Well to say the Multi Family Market in Arizona has been crazy the past couple of years would be an understatement. Arizona has had soaring demand for rental housing coupled with a climate for Landlords that seems “landlord friendly” sparked a surge of investors selling off assets in other markets to invest in Multi Family Real Estate in Arizona. The demand for rental housing was intensified as residents from “high cost” Western Cities saw Phoenix as a place to find a lower cost of living. There was a mass redistribution of population coming from cities like Los Angeles, San Francisco, and Seattle. This was apparent as places like Phoenix had a resulting record net absorption, this is defined as the difference in units of the number occupied and the number vacated.

To give you some perspective most multi family sales were being sold on “pro forma cap rates.” traditionally the way an investor can gauge the rate of return on an investment is to look at the current net operating income of the property in relation to the price paid; or a “cap rate.” In an environment where demand is surging the rents are rising month over month, so this means that a cap rate based on current income would be changing with every month that passes. As leases come due rents were increases in every case. The norm became to sell multi family properties based on a projected number of what the net operating income WOULD be after a period of time when leases turned. In some cases, this meant investors were buying properties that had 0% cap rate currently, but they were betting on the upward trending rents to produce a good return. There was also a flurry of developers buying land and building multifamily to try and get a product to market to ride the wave of demand. Crazy right?

Well in late 2021 we finally started to see signs of a peak. The Phoenix multifamily market was a performance standout in 2021. By the third quarter, unprecedented demand pushed the region’s net absorption up to 11,000 units, its year-over-year rent growth to a whopping 21.5% and drove the vacancy rate down to 5%, a low unseen for more than 10 years. By the fourth quarter of 2021, a long-coming glut of new supply began to catch up with the market and absorption turned negative. The vacancy rate shot back up, and now stands at 7.9%, the highest rate since 2014.

The moderation in renter demand can be attributed to three main factors: inflation and economic uncertainty, an erosion of affordability and the resumption of eviction filings. Wages have not risen at the same pace as inflation, reducing real incomes and stalling the launch of new household formation.

It was expected that activity in the summer might be seen in Q3 performance. But leasing activity in general was not what Landlords would have hoped. Phoenix tends to outperform the national averages but it is likely Phoenix still sees the same trends; it is just that the highs are higher and that makes the adjustments sharper in the Sun Belt. According to CoStar’s daily rent series, powered by Apartments.com, shows third quarter year-over-year rent growth slowing from an average increase of 9.4% at the end of the second quarter to an average increase of 5.8%. Taken by itself, the 5.8% national rent growth number still looks fantastic for a sector that pre-pandemic considered 4% annual rent growth an excellent outcome, yet the quarter-over-quarter sequential change showed rents declined by $7 nominally, a drop of 0.4%.

In general, it is good to remember that everything in the world of real estate is cyclical. Nothing stays the same forever. Investors have to think long term. Phoenix is a city that saw such a long dry spell of new housing that the shortage was big enough that even with continued product coming to the market it will take years to fill the pent-up demand. So, the changes in the multifamily segment might be characterized more as a correction back to a steady growth pattern rather than an all out turn in the market. Normalizing the way returns on investment are accepted.

Let’s watch this space in the coming months as the change in the interest rates could also play a role in this picture. What do you think the future holds?

Source: Costar