Inflation May Have Already Peaked. Here’s What It Means for Multifamily Investors.
by Max Sharkansky Managing Partner at Trion Properties
In our view, inflation may have peaked: We’ve arrived at the beginning of the end of this period of hyperinflation. Not everyone agrees with our analysis—but this discord creates opportunities. Let’s review the current situation and explore the implications of our perspective.
Multiple signs inflation is rolling over
After a painfully high 9.1% year-over-year increase in consumer prices in June, July data delivered evidence inflationary pressures are beginning to ease. As shown below, the trailing 12-month CPI in July came in at 8.5% while the month-over-month change was 0.0%.
Source: Bureau of Labor Statistics; as cited by RCLCO, Monthly Round-Up, August 18, 2022
Other indicators are also suggesting 9.1% may have been the top, including: • Falling gasoline prices – National average down to $3.90/gallon from a mid-June peak of $5.02 • Declining food commodity prices – The UN Food Price Index posted its fourth consecutive monthly decline in July after hitting record highs earlier in 2022 • Easing supply chain pressures – Shipping rates are declining; time to deliver goods is quickly falling; port congesting is easing
• Cooling wholesale prices – The producer price index (PPI) declined 0.5% in July, the first month-over-month decrease in two years.
Market expectations for inflation are also moving in the right direction. The difference between the yield on a regular five-year Treasury bond and yields on inflation-indexed bonds—the breakeven inflation rate—has declined meaningfully from the March peak of 3.59% to near 2.72%, as shown below. The value implies where market participants expect inflation to be in the next five years, on average.
Source: Federal Reserve Bank of St. Louis, 5-Year Breakeven Inflation Rate [T5YIE], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/T5YIE, August 21, 2022
Staying active, disciplined, and identifying opportunities amid uncertainty While inflation has arguably peaked, it remains high and the Federal Reserve (Fed) will need to keep hiking its key rate, pushing up other benchmark rates. The three-month term SOFR forward curve, for example, is currently implying a peak of 3.62% in March 2023. The Fed will also continue its quantitative tightening measures, doubling the pace of its balance sheet reduction efforts in September.
Although these measures are needed to rein in inflation, policymakers could have a difficult time executing a soft landing. Surveys show a healthy percentage of market participants expect a recession in the next 12 to 24 months, albeit likely mild and short-lived. Investors are also weighing the possibility inflation will get stuck in the 4% to 6% range, which could drive real wage growth into negative territory.
These factors are understandably influencing the environment for multifamily real estate sponsors. In response, many sponsors are choosing to sit on the sidelines, markedly slowing or stopping their buying activity altogether. They’ve switched to uber-conservative, risk-off mode. At Trion Properties, we’re taking a different approach. Our investment philosophy and process enable us to be “in business” at all phases of the cycle; we don’t rely upon perfect market timing to execute our value-add strategy. Right now, we are appropriately cautious, but we’re not on the sidelines—in fact, we’re actively seeking opportunities.
What gives us confidence to be active in a period of uncertainty? First, the fundamentals: The multifamily sector continues to benefit from favorable demographics, job growth, rising wages, and increased renter household formations. These demand drivers are expected to remain resilient through year-end.
As shown below, rent growth rates are expected to normalize, coming down from exceptionally high levels. Experts anticipate rent growth to remain above average in 2022, reaching approximately 6% to 7%. Thereafter, rent growth is expected to settle in at a more sustainable, organic pace of about 3% to 5% annually. In our view, this normalized rate is still quite attractive and offers more than enough room to underwrite profitable deals.
In terms of a tighter lending environment and rising borrowing costs, we are appropriately mindful of these factors but believe they can be sufficiently managed through diligent underwriting, prudent use of leverage, and hedging.
Amid the current environment, multifamily asset prices have ticked down from the Q1 2022 peak. Our decades of experience have taught us that multifamily prices go down maybe once every five to seven years. Today, as some sellers reduce their prices to meet the market, we believe we’re in a relatively rare window of opportunity that likely won’t last long. We’re ready and willing to act and will continue to maintain a robust pipeline. Above all, we maintain our commitment to disciplined investments backed by rigorous underwriting and asset management practices.
[1] AAA, https://gasprices.aaa.com/, August 21, 2022
[2] UN Food and Agriculture Organization, https://news.un.org/en/story/2022/08/1124012, August 5, 2022
[3] Fitch Ratings, https://www.fitchratings.com/research/sovereigns/easing-supply-chain-pressures-should-help-reduce-core-goods-inflation-12-08-2022, August 12, 2022
[4] CNBC, https://www.cnbc.com/2022/08/11/producer-price-index-july-2022-.html, August 11, 2022
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