is the gold standard of real estate investments.

Luke Babich is the Co-Founder of Clever Real Estate, a real estate education platform committed to helping home buyers, sellers, and investors make smarter financial decisions. Luke is a licensed real estate agent in the State of Missouri and his research and insights have been featured on BiggerPockets, Inman, the L.A. Times, and more.