Moody’s Reflects on Past Recessions to Forecast what’s Upcoming for Multifamily

Given the likelihood of a recession on the horizon, Moody’s Analytics recently released a report called, “What Would a Recession Mean to the Multifamily Market?” Partner Insights spoke to Lu Chen and Thomas LaSalvia, senior economist and director of economic research, respectively, for Moody’s Analytics about some of the report’s more impactful findings. 

Commercial Observer: What are some of the most striking conclusions from this report for you?

Lu Chen: Looking at recessions as early as the 1980s, we found that subcategories of housing have different sensitivities to economic conditions. In each recession, single-family housing prices would slide due to smaller demand. If a long recession hit, we can expect panic selling due to the fear of prices falling further, and this would create a spiraling effect in the market. Back in 2007 and 2008, when demand evaporated for single-family homes, potential first-time homebuyers stayed in the multifamily market longer, which helped keep the rent steady until the end of the recession. So overall, in a mild recessionary environment, we would expect only a moderate vacancy increase, and rent growth would simply decelerate. We don’t think a free fall would be likely. One lesson we learned from past recessions is that places that experienced the most rapid housing-price or rent growth during the economic expansion would have the most decline or correction during the economic contraction. 

CO: When you consider the economic situation in the 1980s, what are some of the similarities that help you project into the economic situation today?

LC: If a recession runs long and deep, we would expect nearly all assets to be negatively affected, including multifamily. That’s what happened when there were back-to-back recessions in 1980-1981 and then in 1982. If we adjust for inflation, multifamily rent declined in both periods. But that doesn’t mean today’s market is the same. The downturn in multifamily has always been shallower and shorter than the downturn in single-family housing because the demand is more stable.

Thomas LaSalvia: One big difference is the strength of the labor market. As we enter this downturn — if it is a true downturn — we’re at near record-low unemployment at around 3.6 percent. The ratio of job openings to the number of people unemployed is still about 2-to-1, which is unprecedented. This means there is room for softening, which is already happening. An unemployment rate well below its peak from previous recessionary periods will moderate all of the housing declines during this recession.

CO: What good news can we take from comparing the ’80s to today regarding the housing market?

LC: During the Volcker period, the nominal housing price did not decline. If you look at the quarter-over-quarter data, it has been continuously rising, although not as fast as inflation. That means, as higher inflation brought higher construction cost to the intrinsic value of housing, we might see levels of decelerations or even mild declines in the nominal housing price, but it’s unlikely we’ll see a huge price cut.   

CO: Let’s jump from the ’80s to 2008. What effects from the Great Recession are still resonating in the housing market today?

LC: During the Great Recession, the deep downturn in single-family housing shied potential homebuyers away, transferring demand to multifamily markets. It was instantaneous. We think that is likely to happen today if rising interest rates cause single-family housing demand to drop. Also, expensive, tier-one markets had deeper declines during the Great Recession than some of the less expensive tier-two markets. Today, COVID expanded growth opportunities for many of those tier-two markets — e.g. Phoenix, Raleigh, Las Vegas. That said, their multifamily rent levels have to be closely watched if we do enter a recession. 

CO: What can the economic patterns from the ’80s tell us about where the market will head next?

LC: A five-year average nominal year-over-year housing price growth was 11.7 percent in the years leading to the 1980 crisis. Over the past two years, the nominal housing price grew at an average annual rate of 16.4 percent. That seems really high — almost dangerous — but the growth is only two years running, and that’s partially due to heightened pandemic demand. Then add in very tight inventory with institutional investor purchasing making up nearly 20 percent of all single-family housing earlier this year and an interest rate not rising as rapidly and as high as it did during the Volcker period. We might see some corrections, but it could go lower.

TL: On the multifamily side, we are not expecting a rent decline. Apartment rent growth will definitely decelerate, and the economic situation will weaken in the second half of this year. But we were growing at a 10 percent annualized rate anyway. Regardless of a downturn, that was going to be unsustainable. Now growth is slowing toward a 3 to 4 percent annualized rate, which is more toward our long-term averages. That’s what we’re expecting. 

CO: In the report, you identified several factors that indicate how the market will proceed. Let’s discuss how these will affect the housing market based on trends from previous recessions. Let’s start with the slowing of new construction.

LC: Overall, the new construction rate is still fairly slow, and that could keep the demand balanced for some time. Even if multifamily demand cools, giving us a very deep, very long recession, limited multifamily construction will still help sustain the sector.

TL: Right now, multifamily vacancies for Class A and Class B/C combine to under 5 percent. So we’re still looking at an incredibly tight multifamily market. We’re not expecting large increases in the vacancy rate, or any declines from a rent perspective.

CO: Let’s move to the substitution effect.

LC: The single-family housing price has been much higher than multifamily market rent, and the price-to-rent ratio is approaching a level near the Great Recession. That could make the substitution happen quickly and easily. As mentioned earlier, if the single-family housing market cools down, that could help maintain multifamily demand.

CO: And, changes in the labor market and income.

TL: This is a consumer choice problem. There will always be trade-offs, and if there’s an economic softening, as we’ve seen in previous recessions, then some consumers will switch from A to B- or C-level housing. We’re not expecting households to be hit at the extreme level of the Great Recession, but as they soften, there could be a little bit of movement from single-family to multifamily. All of that puts only moderate downward pressure on the demand for multifamily housing.