Fannie Mae’s September Multifamily Market Commentary repeats a common misunderstanding about small multifamily properties that is worth addressing. By way of background, it opens,
Multifamily rental units can be found in high-rise structures or in garden-style buildings, but there are a number of properties that house between just five and 50 housing units. These properties are usually identified as small multifamily and can be found in many different metros across the country. In many places, they can also be a key source of affordable rental units. (1)
While the data is not definitive, there appears to be somewhere between “296,000 and 360,000 small multifamily properties” with between 2.3 million and 4.4 million units of housing among them. (1) These units appear to be concentrated in about ten states that contain three quarters of the stock. California and NY have the most small multifamilies by a wide margin and the cities with the most come as no surprise: LA, NYC, SF-Oakland, Chicago and San Diego.
Here’s where I have issues with the analysis:
Fewer Small Multifamily Properties in the Pipeline
According to data from the Dodge Data & Analytics Construction Pipeline, the number of new multifamily projects being started has been declining since peaking in the second quarter of 2015, falling to 678 projects during the first quarter of 2016 . . . . The average number of units rose, however, to about 117 units per project.
Given the high land acquisition and construction costs in most metros, this trend of maximizing square footage in multifamily development, rehabilitation, and renovation should not be surprising. Unfortunately, it does have implications for the small multifamily segment, which in many places tends to offer more affordable rents when compared to newer properties.
An Uncertain Future for Small Multifamily
Over the next decade, the nation’s multifamily stock will likely see an influx of higher unit count properties. As older small multifamily rental properties age and/or fall into disrepair, they will likely be replaced with properties with more density per square foot. Developers will likely create more, but much smaller, units on the same size lot. As a result, these small multifamily properties may end up moving out of the 5-50 unit category and push up into the 50+ unit category, making preservation of the existing stock of small multifamily rental properties offering more affordable rents even more critical.(6)
The logic of this last sentence is faulty, but it is also oft-repeated by sophisticated housing market commentators. Small multifamilies are not cheap because they are small, they are cheap because they are old. Old housing is generally cheaper than new housing. So this notion that we should preserve old housing for its own sake is faulty. Generally, we would want to see an expansion in the supply of housing, so replacing an aging small building with a bigger new one would generally be a positive development. We also would like to see investments in upgrades to the housing stock, either through rehabilitation or replacement. Effectively, this Fannie Mae Commentary is saying that we should preserve very old small multifamilies instead of upgrading those properties. That is short-sighted because while it may keep particular units affordable, it will also tend to raise rents more generally (by restricting supply) and lowering the overall quality of the housing stock (by disincentivizing investment).
The Commentary acknowledges that “it seems that there are a variety of financing sources available in the financing of small multifamily rental properties, indicating there is sufficient and ongoing liquidity for this property type. ” (5) Perhaps it is best to treat small multifamilies just like the bigger ones and let the market determine the highest and best use of each parcel zoned for multifamily construction.