The multifamily sector has benefitted by the downturn in the single-family housing market as tighter lending standards help keep potential home buyers in apartments, but that effect is likely to be blunted in 2009.

The recession spells lower rent growth and higher vacancy rates for multifamily properties in the coming year. Average effective rents are forecast to rise 1.7% in 2009 compared with a projected gain of 2.7% this year, according to real estate research firm Reis.

One factor hampering rent growth is stagnant income. Wages tend to stay flat during a recession, while unemployment worsens. In the first 10 months of 2008, the U.S. shed 1.2 million jobs, pushing the national unemployment rate to 6.5% in October. Economists at Goldman Sachs warn that U.S. unemployment could jump to 9% by late 2009.

Unemployment among younger adult-age workers could become an important factor, since they are overwhelmingly renters. Researchers for brokerage Marcus & Millichap estimate that 42% of adults under the age of 35 are renters.

“When the economy is not creating jobs for younger households, it is particularly significant for apartment demand,” says Sam Chandan, chief economist at Reis. Faced with dwindling employment prospects, younger people tend to double up or move back to their parents' homes.

What might soften the blow for owners is a decline in multifamily construction as developers struggle to find financing for new projects. The National Association of Home Builders estimates that multifamily starts will decline from an expected 300,000 in 2008 to 238,000 in 2009, before rising to 260,000 in 2010.

“We'll see reduced construction next year and probably the year after that,” says Mark Obrinsky, chief economist with the National Multi Housing Council. “Even with that, we are still going to have a tough time if demand remains depressed by the economy.”

Investor strategies

The outlook makes executives cautious at Equity Residential, one of the nation's largest apartment REITs. “Our markets are currently experiencing significant headwinds due to the slowing economy and resulting job losses, which will slow revenue growth in the fourth quarter and cause property fundamentals to further weaken in 2009,” noted David Neithercut, president and CEO of Equity Residential, in the REIT's third-quarter earnings report.

Equity Residential ranks No. 4 in the National Multi Housing Council's list of top 25 apartment owners in the nation, with ownership interests in 154,152 units as of Jan. 1, 2008. The REIT is trying to conserve cash by postponing acquisitions. Through the end of October, it had disposed of $835 million in assets out of $1 billion disposition goal for 2008 to shore up the company's cash base. Equity Residential wants to exit lower-price markets in Texas, Florida, Colorado, Arizona, Connecticut and North Carolina.

All investments are relative

Despite the dampened outlook, respondents to a recent survey conducted by the Washington, D.C.-based Urban Land Institute, a nonprofit research group, picked multifamily as the best investment opportunity in 2009 among the major commercial real estate property sectors.

Survey respondents perceive the housing market downturn as a plus for multifamily in the near term. And in the long term, this sector has demographic potential, with increasing demand coming from the echo boomers and immigrants.

“This is not to be confused with saying that the outlook is strong, but it is stronger than other property sectors,” says John McIlwain, senior resident fellow for housing with ULI. Distressed urban condos near transit points offer the best prospects for multifamily investors, according to survey respondents.

Richard Campo, CEO of Camden Property Trust, a Houston-based multifamily REIT, also sees opportunities in distressed properties. Camden will look to acquire properties, if distressed sellers provide attractive pricing.

As for specific market picks, Campo favors Houston, Atlanta, and certain Florida cities that offer solid, long-term growth prospects for jobs, population and household formation. Camden ranks No. 13 on the National Multi Housing Council's top apartment owners list, with ownership interests in 62,338 units as of Jan. 1, 2008.

The one wildcard to the forecast is the future of Fannie Mae and Freddie Mac. The government-sponsored enterprises (GSEs) have long been major players in the secondary markets by providing innovative and attractive lending products.

But the federal takeover of the struggling GSEs fuels uncertainty, Obrinsky points out. “Our hope is that they will continue to provide some mechanism so that the apartment industry will be able to have liquidity when it really needs it.”