What Inflation Means for Multifamily Housing

Inflation is due to rise to its highest level in 14 years as squeezed supply chains and pent-up consumer demand is putting pressure on prices, particularly for raw materials. 

The Bloomberg Commodity Spot Index, which tracks 23 raw materials, is at its highest level in almost a decade. Raw material inflation can easily be seen in the real economy, for example the average price to build a single-family home is up about $36,000 over the past year due to a lumber shortage.   

The Federal Reserve is betting that this inflationary data is temporary and will abate once the shock of consumer’s and supply-chain’s coming out of their Covid slumbers slow down. History shows us that this is a sizeable and risky bet. When inflation becomes untethered as it did in the late 1970s, it can take at least a few years to get it under control and in the meantime, inflation eats into the purchasing power of wages that do not always keep up with prices. 

But what does inflation, particularly raw material inflation, mean for multifamily real estate? Traditionally investors have flocked to real estate as a hedge during moments of consumer and raw-material inflation. Will that hold true today? Will valuations rise enough to keep intact with higher costs of capital? Will rents be able to keep up with the prices of supplies, utilities, and labor?

When prices rise, the costs of goods and services, like buying a new home, rise as well. Increasing prices can halt the plans of a couple who were thinking of buying their first home as the money that they saved up and their wages do not carry as much weight in an inflationary environment. During inflationary times because less people can afford to buy homes due to diminished purchasing power and rising interest rates, demand for multifamily rental housing increases.

Higher demand for rental units also allows multifamily operators to increase their rents to compensate for the rising costs of operating expenses. 

While this can happen in multifamily real estate during times of inflation, most industries do not have this luxury. For example as the price of jet fuel rises, airlines will have to raise the price of a ticket to compensate for higher expenses, but consumers may choose to hold off on a vacation. In the case of rental housing, people do not have the luxury of holding off when it comes to finding a place to live.

While many sectors of the economy struggle to keep up with rising prices during times of inflation, multifamily real estate usually does not. Due to increased demand and decreased supply, less properties are built when inflation takes hold because of the rising cost of construction in conjunction with rising interest rates, multifamily rents generally keep track with or even outpace the rate of inflation. This, in addition to the appreciation of multifamily assets that generate higher Net Operating Income, allows multifamily real estate to act as one of the best hedges against inflation.

Will this time prove to be different than past inflationary cycles? American Homes 4 Rent, the owner of 54,000 single family homes, increased their rents 11% on vacant properties in April. Invitation Homes, the largest single-family homeowner in America, boosted rents by about the same amount. While multifamily rental owners have traditionally fared well during times of inflation, single-family rental owners may fair better this time because in the age of remote work, tenants prioritize an abundance of living space in lieu of over-the-top amenities.

That does not mean that multifamily rental properties will struggle over the next few years, particularly with workforce and affordable housing in a prime spot to thrive. Many affordable properties, whose rents are directly based on the area median income for a particular area, may do well as wage pressure picks up. These rents, that through land use restrictions, rise and fall with the wages of a metropolitan area, seem to be particularly inflation-proof as employers find it challenging to source labor and have to raise wages to compete for hard to come by workers.  

Real estate, particularly rental housing, should outperform other asset classes if the inflation that we have seen over the past few months (c. Summer/Fall 2021) turns out to be permanent rather than transitory.