Fitch: New U.S. CMBS Multifamily Supply Increasing Risks

Risk of Class A multifamily overbuilding is rising in some submarkets, reported Fitch Ratings, New York.

But Fitch Commercial Mortgage-Backed Securities Managing Director Huxley Somerville said not to panic: “We’re not past the peak for multifamily CMBS, however there are markets that for one reason or another are susceptible to declines from their peak performance.”

Somerville noted that multifamily property fundamentals remain strong overall. “Demographics are running in favor of it, especially the lower age cohort, which seen rental increases for 24 straight quarters,” he said. “And while vacancy has increased recently, it is still just 5 percent.”

While current apartment construction exceeds recent averages, “that’s only to be expected given the falloff that occurred after the Great Recession,” Somerville said. “And current construction is well shy of the construction bubbles that occurred in the mid-1970s and mid-1980s and is expected to stabilize next year.”

Somerville called CMBS transactions granular, “so relying on national trends is not prudent,” he said. “For instance, construction is limited to a handful of cities: New York, Washington, D.C., Houston, Dallas, Denver and maybe six others.”  

Metro areas with oil and gas industry exposure carry some additional risk, but in this case Dallas and Houston have diversified their markets in the wake of past energy market crises, Fitch reported, which has muted the impact of energy-sector declines so far.

The most common type of construction by far remains the Class A segment in higher-rent neighborhoods. “Multifamily construction concentrates in Class A properties because Class A provides the rental income needed to justify the cost of land and construction,” Somerville noted.

Reis reported that Class A asking rents increased 4.6 percent in 2015 and could increase an additional 3.4 percent this year. “If the pace of rent increases continues to fall, this concentration could compound downward rent pressure on rents in those areas,” Somerville said. He noted that as asking-rent gains remain strong and vacancy rates remain low-albeit increasing.

“It’s fair to say that multifamily will perform as expected during the long term,” Somerville said. “The biggest question remains: what will the market be like when they refinance in 2020 and beyond?”