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Every two weeks, I share my writing on investing, career transitions, meaningful work, parenting, living intentionally, and other topics that engage me.

In my fifties I'm still just trying to figure stuff out.

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Improving Setup

It’s been years since I’ve been this excited about the setup for investing in apartments.

Besides one acquisition for an institutional investor, Cove hasn't participated in any deals since December 2021. Even that was an exception. We acquired 48 units in the DC metro market at a good price from an unsophisticated seller in an otherwise frothy market.

Why am I so excited?

Because something doesn’t make sense. Or does it?

Despite an influx of supply unseen since the mid-80s, prices are stabilizing and showing signs of growth. In a fixed-cost business, massive supply additions should lead to significant price declines.

But that’s not happening.

When things don’t seem to make sense, I rely on some wisdom shared by macro investor and Princeton Review founder Adam Robinson. In a 2018 interview with Tim Ferris, Robinson said,

It’s like when you see a stock that stops going down while a broader correction persists. Or maybe it goes down less than others. In that subtle departure from expectations lie clues to powerful dynamics under the surface.

Underestimating demand for apartments could be one plausible explanation. If that’s true, as supply additions continue to trail off, as indicated in collapsing permits and starts, rent may rise much faster than people expect.

Despite my optimism, the near term remains challenging for apartment operators and investors. Higher insurance, taxes, labor, and material costs have squeezed margins while rent growth has been under pressure.

Higher interest rates have stung too. Not only have cap rates risen (valuations lower), but lenders have retrenched, raising borrowing costs significantly and limiting leverage ratios.

So naturally, the permabears (who missed much of the upside ahead of 2021, by the way) are now having a moment, especially online, where social networks incentivize hyperbole.

These doomsayers seize every opportunity to validate their predictions of an imminent collapse. Fear sells.

Lately, they’ve been particularly exercised about multifamily deliveries (read: supply) hitting multi-decade highs or the coming “wall of maturities.”

I assume they have an angle. Other than craving attention, maybe they’re hoping to invest in distressed assets.

Regardless, I think the multifamily bears might want to be careful.

Price, or rent in this case, is telling us something.

Having followed multifamily housing closely, I was also concerned about the near-term impact of supply hitting the market (see chart below). I expected rent growth to be much weaker than it has been.

In fact, recent surveys have shown more resilient rent prices than feared. Not only are rents not collapsing, but they’re starting to rise again in many markets. The improving trend is visible in April's Apartment List National Rent Index.

Supply is certainly an issue and has had an impact. Rent has fallen in the high single digits in markets like Austin, where new construction activity has been most intense. But demand is an important factor too. As housing economist Jay Parsons highlighted this past week, demand has been on fire.

One driver could be the rising cost of home ownership.

In fact, despite significantly higher rents over the past several years, the cost of renting vs. buying now looks more attractive than it has in years.

A recent Redfin report states, “First-time homebuyers must earn roughly $76,000 to afford the typical U.S. starter home, up 8% from a year ago and up nearly 100% from before the pandemic.”

Beyond higher financing costs and access to funds for a down payment, would-be homeowners also have to contend with rising insurance and maintenance costs.

The same Redfin report revealed that 40% of renters don’t believe they’ll ever own a home, an increase of 27% over the past year.

While devastating to many, the net result is that rental demand looks well-underpinned for the foreseeable future.

Rising Rent Ahead?

There will certainly be multifamily owners and investors who struggle in the current environment. But if they can get through it, things start to look more attractive on the other side, at least from an investor’s perspective.

It’s not great news for renters, I’m afraid.

We can debate the reasons, but it’s widely agreed that the US faces a structural shortage of housing. Estimates range from 1 million to 7 million units. Yesterday, I saw an estimate of 10 million units needed to balance the market.

Private capital cannot solve all of America’s housing affordability challenges, but it’s critical to creating more supply. Developers (and lenders) must be compensated with attractive returns to incentivize investment in new construction, an inherently risky business with long lead times.

And that’s not happening now.

We have likely seen the near-term peak in the supply cycle. Permits and starts have collapsed. As seen in the chart below, also highlighted by Jay Parsons, higher costs and availability of financing have started to bite.

If rent is beginning to rise again despite record supply deliveries, you can imagine what will happen when construction slows.

Conclusion

Continuing forward, the multifamily real estate market appears poised for a shift. Despite initial concerns about oversupply, recent data indicates a more resilient rental market than expected. If the recent supply is absorbed over the next 12-18 months, rents could move considerably higher.

Renter demand will likely remain strong due to various factors, not least of which will be the relative cost advantage of rent versus buying. In that environment, apartments may emerge as an increasingly compelling asset class.

While I don’t think we’re there yet, I expect Cove will soon be more active, especially if cyclical weakness and higher interest costs generate more buying opportunities from frustrated owners.

Timing any market is notoriously difficult, but that’s especially true in the less liquid real estate market. In anticipation of more opportunities, I’ve started developing strategies to capitalize on an environment characterized by higher rents.

If you’d like to learn more, email me directly to schedule a time to speak further.

Other Stuff

Household Size and the Housing Stock I discovered Kevin Erdmann's blog, Housing Tracker, via a shout-out on Marginal Revolution for his work on housing costs. Specifically, Erdmann's latest post explains the counterintuitive that we have a shortage of housing supply when homes per capita are at an all-time high. The answer lies in the declining number of children per household.

​Read the post (3 mins)

The Indispensability of Risk The latest memo from Howard Marks of Oaktree Capital briefly explores the concept of risk in investing. Marks makes the important point that we accept risk (of underperformance) when we don't take risks. Like most Marks memos, it's a well-written piece I recommend reading. If you're looking for the TLDR, here you go:

​Read the memo (7 mins)

"What Do You Care What Other People Think?" Last weekend, I listened to the audio version of this book over a series of daily walks. What a treat! Much of the book describes Feynman's time investigating the Challenger explosion. He approached that problem with endless curiosity, honest humility, steadfast determination, and an extraordinary ability to simplify complex ideas into plain language. Feeling inspired, I plan to re-read "Surely You're Joking, Mr. Feynman!" and watch some of his recorded lectures.

​Read the book (not an affiliate link)

Beavis and Butt-Head - SNL I'll admit to watching an unhealthy amount of (i.e., some) Beavis and Butt-Head back in the day. That guilt is probably why I laughed so hard. If you know what I'm talking about and haven't seen this skit yet, you'll thank me later.

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​Watch the skit (6 mins)

And a Farewell Photo...