Multifamily Market Update: Activity is beginning to slow across the board, but the downturn should be fairly shallow and short-lived – Feb 2024
By Jennifer Bardoner
Multifamily has been one of the strongest segments for creating flooring demand over the past few years. However, with increased costs for everything from labor to financing, investors and management companies are pumping the brakes on development of new multifamily construction projects. Further, the market has cooled for developers who were building complexes with the intention of flipping them. With construction activity slowing, flooring installations, which take place late in the build process, are expected to follow suit in the second half of 2024.
There are also factors on the renter side negatively impacting the multifamily business. First and foremost, there is a fear that properties will be short on tenants once the single-family housing market begins to recover. In addition, with the rates of inflation, affordability has become an issue for some renters, holding them in the less-expensive properties, and the uptick in remote work means some people who would previously have been on the move are staying put. Of course, fewer moves means fewer opportunities to refresh flooring.
Given the collision of all these influences, a drop in demand is anticipated in both the new construction and apartment turns, though, as the segment is relatively stable, the dip is expected to be short-lived.
COST FACTORS IMPACT ACTIVITY
Last year saw the highest number of new multifamily units brought online since the pandemic, which kickstarted an uptick in multifamily construction and completions-and inflated costs.
Whether due to material prices, market trends, general inflation or an effort to recoup income lost as a result of pandemic-induced eviction moratoriums, rents have soared, leading to record homelessness, according to Market Insights economist Santo Torcivia. Roughly half of the nation’s renters spent more than 30% of their income on rent and utilities in 2022, with approximately half of those cost-burdened individuals spending more than 50% on basic necessities, he reports. That helped drive up last year’s rental vacancy rate 13.8% above 2022 levels to 6.6%, Torcivia says.
“New development and new-unit absorption are the most important factors on affordability,” says Graham Howerton, president of the FEI Group of interior and exterior finish contractors. “There has to be more inventory brought to market, but the properties that were built in 2022 and 2023 were built at a premium due to very high material and labor costs, so their finished cost may be 25% to 30% more than originally budgeted. That, of course, has to be factored into the rent for the investment to work. Until that dynamic changes to some degree, it’s going to have a cooling effect on our marketplace.”
In a catch-22, the same high interest rates that are negatively impacting the single-family market and keeping would-be homebuyers in rentals are also chilling new construction within the multifamily market, due to the pipeline and completion time for new multifamily construction stretching 16 to 18 months, according to Shaw vice president of multifamily sales Matt Walker.
“I think as we get to the end of this year and into next year, the effect of the slowdown in new-construction multifamily is going to be very noticeable,” he says. “And when that happens and these big property management companies can’t buy and sell and develop housing, it really puts a lot of pressure on the rest of their businesses in terms of their renovation spend.”
Still, the market is somewhat insulated due to the fact that everyone needs a place to live and the nation remains drastically short on housing.
“The first half of 2024 is going to be great because the work’s already there. Units are out of the ground, and the flooring still needs to be installed,” says Geoff Gordon, executive director of the Fuse Alliance co-op of commercial flooring contractors. “The second half is going to see a slowdown. I’ve heard for years that multifamily was going to slow down, and it never has. But with the soft landing, multifamily is going to see slower growth, though, at the end of the day, it’s still going to be a good market; it’s not going away.”
Dan Hill, vice president of business development for Mohawk’s multifamily offerings, says its multifamily business mirrors the general market: roughly 80% is replacement, 10% to 15% is rehab projects and 5% to 10% is new construction. “To be competitive and relevant in multifamily, property owners have got to be willing to adapt and upgrade their facilities or build something that’s new and shiny and bright,” he notes.
MULTIFAMILY CONSTRUCTION OUTLOOK
The lack of available housing will ultimately lead to more construction in both the single-family and multifamily markets.
As aging Baby Boomers continue downsizing for smaller living quarters with desirable amenities and no personal upkeep required, the multifamily market will benefit, providing a wealth of new flooring opportunities. In addition, there is a contingent of younger generations that prefers flexibility-and the option to travel and change jobs freely-to the hassles of homeownership, likely keeping them in rentals longer.
“As long as the housing market stays where it is, renting has become the new thing,” Gordon says. “I don’t think people have the down payment to buy a home, and with interest rates being so high, now they can’t afford whatever that monthly payment is going to be.”
Fallout from those high interest rates will impact multifamily construction in the third and fourth quarters of 2024, but Gordon notes, “Demand for new multifamily construction is going to be there because the housing market is still a mess, though with all this construction coming on board, it’s going to equalize, and there’s not going to be a big rush to build.”
Torcivia says there’s already been a slowdown in new multifamily starts, and the segment is not keeping pace with single-family starts due to affordability issues both during and after construction.
“We’re now in the ninth quarter in a row of continued limited access to debt financing, so it’s been harder and harder for these developers and builders to find good financing for these projects,” says Howerton. “And while building materials have settled some, the increase in labor hasn’t, the increase in insurance and bonding hasn’t, and some materials are still scarce and priced at a premium. But the cost of capital is certainly having the biggest impact.”
Noting that even places like Texas and Florida-which lead the nation in terms of residential relocation-are anticipated to be down 10% this year, Torcivia says “2024 is going to be a slow year for construction in general, but multifamily especially. It should start to pick up at the end of the year into 2025.”
The Dallas-Fort Worth area accounted for the majority of new apartment homes built nationwide in 2022 and 2023, according to Hill. Citing data from ALN, the largest collector of apartment data in the U.S., Austin and Houston came in number two and three, respectively, he adds. Howerton also points to cities like Nashville, Tennessee and Raleigh, North Carolina as pockets of strong activity, places where “everyone wants to live or is living,” he says.
“The demand is still there in certain parts of the country and probably will continue to be,” says Hill, noting that the ability to work remotely means more people can live where they’d like to. “Then, taking a look at the empty nesters and where they would like to live, they want to live in exciting, vibrant areas, whether that be suburbs that have a walkable downtown or cities that are desirable to live in. And they still want a really nice place, nice amenities, nice finishes.”
Perhaps that is why Class A properties shot up in terms of the percent of new inventory brought online in 2022 and 2023. Citing ALN data, Hill says these high-end units represented nearly 20% of all the new completions in that period, versus roughly 10% prior. “If you compare it to what already exists in the market, there is a bigger demand of putting A- and B-class properties into the funnel,” he notes.
Howerton says that while things may be flat in the traditional multifamily arena, FEI Group members have recouped some of that volume in the emerging single-family-for-rent market. Pointing out that the pandemic forced many companies to re-evaluate and diversify, Hill says that “the single-family rental market has grown over the last couple years and probably will continue for a bit longer.”
Mohawk’s top 20 clients, which represent the largest multifamily managers and owners in the country, have become more involved in that segment, depending on where they’re located, as the single-family-for-rent market is strongest in Arizona, Nevada, California and parts of Florida, he adds.
RENOVATIONS AND TURNS
The concentration of new Class A and B properties hitting the market is putting pressure on existing properties, which then have to try to compete against gleaming new facilities and enhanced amenities. Generally, this would mean capital improvements to upgrade the look of existing properties-creating lucrative flooring-related opportunities-but elevated interest rates are causing existing-property owners in some markets to turn to rent concessions instead, says Howerton, whose group specializes in the turns and renovations segments of the business. This is resulting in flat to declining rent rate growth in some areas, which then compounds the issue and makes these profitable flooring projects even less likely.
“In 2023, it’s looking a lot like it will be one of the highest numbers of completed new apartment units brought online, exceeding somewhere around 390,000 units,” he explains. “That obviously begins to put a lot of pressure on the existing vacancy rates in many markets. And in 2022, we saw rent rate growth climb pretty significantly-in most places, double digits: 10%, 11%. If you’re in one of those markets where there’s a tremendous number of new units being brought online, you’ve got to start offering concessions to keep that resident in your apartment unit from moving to the brand-new one down the street that has all the new amenities: the new dog park, the new swimming complex, the coffee bar, the mega movie theater.
“The financing they have in place on these existing communities, their interest payments have doubled or tripled in this past year to two years. It’s become very expensive for them to own these communities, so they are not cash-flowing the way they were historically, especially if they have to tap into their lines of credit, which many do; that’s how they operate. Most of our clients are saying now, ‘At least for the first half of 2024, we’re holding everything tight. We’re not going to have these big renovation projects going on. We’ve got to hoard our cash and see how long these interest rates hold high before they begin to fall.’”
Gordon anticipates seeing some interest rate reductions “sooner rather than later,” which should help to kickstart activity, as the need for new units and upgrades to existing units persists.
“Most everyone believes the market being flat to a little down is a short-term dynamic, because the existing inventory has to keep pace with the trends of the new if they want to be viable,” says Howerton. “It’s just going to create more pent-up demand. Once our marketplace normalizes a little bit and the cost of financing comes down a little bit, those existing communities will have to refresh. They have no choice.”
But the current pullback in renovation spending is taking a major source of income for flooring contractors offline, as renovation projects yield much higher margins than apartment turns. Noting that common areas tend to feature premium products in an effort to attract new residents, Walker says that, “typically, where they’d be open to VE’ing (value engineering) the units, the common areas are a nonstarter because that is the perception people are going to have of your space. I can honestly tell you that in the last couple of years, I have not had anybody come to me and say, ‘I want you to VE our common areas and corridors.’”
Apartment refurbishment generally makes up the meat of the market, but it tends to be a pennies business focused on minimal spends. Regardless, it is also slowing down as remote work means that one of the main causes of such activity-moving for a new job-is no longer a necessity.
“The most important drivers for our business in the turn world continue to be, first, new job growth and then, to some degree, new-unit absorption, job growth being the most important factor,” Howerton says. Another common cause of moving is the purchase of a first home.
“All that’s resulted in, especially for the second half of last year, multifamily turn work being a bit flat,” he says. “It’s fine, because 2022 was such a good year, but ’23 wasn’t a particularly busy year in the turn world. You’re having to hunt for new opportunities-you’re going out and trying to take business from your competition, you’re investing in the single-family-for-rent space, student housing. And you’ll still have some of your traditional turn work, it’s just not going to be as good as it has been.”
Acquisitions are another avenue to major renovations as buyers seek to make their investment pay them back quicker. “We’re seeing a lot of larger or medium-sized management companies get larger through acquisitions,” Hill says, noting that new builds don’t just require a huge investment, but also an extended timeline of 12 to 18 months. “They will buy an existing community and put money into it, whether that be upgrading amenities or going through a large-scale rehab to update inside the apartment homes and in the amenity and common area spaces.”
PRODUCT SELECTIONS
There is not much difference between the materials selected for new construction, rehab or refurbishment projects-which is to say there is a lot of LVT. Hill estimates that roughly two-thirds of rental units’ square footage now features resilient flooring products, and that can be even higher in new builds, where carpet is typically only used in the bedrooms, if at all.
“Installers make more money installing vinyl plank, our account managers make more money selling vinyl plank, and residents and clients believe it gives a much more premium look to have vinyl plank, so there are a lot of factors working against carpet,” Howerton points out.
Soft surface still retains a foothold in corridors, and in common areas it shares space with porcelain tile, laminate or engineered hardwood and a growing amount of LVT, depending on the class of property.
Of the LVT used in multifamily, Hill says that more than two-thirds is gluedown, which offers more competitive price points and can accommodate heavier traffic than floating resilient products; though, click products have a place in higher-end developments. Overall, the LVT used is generally more expensive than carpet at the outset-costing roughly two to three times more, says Howerton-but more managers are focusing on long-term value, especially if they are the property managers, Walker says.
“What we see, on average, is a management company is going to replace 20% to 30% of [the flooring in] the apartment homes in their portfolio, and within that 25%, only 8% to 10% of that is actually replacing LVT,” says Hill. “People are generally pleased with LVT.”
There are some drawbacks, which property owners are becoming more aware of, but LVT’s scratchability and poor acoustics aren’t swaying them back to carpet. The finishes selected need to appeal to the masses, and LVT is in line with the general market’s expectations and preference for wood looks.
“Our interior furnishings, at least specific to floorcovering, haven’t changed a ton-different styles and designs of the same vinyl plank product, maybe some kind of tonal or fleck carpet in the bedrooms versus a standard cut pile,” Howerton says in regard to the typical upgrades happening in the units themselves. “Everything that attracts renters today has to do with the common areas, amenity spaces, all those sorts of things, so a lot more focus is being put on that part of the community versus some kind of major change to the interior units. Design is trending much more toward outdoor amenity spaces, remote workspaces and anything and everything having to do with pets.” However, he adds that with the current competition in the market for occupants, the LVT inside units is being changed out more frequently.
In terms of aesthetics, the multifamily market tends to lag the residential market and is now responding to the move toward softer looks and lighter colors. In addition to offering a neutral backdrop in line with generic tastes, the flooring is fading even more into the background so as not to detract from other finishes, says Hill.
“When LVT first came out, it was, ‘Let’s make it look as close to wood as possible.’ Now, it’s visually softer, quieter,” he explains.
As carpet sought to retain share against LVT, in many cases, it competed by getting cheaper. “I think we’ve done a ton of damage as the industry said, ‘Okay, if we make it cheaper, we will sell more,’” says Walker. “Carpet still shrunk.”
While LVT is expected to last several turns, the general expectation is that carpet will be changed out before every new tenant, diminishing the return on investment, and Walker notes that property managers are becoming more cognizant of long-term value.
“If multifamily companies didn’t understand long-term value, we wouldn’t be selling nylon, and we wouldn’t be selling Eclipse,” he says, referencing Shaw’s sector-specific performance PET. “So, there is a lot of awareness around the long-term value of flooring, not just carpet but all of it. The initial cost can be very deceiving when that initial cost happens every single year.”
With carpet going into smaller spaces, he believes there is an opportunity to elevate the offerings, which Shaw is seeking to do through its new Eclipse Enhanced line. Designed specifically for the builder/multifamily market, it offers upgraded performance at a competitive price point, with a new yarn structure that features more twist and less crimp to help it bounce back and wear better in light of bedrooms’ consolidated traffic patterns. It also incorporates R2X stain protection, and utilizing delustered yarn at a reduced pile height helps to hide any wear.
Noting that “if you have a designer involved, he or she is always going to want to pick something unique,” Eclipse Enhanced includes patterns specifically geared for the multifamily market, where waste costs are crucial. Christine Slaughter, Shaw’s vice president of marketing and design for builder/multifamily, describes them as “non-committal, non-directional, timeless patterns with a consideration for pattern repeats and overage.”
“There is always an appetite in new construction multifamily for a designer to select something beautiful-it doesn’t matter what the rent or market situation is,” Walker says. “For these developers and owners, it’s a math problem: They know exactly how much they can expect to get and how much they can spend inside the unit on all the finishes, not just flooring.”
Copyright 2024 Floor Focus
Related Topics:Fuse, Mohawk Industries, Fuse Alliance, FEI Group, Shaw Industries Group, Inc.