The Endurance of U.S. Rental Housing Investments

​​​​​​​​​​​​INTRODUCTION

Over the past decade, U.S. multifamily has been among the most sought-after sectors by institutional investors due to its necessity characteristic, the underlying strength of property-level fundamentals, and high historic risk-adjusted total returns. It has remained an integral part of commercial real estate (CRE) investment portfolios with a portfolio weighting of 29.2% in the NCREIF Fund Index-Open End Diversified Core Equity (NFI-ODCE).¹ Clarion Partners believes that well-located, high-quality rental housing will continue to be a strong performer over the long term due to a variety of macro, demographic, and financial factors.

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MACRO DRIVERS SUSTAINING RENTAL HOUSING DEMAND

Clarion Partners is optimistic about the outlook for U.S. multifamily in 2023 and beyond primarily due to two macroeconomic factors:​

• ​The National Housing Shortage. Following a decade of underbuilding, there continues to be a national housing shortage.² Both the U.S. for-sale housing inventory and the rental housing vacancy rate have remained near a two-decade low in recent years (Figure 1). Based on the difference between household formation and housing completions, Clarion Partners estimates a shortfall of 3.2 million housing units, which includes 1.2 million owner households and 2 million renter households, which is consistent with other estimated shortages ranging between 2.5 to 3.7 million housing units.³ 
  
  This approximation jumps to 6.8 million when also taking into account the loss of existing units due to demolition, natural disaster, or functional obsolescence.⁴ The deficit is even more pronounced in the low and middle price point market, as much of the new construction targets the high-end segment.^5​
  

FIGU​RE 1: LOW AVAILABILITY IN ALL FORMS OF HOUSING​

• ​Favorable Demographics: Robust Renter Base in All Generations. The increasingly onerous cost of owning a home has led to many in all age groups to remain in the renter cohort, sometimes by choice. While the overall U.S. homeownership rate is now near its long-term average, the rate amongst first-time buyers is at an historical low.⁶ It is also well below the U.S. average in the Northeast and West regions, especially in the major markets where the cost of living is very high.
  
  
  While more Millennials (~72 million) are buying homes, Gen Z (~70 million) has started to enter the workforce and will remain in the renter cohort for the next decade or so. Furthermore, more Gen X-ers and Baby Boomers (~138 million combined) are choosing to rent for lifestyle reasons.⁷
  
  Additional key factors likely to sustain future rental housing fundamentals include strong ongoing job and wage growth, elevated construction and replacement costs, and tighter lending conditions for new construction, which will likely suppress future new supply.

FINANCIAL HEADWINDS: ACUTE FOR-SALE HOUSING AFFORDABILITY CHALLENGE PERSISTS

U.S. For-Sale Housing Affordability at an All-Time Low. Over the past year, the median U.S. home price climbed to a new high, and U.S. for-sale housing affordability reached an all-time low (Figure 2). Even as residential mortgage rates surged to the highest point since 2002, home prices have remained near record levels across many U.S. markets, and financing costs to purchase have more than doubled in the last year (Figure 2).⁸ This has created steady demand for professionally managed rental housing across a wide range of U.S. metros.

U.S. For-Sale Housing Price Has Surged. Over the past decade, the U.S. median home price has risen swiftly, up by almost 100% from $195,000 to $383,000.⁹ During this time, the national average income grew by 40%.¹⁰ Housing prices in many secondary markets in the South and West regions approached new highs, with a few rivaling the levels of some high-cost major markets. However, overall home prices are still significantly lower in much of the Sun Belt. 

Many U.S. Counties Report a Home Price Above the National Median. Many of the most populous U.S. counties report home prices above the U.S. median level (Figure 3). Of the 50 largest metropolitan statistical areas, 30 now have median home prices above that of the nation, which has climbed from 24 in 2013^.11 This has led to a greater demand for high-quality Class A and B rental housing in more metros.

FIGU​RE 3: 2023: MEDIAN HOME PRICE BY COUNTY (U.S. Median Home Price = $383,000)​

Rise in Cost-Burdened Households. Furthermore, over recent years, there has been a rise in total cost-burdened households, which pay more than 30% of their monthly income on housing costs. Of ~130 million U.S. households, over 30% are now cost-burdened, representing the highest rate on record.¹² The share of severely cost-burdened households (those paying over 50% of monthly income on housing costs) is significant for both renter and owner households.¹³

ONGOING SHIFT: SUN BELT LURE & SUBURBAN BOOM

Higher for-sale housing costs have led to greater residential mobility and shifted the geography of housing demand. Recent domestic migration and population growth trends have continued to heavily favor the Sun Belt and suburbs, which have had a significant impact on CRE demand overall in these areas.

• Sun Belt Lure 
  During the pandemic, Sun Belt markets saw a surge in net immigration, often at the expense of major markets. Looking ahead, the Sun Belt boom is expected to continue given the relative cost of living, quality of life, and job opportunity. Overall, the Sun Belt markets’ rental housing costs still offer a sizable discount relative to the six major markets at about 40% (Figure 4). Over the next five years, the top markets for population and employment growth are largely forecast to be in Texas, Florida, North Carolina, Nevada, Utah, Arizona, and Tennessee (Figure 5).​
  
  

FIGU​RE 4: SUN BELT APARTMENT RENT DISCOUNT RELATIVE TO SIX MAJOR MARKETS​

FIGU​RE 5: SUN BELT MARKETS’ OUTLOOK STRONGEST: TOP 20 MARKETS FOR TOTAL POPULATION & JOB GROWTH (2023F-2028F)​

• Suburban Boom
  At the same time, with a robust inflow of Gen Z and Millennials into the central business districts (CBDs) of major markets, we expect steady demand there as well in the years ahead. However, as Millennials reach middle age, cost pressures mount, and growth industries are more diversified by region, we expect strong rent growth performance in the urban fringe and suburbs to persist. From 2015 to 2023, the average annual rent growth in the suburbs was double that of urban areas.¹⁴ More young adults are choosing to live in suburbs to have families, more living
  space, and access better public schools.

MULTIFAMILY INVESTMENT PERFORMANCE STRONG, ESPECIALLY IN CERTAIN SEGMENTS

Over the past decade, the NCREIF Property Index multifamily subindex (stabilized and unlevered) has performed very well (Figure 6). The short- and long-term total returns have also indicated strong outperformance in the Mountain, Southeast, and Southwest regions, along with the two lower-density multifamily formats - garden-style and low-rise apartments. Given the recent population, migration, and job growth trends, Clarion Partners believes that CRE investors should align investment strategies accordingly in the future.​

FIGU​RE 6: NCREIF MULTIFAMILY INVESTMENT PERFORMANCE: 10-YEAR TOTAL RETURNS BY SEGMENT

Going forward, we believe there are several other considerations to bear in mind as a multifamily investor:

- Political risks (i.e., rent control and environmental mandates/policies);

- High-growth industry clusters (i.e., tech, life sciences, & health care);

- Climate change risks;

- The high cost of living, including food, electricity, transportation, & caregiving; and

- The potential endurance of remote and hybrid work; physical office occupancy now averages about 50% of pre-COVID levels, ​which may influence future living arrangements.¹⁵

Elevated new supply levels in 2022 and 2023 may cause an uptick in the historically low rental housing vacancy rate; however, we expect rental demand to remain strong given the acute housing shortage theme.¹⁶

Last, but not least, multifamily housing landlords can adjust rent more quickly than in other sectors. Therefore, multifamily investments can potentially serve as a hedge against rising inflation, a desirable characteristic in today’s inflationary environment.

INVESTMENT FOCUS

​Over the past decade, U.S. rental housing fundamentals have remained very healthy overall. U.S. multifamily rents are at all​-time highs, and most markets report vacancy rates under 5.5%. Furthermore, all major markets reported positive rent growth in 2022. Year-to-date 2023 rent growth has largely remained positive excluding a handful of markets.¹⁷ Clarion Partners is focused on the following acquisition and development investment strategies:

- Sun Belt metros with a concentration of high-growth industries, strong population growth, and a low cost of living;

- High-quality Class A and B apartments in top suburban and urban fringe submarkets of major and secondary markets; and

- Assets targeting renters by choice in top lifestyle markets/​submarkets.