For the first time in its history, BAM Capital made predictions for the multifamily market in 2024. The economic and geopolitical environment made this task difficult; this year is no different. However, BAM Capital was relatively accurate in its predictions for 2024 by saying construction starts will slow, fundamentals will begin to stabilize on the backbone of strong renter demand, multifamily distress will be more sporadic than widespread, and multifamily served as the favored asset class with investors. Predicting that rates would stabilize was a miss as interest rate volatility continued to frustrate the debt markets. Unfortunately, the crystal ball still doesn’t exist today. As BAM Capital said last year, one can only take the important lessons learned in the past to better prepare for the future.
The U.S. apartment market saw its challenges last year but remains resilient despite heightened supply. Inflation plagued our industry with higher operating costs. Interest rates were still a thorn in the borrower’s flesh. New supply being on the cusp of a 50-year high is a tough nut to crack. However, resident demand remained robust, year-over-year rent growth was positive, and occupancies held relatively steady. Rest assured, the multifamily industry is poised for improving fundamentals going forward, with construction starts falling off a cliff and sustained resident demand.
Institutional Quality Apartment Communities Will Continue to Shine
It’s not uncommon to think that the development of luxury apartment communities will have the largest adverse impact on the existing Class A inventory. However, this belief isn’t reality. There is typically a flight to quality during high supply or an economic downturn. Simply put, more supply closes the rent delta between Class A, B, and C apartment communities. Effective rents for Class C apartment communities usually see the most significant adverse impact. Once this rental rate gap closes with new developments, Class B and C residents tend to upgrade to apartments with more community amenities in areas with exceptional schools and upscale retail. As a result, owners of Class B and C communities will lower rents to backfill lost residents and maintain occupancy. This flight to quality holds true with every real estate asset class in my 30+ years of experience.
By illustration, the attached chart from Madera Residential Research and RealPage Market Analytics clearly displays Class C rents declining most in markets where supply is at its peak. Conventional wisdom tells us that new development is detrimental to the apartment fundamentals of a specific market. However, the silver lining in the cloud is twofold. 1) New development is helping with the massive housing shortage as the U.S. faces a pressing need to build 4.3 million new apartments by 2035, according to a recent study commissioned by the National Apartment Association (NAA) and the National Multifamily Housing Council (NMHC). 2) It contributes immensely to rent affordability in the Class B and C apartment communities. Affordability is essential for the current economic environment.
Source: Madera Residential research, RealPage Market Analytics. Supply rate = year-over-year change in apartment inventory relative to U.S. average of 2.8% as of September 2024.
Jay Parsons. (2024). “Class C Rents Fall.” https://www.linkedin.com/posts/jay-parsons-a7a6656_rents-apartments-affordability-activity-7264271409009311744-R2qL/?utm_source=social_share_sheet&utm_medium=member_desktop_web
Consistent Narrative Akin to 2024 – New Supply Peaks Versus Construction Starts
While new supply will remain elevated in 2025, there is far less construction than our industry has seen since 2020 and before COVID-19. For your edification, “current deliveries” refers to shovels in the ground today, while “construction starts” represents waiting to put shovels in the ground. New deliveries will garner plenty of attention again this year, but don’t underestimate this halt in construction due to rising costs and its positive long-term impact on multifamily fundamentals. The math is easy and relatively predictable. Renter demand has surged to levels few expected because of household formation and affordability. The attached bar chart on absorption and supply paints a picture that will speak 1,000 words. Expect this trend to continue in 2025 as it’s currently much less expensive to rent than to own.
Sources: Madera Residential research, RealPage Market Analytics.
Jay Parsons. (2025). “Apartment Supply Surge.” https://www.linkedin.com/posts/jay-parsons-a7a6656_rents-apartments-affordability-activity-7264271409009311744-R2qL/?utm_source=social_share_sheet&utm_medium=member_desktop_web
Negative Leverage is Real – More Groups Focus on the Stabilized Yield on Cost
Investors often ask about in-place cap rates on BAM Capital’s acquisitions relative to current interest rates. This relationship tells investors if BAM Capital is creating positive or negative leverage on these investments. While this question is fair, it doesn’t tell the whole story. This relationship will speak volumes in 2025 as interest rates remain elevated and are sometimes higher than the actual in-place cap rate. That’s negative leverage—another way to say it’s not prudent to borrow—a cardinal sin to real estate investors.
Real estate is a cash-flow business. The trick is to underwrite a property not on in-place cash flow but on stabilized cash flow. This calculation gives us a stabilized yield on cost, the most important metric for evaluating real estate. Not only is this metric important relative to current interest rates, but it gives us the intrinsic value of the property.
For example, an investor is looking to acquire a property for a 5% cap rate when the interest rate on the first mortgage is 5.5%. That equates to negative leverage because the cap rate is less than the current interest rate. Don’t look at things in a vacuum. First and foremost, focus on the owner/operator and the business plan. There is a high probability the operations team will take that 5% cap rate to a 7.5% stabilized yield on cost, which results in positive leverage and outsized returns. That is BAM Capital’s advantage.
Expect an Increase in Transaction Volume
The years 2021 and 2022 were banner years for multifamily investment sales that reached unprecedented investment activity. Don’t expect 2025 to reach these levels, but there will be increased activity from 2024 despite elevated interest rates. The development pipeline will continue its descent, highlighting the lack of supply being delivered in 2026 and 2027. With that in mind, expect more capital to come off the sidelines, making the bet that apartment fundamentals will improve significantly in markets where demand is robust. For example, KKR, a leading global investment firm, acquired a portfolio of 18 apartment communities totaling approximately 5,200 units for $2.1B, underscoring the appeal and belief in the long-term fundamentals of multifamily. The unfortunate news for buyers is that cap rates may compress as there is more competition for quality assets with improving fundamentals.
Source: MSCI Real Assets
RealPage. (2024). “Apartments Remain the Favorite Asset Class Among Real Estate Investors.” https://www.realpage.com/analytics/3rd-quarter-2024-sales-volumes/
Delinquency and Distress for Multifamily
According to the Mortgage Bankers Association (MBA), delinquency rates for commercial mortgages increased slightly during the third quarter of 2024. Remember that the commercial mortgage market encompasses a variety of property types, sponsors, lenders, geographic markets, etc. Every situation is different, and these differences impact loan performance to varying degrees.
As BAM Capital predicted last year, multifamily distress will be more sporadic than widespread. For example, 1.2% of multifamily loan balances were delinquent for over thirty days. This pales in comparison to office buildings (7.8%), lodging (5.6%), and the retail sector (3.8%). The only real estate asset class with a lower delinquency rate is industrial, which stands at 0.6%, which is unsurprising considering how Amazon transformed the distribution industry.
Mortgage Bankers Association. (2024). “Commercial and Multifamily Mortgage Delinquency Rates Increased in the Third Quarter of 2024.” https://www.mba.org/news-and-research/newsroom/news/2024/10/22/commercial-and-multifamily-mortgage-delinquency-rates-increased-in-the-third-quarter-of-2024
Similar to BAM Capital’s prediction in 2024, expect sporadic distress to occur with inexperienced sponsors/borrowers who acquired Class B/C assets in tertiary locations with subpar demographics. If the sponsor has failed to execute their business plan and doesn’t have ample cash reserves to cover the downside risk, the borrower will have two options: 1) sell at a potential loss or 2) invest additional capital to cover the delta between the existing loan and new loan. There might be some opportunities in the Class A space, but fundamentals have remained healthy despite the high supply environment. The Commercial Mortgage-Backed Security (CMBS) world will bear most of this distress/delinquency, albeit small.
Conclusion
Multifamily will remain the darling child of real estate for investors, accounting for 37% of all real estate asset sales in 2024’s third quarter. BAM Capital will not stop beating this drum as there is no dearth of debt and equity on the sidelines waiting to pounce on quality multifamily acquisition opportunities. There is no capitulation here. Cash flow stability, cash preservation, and appreciation potential are consistent pillars defining the multifamily industry. The attached chart shows that this real estate asset class has stood the test of time and provided above-average risk-adjusted yields to its investors.
Average annualized return over each five-year period from 1/1/1990 to 12/31/2023. Returns are unlevered.
Source: National Council of Real Estate Investment Fiduciaries (NCREIF) Property Index.
National Council of Real Estate Investment Fiduciaries. (2023). “Average Annualized Return.” https://user.ncreif.org/data-products/property/
At the end of the day, real estate math in the multifamily world is simple arithmetic, but it’s also a game of inches. The margin for error is small in a management-intensive business that requires a constant eye on the ball. That’s why the owner/operator is as important, if not more important, than the actual real estate. Determination, persistence, experience, and fortitude characterize The BAM Companies, qualities that separate a good company from a great one. It’s fortunate to say that our organization is a great one.
Author: Tony Landa, Chief Investment Office, The BAM Companies, January 2025
