Investors have been raising the topic of inflation more frequently over the last few months as the demand for multifamily assets is surging in the Central Valley. The U.S. inflation rate accelerated to 7.5% in January 2022, the highest since February 1982 and well above market forecasts of 7.3%. Soaring energy costs, labor shortages, and supply disruptions, coupled with strong demand, are behind much of the surge.

Unlike bonds and cash, which lose purchasing power when prices for goods and services are rising, commercial real estate is generally a secure hedge against inflation. It holds intrinsic value, is in limited supply, and is a yielding asset. At Visintainer Group, we view multifamily investments as one of the best inflation hedges within commercial real estate as the lease structures are far better positioned to benefit from an inflation increase than other asset types. Other commercial real estate assets might have lease durations of five, seven, or even ten years, but multifamily leases can reset at six, nine, or 12 months. When these leases reset, it gives investors an opportunity to adjust rents as prices increase.

It is essential to remember that multifamily real estate is a necessity-based asset. The primary purpose is to provide shelter. Moving is costly and time consuming and with dwindling alternatives in the home buying market, opting to rent is gaining popularity. Home prices have skyrocketed over the past 18 months due to the lowest inventory of for-sale housing in years, creating more pressure on pricing and making affordability an issue for many consumers. Since home ownership is becoming increasingly unaffordable, the demand for rental units in multifamily properties has increased.

GENERATIONAL CHANGES IN HOME BUYING

Multifamily as a substitute for single-family homes has been trending over time with profound shifts in demographics and consumer preferences. Baby boomers are downsizing, freeing up cash, and avoiding taking on new mortgage liabilities in the current chapter of their lives. Millennials are forming households far later in life and are still scarred from the financial crisis of 2008. Gen Z is just entering the workforce, with their savings rate at historical lows, creating a likely struggle to amass savings for a down payment for a home purchase. Inflation aside, these trends are a key driver for increased demand for multifamily real estate.

OPERATIONAL COSTS ARE ON THE RISE

It’s important to remember that although it is true that the main benefit of multifamily real estate is its short lease durations enabling investors to reset rents, the costs to operate a commercial investment property is rising steadily and aggressively. California’s rent cap law, AB 1482, took effect on January 1, 2020 with two main functions – it restricts the allowable annual rent increase to 5% plus a local cost-of-living adjustment of no more than 5% (for a maximum increase of 10% per year) and it removes the right of landlords to evict tenants without just cause.

Multifamily operators are starting to account for higher operational expenses due to inflation and its effect on the rising costs of goods, labor wages, insurance, materials, and property taxes to name a few. The increase in certain expenses is expected to rise between 6%-21%. It is more important than ever to audit operational costs accurately and more frequently. In an environment where the costs of operation are steadily rising, coupled with a limit to the amount rents can be increased each year, the burden is on investors and managers to gauge costs accurately to protect yields as much as possible.

 

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Dustn Ilic, CCIM is a Multi-Family Investment Advisor with the Visintainer Group in Fresno, CA. Formed in 2018 and built on a foundation of investment real estate, the Visintainer Group is a client-first commercial real estate firm. The Group has executed over $450 million in transactions across the United States. Dustin specializes in multi-family property acquisitions and dispositions for owners in the Central Valley and Central Coast markets. He can be reached at 559.890.0319 or dustin@visintainergroup.com.