Class B & C Multifamily Net Operating Income Holding Steady

Over the last year, S&H Capital has seen a fairly consistent set of expense and revenue increases across the various properties we track. We currently own a fraction of 46 different apartment complexes across the US (mostly in smaller markets), with a notional value of $2.6B in total real estate. 

Recently, an S&H Capital client sent an article by the WSJ (Renters Are About to Get the Upper Hand). I assume that most of our market data is outside of the scope of the WSJ article, since they're most likely tracking the larger markets in the country, whereas most of S&H Capital’s investments are in smaller cities. The bigger cities would certainly have absorption challenges - as new housing stock comes online, it takes some time for the market to readjust; high deliveries can lead to high vacancy rates.

Using Year over Year data and removing any large cash events (sales or refinances), our portfolio's net income:

• Q4 2022: up 5.6% vs Q4 2021

• Q1 2023: up 2.1% vs Q1 2022

• Q2 2023: down 1% vs Q2 2022

Q2 is down for esoteric reasons specific to our portfolio: two properties had loans that began amortizing (so debt payments increased, but that increase flows to our bottom line as we owe less debt going ahead); and one property paused distributions this quarter to pay for some expensive "unit turns" as very long term tenants moved out and the cash was used to refurbish the units --> which will lead to higher rents in the future. 

New Supply and Absorption

For most of the property reports this quarter, we generally see less than 1% new stock coming online in any given year, which allows our portfolio to keep well-occupied. Some markets have higher delivery rates, but that new stock is typically Class A properties, whereas we focus on the Class Bs and Cs - they're older units and tend to experience lower variance when new Class A stock comes into a market. The Class As directly compete with new builds, and their vacancy rates may fluctuate more.

Cities, Wages Insurance

All this said, the biggest factor we see lately that tempers our income comes from:

• Cities: as cities grapple with budget challenges, we're seeing larger tax increases this year than in previous years - as much as 49% for one property! These are being contested.

• Wages: there was a scramble for good workers over the last 1-2 years, but that churn appears to be slowing down. Most managers are now reporting stable maintenance crews after spending quarters trying to solve the problem. 

• Insurance: Florida is in the news lately for some insurers leaving the state. While we have no properties in Florida, we do see some pockets of 10-20% annual rises in insurance costs. 

Revenue & Rents

Generally we now see single digit rent growth in most markets, down from double digits the last few years - very much in line with the article you sent. While there are concessions from time to time (usually a free month of rent, lower deposits, etc), we have yet to see any decline in asking rents across the portfolio. Again, this is often related to the Class B/C nature of our apartments: most often older tenants have lower quality units, and when they move out, there is some rehab work and newer tenants almost always pay more, which buoys rent across a complex.

Overally, the history and future expectations is that the Net Operating Income across the portfolio will creep up 1-2 percentage points each year. There are expense challenges but also other ways to boost income. And the new supply pressure is low across our portfolio due to being in small markets and focus away from Class B and C.

What do you think?

If you’re reading this article, what do you think? Do you have any data that supports our opinion? Or another?

This is the first of a series of blog posts that come from various questions of our clients. Nothing above is intended to be investment advice.