We’ve been fielding a lot of questions from our clients about where we see the market going and what factors they need to be thinking about, from emerging opportunities impacting the multifamily asset class to the new administration. To help shed some light on the changing dynamics of today’s marketplace, I recently sat down with REIS Chief Economist Victor Calanog to discuss New York City’s multifamily outlook.
Here are a few of the main highlights from our discussion:
Chad Tredway: Do you think the administration’s policies will drive inflation? Inflation obviously helps with asset prices, but the flipside is higher interest rates.
Victor Calanog: The new administration’s economic agenda includes some key components that are expected to drive growth.
Consider something like investments in infrastructure: The expectation is that it will drive economic growth, and inflation will likely follow that growth. Inflation is good for asset prices—but you’re exactly right, increased inflation will give the Fed the ammo it needs to continue normalizing interest rates.
At their June 14 meeting, the Federal Open Market Committee (FOMC) moved to increase the federal funds rate by 25 basis points, bringing it to a target range of 1% to 1.25%. The Fed is expected to raise rates three times this year, moving closer to its long-term goal of 3%.
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Source: J.P. Morgan Markets; as of June 16, 2017
A higher interest rate environment might have some multifamily investors worried—but ultimately, the FOMC moving to raise rates should instill confidence in investors. For one, if you look at interest rates over the past 20 years, 1.25% stands on the very low end of the spectrum. It’s also worth noting that the Fed has been holding down interest rates since the 2008 recession in an attempt to spur growth and investment in the private sector. Until recently, the Fed has been very cautious to raise rates—and it has only done so when it has been confident that the economy is on strong enough footing to withstand it.
“when the broader economy is growing—with higher wages and strong job growth—multifamily investors can benefit from higher rents and values.”
Chad Tredway: Another big question we’re getting is around tax reform. What do you think our clients should know about tax reform?
Victor Calanog: Tax reform is definitely on the new administration’s agenda. But with that said, the devil is in the details.
Let me tell you why I emphasize that so much. Earlier this year, we expected that the net effect of tax reform—which will put money back in the pockets of consumers and businesses—was that GDP would grow by a relatively healthy 2.8% in 2017. But if you look at it today, it doesn’t seem like tax reform will actually be implemented this year. So, we’ve already lowered our expectations for economic growth to around 2.2%.
Interestingly, tax reform can have an unexpected effect on affordable housing. Take, for example, the Low- Income Housing Tax Credit (LIHTC) sector, which is essentially a tax play for a lot of investors. If tax reform is implemented, and an investor is paying 15% in taxes instead of 35%, those LIHTC tax credits are just not going to be worth as much.
“If I were to point out one key component of tax reform that multifamily investors need to keep an eye on, it’s 1031 exchanges.”
If they were cut out, the amount of transactions on the market would likely take a hit—and the rollover strategy that many owners use to invest would need to be reworked.
There are still a lot of questions around tax reform, and while I think that, in general, paying less in taxes and harmonizing tax inefficiencies will result in a net benefit in the short term, it gets more convoluted when you look at the long-term effects and how we’ll make up for the increased budget deficit tax reform may cause.
Chad Tredway: What indicators do you think our clients should be watching to get a better understanding of where we are in the cycle?
Victor Calanog: Commercial real estate cycles can go much longer than a normal economic cycle. It’s important to be strategic about how you’re investing—and while it’s prudent to plan for the downside, you also want to be well-positioned to take advantage of opportunities that will benefit your bottom line in the long run.
How do you do that? Make sure you understand the fundamental sources of demand. In other words, if you’re investing in rentals, values may go up and down, but consider: What kind of income can you expect to generate from the assets that you’re planning to invest in? Can that income grow over time? And will the underlying demographics actually support your view?
Especially for multifamily, you want to look at population growth, household formation and whether people are moving away. In NYC, none of these factors are really a concern—in fact they’re all positive indicators for multifamily investors here.
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Chad Tredway: Overall, what’s your view on the multifamily asset class in New York City?
Victor Calanog: Beyond the subjective commentary—“New York City will always be the best because of what an amazing city it is”—there’s a solid argument to be made about why it’s so attractive to investors: supply versus demand. Manhattan is restricted to 28 square miles—so at this point you can build vertically or rezone areas, which creates a cap on the supply growth you can have.
“On the whole, demand to live in NYC should remain strong, and rents and values should stay high.”
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