The Weird World Of Multifamily And Single-Family Assets In An Inflationary Environment

The future of Dallas-Fort Worth's multifamily market hinges on whether home price growth in the single-family segment is sustainable enough to keep propping up multifamily rents.

But there are a few problems: DFW home prices are likely overvalued and could face a correction, according to Fitch Ratings, and the two sectors aren't converging the way they usually do, making predictions difficult. 

"In normal times, rent growth follows home price growth," Fitch analyst Suzanne Mistretta said. "When rents go up, it's because home prices are going up."

But DFW may have actually reached a new norm that cannot be evaluated using Fitch data sets established in past decades, she said.

DFW-area home prices rose 11.8% year-over-year in March, reaching a median value of $392K, according to Redfin data. Multifamily rents remained stable after the pandemic outbreak in March 2020 with RENTCafé reporting an average Dallas apartment rent of $1,256 in January, up a minor 0.8% from the previous year.

The rapid rise in single-family home values in DFW has prompted some market observers to warn of a disconnect between underlying economic fundamentals and home price increases in DFW. But how much of a disconnect exists ― and its potential impact on multifamily if home values stop rising ― remains unknown.

A few months ago, Fitch Ratings estimated DFW home prices are overinflated about 20%, but the research firm said Tuesday it's revisiting those data points to see just how inflated home values in DFW really are when analyzed against the full impact of massive migration into the state during the coronavirus pandemic and the higher cash flows and income levels that transplants are bringing into the area. Rising lumber prices and shrinking house inventories, which push up prices, have been an issue in the local real estate market and driving some of the valuation increases. 

Mistretta doesn't expect the re-evaluation to completely change Fitch's analysis that home prices are in a bubble.

"We would still see Dallas as somewhat overvalued based on rents, employment, income growth, household formation and mortgage interest rates. Those are the five economic variables we look to to see if home prices are sustainable."

But, she added, the fundamentals in DFW after the pandemic may have changed in the past year, supporting some of the inflationary pressures on home values. 

So what does this mean for multifamily?

Two years ago, Paul Moore, founder and managing partner of Wellings Capital, was warning investors that multifamily had run its course and advising them not to buy apartment assets, which he deemed as overpriced at the time. 

He has since changed his tune.

"I have a new perspective," Moore told Bisnow. "The federal government has obviously been printing money at an unprecedented rate and with the increase in the money supply, a whole lot more money is chasing the same amount of investments, the same goods and the same apartments to rent. Mathematically to me, it seems we are going to have inflation."

Inflation in home values forces more people to rent who cannot afford a home, which pulls some of that demand into the multifamily market. 

"We have seen cap rates compress incredibly over the past decade, but now it looks like we are going to see rising income based on inflation," Moore said. "If that is true, it looks like that rising tide is going to continue and multifamily is going to be doing really well for years to come."

Even multifamily loans tied to CMBS are performing well considering the pressure the pandemic placed on apartment renters who work in the retail and restaurant sectors. 

"Delinquencies in multifamily have actually remained pretty low still for multifamily," Fitch CMBS analyst Melissa Che said. "I think overall multifamily asset performance in CMBS has remained pretty resilient in the pandemic, and I think it has been largely helped by the fiscal stimulus support and the eviction moratoriums that have been in place."

The question now is whether a sudden disruption in the single-family housing market could pop a housing bubble and derail both single-family and multifamily. But analysts think apartment owners probably have a longer runway on demand and pricing staying high than single-family does.

"I've actually talked to two prominent realtors in the past couple of weeks, both who said something like it might be better to rent right now and wait this one out," Moore said. "If a lot of people think that, it's likely people will continue to rent even more and what that will do is drive the rents up."

The bigger story is that nobody knows if the rise in DFW single-family home prices is sustainable, and with that factor unknown, the effects on multifamily also remain a mystery.

"We have seen a confluence of so many things happening between the pandemic, the foreclosure moratorium, forbearances for delinquent borrowers who were affected by the lockdowns and an influx of companies leaving high-cost states," Mistretta said.

"There is a confluence of so many different things happening, and we are still in a dust storm and we have to wait for the dust to settle to see what the outcome is or to see it stabilize a bit."