We are pleased to present Providence Real Estate’s Fourth Quarter 2023 Multifamily Market Update.

Property Insurance Costs Rising for Multifamily Properties

In 2023, multifamily property insurance premiums saw an unexpected sharp increase. This rise can be attributed to several factors: the increased frequency and severity of natural disasters, rising costs for construction and repairs, higher property values, a trend towards larger legal settlements, changes in regulations like building codes, adjustments for previously underpriced premiums, and shifts in insurance market dynamics, including reduced competition and elevated reinsurance costs.

Rising insurance costs are affecting not only multifamily properties but also other types of property insurance. According to the Wall Street Journal on January 8, 2024:

“Insurers are coming off some of their worst years in history. Catastrophic damage from storms and wildfires is one big reason. The past decade of global natural catastrophes has been the costliest ever. Warmer temperatures have made storms worse and contributed to droughts that have elevated wildfire risk. Too many new homes were built in areas at risk of fire.

As losses mounted, inflation only made matters worse, boosting the cost of repairing or replacing cars or homes.

Climate change also has made it harder for insurers to measure their risks, pushing some to demand even higher premiums to cushion against future losses.”

New Apartment Deliveries Continue Expected Throughout 2024

The multifamily construction pipeline remains robust, with nearly 1 million units currently under construction, most of which are expected to be completed in 2024. This surge in new apartment supply originates from construction projects that began between 2020 and the first half of 2022 — a period characterized by near-record highs in rent growth and occupancy rates, coupled with historically low interest rates. However, these projects are now coming to fruition in a markedly different environment in 2024, one with slower rent growth, significantly higher interest rates, and increased operating costs. As a result, the pace of new multifamily developments has decelerated. Consequently, it is widely anticipated that the influx of new apartment supply will begin to taper off starting in 2025.

Apartment Rent Demand Remains Strong as Home Ownership becomes More Expensive

Renters continue to absorb the new apartment supply, partly because renting an apartment is relatively more affordable than purchasing a new home.

For most U.S. consumers, renting an apartment has become more advantageous than buying a home for the first time in decades. As steep home prices and high mortgage rates keep homeownership out of reach for many Americans, the housing market is undergoing a significant shift.

New industry data reveals the cost of buying is at a 30-year high compared to renting:

• Overall, mortgage rates and home prices have accelerated so much in 2023 that the “buy premium” – the difference between the monthly cost of a new home purchase versus a new lease – has reached a historical high of 52%, according to CBRE.
• In the third quarter of 2023, the monthly cost of a new apartment lease was $2,184 versus the monthly cost of a new home purchase of $3,322, a $1,138 per month difference.

Multifamily Operating Forecast for 2024

While Providence maintains a positive outlook on the long-term prospects for multifamily net operating income (NOI) growth, fueled by strong demographic trends and a significant shortage of middle-income apartments, 2024 is expected to be an exception in this upward trend. This anticipated deviation is attributed to the previously mentioned surge in new apartment completions, which may moderate rent growth, and the rise in property insurance costs, which are poised to elevate operating expenses.

Considerable Reasons for American Optimism – Avoid the 2024 Political “Doom Speak”

It’s hard to miss the pervasive sense of “doom and gloom” surrounding the dysfunctional U.S. Congress and the anticipated turbulence of the upcoming presidential election. However, we maintain a confidently optimistic outlook, emphasizing the numerous non-political factors that indicate a continuing robustness in the U.S. economy that will contribute to the long-term success of the multifamily industry:

• American Technological Dominance

The U.S. leads in global technology due to its (1) innovation ecosystem and mindset, (2) substantial venture capital, (3) skilled workforce, (4) advanced infrastructure, (5) supportive government policies, and (6) tech hubs like Silicon Valley, all fostering a fertile environment for technological advancement.

The U.S. holds a commanding position in global technology, with its tech industry constituting an estimated 35% of the world market. This is impressive considering the U.S. only makes up 4% of the global population. It is home to six of the largest technology companies by recent market cap: Apple, Alphabet, Microsoft, Amazon, Nvidia, and Meta

• U.S. Energy Independence

The U.S. has achieved the status of the world’s largest oil producer, surpassing other major producers like Russia, Saudi Arabia, Canada, and Iraq.

• The Unparalleled American Ecosystem for Investing

The strength of the U.S. judicial system lies in its impartiality and robust legal framework, complemented by the country’s deep and liquid capital markets, which provide a stable and efficient environment for financial transactions and investments that has allowed the U.S. to build a large and diverse economy.

• Healthy U.S. Population Growth

The U.S. population continues to grow, with a current rate of +0.68%, higher than other major economies such as the slower growing U.K., and the shrinking populations of China, Germany, and Japan.

• America’s Natural Geographic Advantages

America’s geography, featuring fertile plains, large mountains, navigable river systems, extensive coastlines along the vast Atlantic and Pacific Oceans, and abundant natural resources, supports diverse economic activities and enhances trade and defense.

• Strong Recent Economic Growth in the U.S.

In the third quarter of 2023, the U.S. economy expanded by 5.2%, surpassing the IMF’s global growth estimate of 2.1%. This remarkable growth outperforms economies like Canada, the U.K., and Germany, continuing a two-decade trend of outshining European counterparts.

• Decreasing U.S. Inflation

At the end of 2023, the U.S. inflation rate was on a downward trend, dropping from 3.7% in September to 3.1% in November 2023.

• Rising Real Wages in the U.S.

From November 2022 to November 2023, there was an increase in real average hourly earnings by 0.8% and real average weekly earnings by 0.5%.

Given these factors, the U.S. maintains a commendable position in spite of the frequent waves of pessimism that are widely broadcasted and even amplified by the round-the-clock coverage of cable news and social media platforms.

Developing Environment for Opportunistic Property Acquisitions
The interplay of short-term multifamily operating challenges and the long-term positive multifamily environment, characterized by strong renter demographics and a shortage of middle-income apartments, may present attractive acquisition opportunities in 2024. This comes after a year-long period of scarce compelling acquisition prospects in the multifamily industry.

A number of factors may contribute to an increase in acquisition opportunities:

• Pent Up Seller Supply of Apartment Communities

Globe Street reports a significant decrease in apartment sales in 2023, with a 68% drop in activity compared to the previous year. This slowdown has led to a buildup of unsold apartment communities from owners who were unable to sell in 2023. We anticipate that this accumulated inventory will stimulate an increase in apartment sales in 2024, potentially leading to price adjustments as more sellers enter the market to offload their properties. Moreover, stability in interest rates would contribute to driving transaction volume in the multifamily market. Freddie Mac expects sales volume to rebound in 2024, reaching up to $375 billion, aligning with 2019 levels but remaining below the post-pandemic years of 2021 and 2022.

• Undercapitalized Multifamily Properties Sales Expected

Due to the challenges in selling multifamily properties in 2023, many owners found themselves holding onto their investments longer than anticipated, straining their capital resources. This extended holding period often led to properties being underfunded. Consequently, Providence anticipates a significant influx of these undercapitalized and underperforming properties in the 2024 market. However, the potential buyers for such properties are likely to be a specialized group, equipped with the necessary expertise and resources to effectively manage and rejuvenate these assets through targeted capital improvements and improved property management strategies, especially those proficient in turnaround operations.

• Potential for Distressed Multifamily Acquisitions

The U.S. multifamily property market may offer investment opportunities in distressed assets in 2024. During the pandemic, many, often inexperienced, buyers acquired multifamily properties using extremely low-cost debt. Now, with borrowing and insurance costs rising and rents stabilizing amid increased competition, some property owners are facing financial strain. This is particularly true for those who opted for higher loan-to-value ratios and engaged third-party property management firms, which Providence believes often underperform in managing properties.

The multifamily sector is also confronting the upcoming maturity of approximately $1 trillion in debt by 2028, increasing the risk of defaults and potential losses for banks and bondholders. Experienced owner-operators like Providence could capitalize on these vulnerabilities, especially in oversaturated markets such as Austin, Texas. These areas are likely to experience pronounced distress, necessitating higher equity contributions from borrowers due to elevated rates and limited cash flow growth. High-end complexes and downtown high-rises, already facing lower occupancy rates, are particularly vulnerable, with MSCI Real Assets indicating over $67 billion at risk across the sector.

Given these circumstances, the multifamily market in 2024 may present favorable opportunities for acquisitions, especially for entities with the expertise to effectively manage and revitalize these assets and a track record of acquiring distressed multifamily properties, like Providence.

About Providence Real Estate

Since 1985, Providence and its affiliates have actively operated as owner-operators of multifamily residential communities. Its principals have acquired over 65,000 apartment units, worth over $7.5 billion. Providence comprises an experienced team of professionals dedicated to searching for, identifying, acquiring, renovating, and operating multifamily properties in select U.S. markets. As a fully integrated real estate organization, Providence includes divisions for Property, Asset, and Construction Management; Acquisitions; Accounting; Information Technology; Human Resources; and Business Development. To learn more please visit https://www.provre.com.

DISCLAIMER

The information contained in this letter is provided solely for informational and discussion purposes. It is not intended as an offer to sell, nor a solicitation of an offer to buy, any security. This document may not be relied upon in connection with the purchase or sale of any security. Any such offer or solicitation will be made exclusively through a confidential Private Placement Memorandum (PPM), subscription documents, and governing documents. These offering materials must be reviewed thoroughly before making any investment decision, as all information herein is qualified in its entirety by those documents.

This letter also contains forward-looking statements, which are based on current assumptions and expectations and involve risks and uncertainties. Actual results may differ materially, and Providence Real Estate undertakes no obligation to update any such statements.

This letter and its contents are proprietary and confidential, intended solely for the individual to whom it is addressed. It is not intended to provide legal, tax, accounting, or investment advice. Any unauthorized reproduction or distribution of this material, in whole or in part, is strictly prohibited without the prior written consent of Providence Real Estate.