Navigating The Shifting Rental Market with Jay Parsons, Principal and Head of Investment Strategy at Madera Residential
Willy Walker: Welcome to another Walker Webcast. It is my pleasure and honor to have my friend Jay Parsons here with me today in our Zoom room in Denver to talk about all of the great data and research that Jay pulls together, manages, deciphers, and puts forth to his partners at Madera Residential. Jay, it's great to have you here. Thanks for coming in.
Jay Parsons: Thanks for having me, Willy, excited to be here.
Willy Walker: It's really great. A quick background on you, Jay. You were chief economist at RealPage before going to Madera. You graduated from the University of Maryland. You're a Terp, a turtle, which is great. Close to my heart.
Jay Parsons: Fear the turtle.
Willy Walker: Father of five. You've got your hands full at home.
Jay Parsons: Yes, sir.
Willy Walker: And a suffering Dallas Cowboys fan, which, as a Skins/Commanders fan, I have to tell you, of all the things that I want to feel sorry for you about as much as my colleagues in Dallas know. I grew up with the Redskins competing with the Cowboys and have always loved that rivalry. You all suffering.
Jay Parsons: You're having a good year.
Willy Walker: We are, except, as you know, two losses in a row. But I think potentially against the two best teams in the NFL. We'll see how they go. Jay let's start here.
After NMHC, at the beginning of this year, you came back from NMHC, and you said, “A good conference. Here are my takeaways about what 2024 might look like.” First, you said, “Optimism is back in the market.” Let's put up this first slide that we have, which shows apartment sales volumes falling to their lowest levels in the past ten years. That's the flip side of it in the sense that the optimism that we saw at the beginning of the year would have led you to believe that we were going to see a huge boom in activity as it relates to trading.
Jay Parsons: Yeah.
Willy Walker: Other than the general sentiment that optimism is back in the market, transaction volumes wouldn't tell you what's there. Why haven't transaction volumes kicked in, if you will, in ‘24 like projected?
Jay Parsons: It's a great question. And that's definitely been the biggest, I think, miss for me and a lot of us this year, you know that. And I think the very high retention rates we've seen are a different topic. I think a couple of things. The buyers are there. People want to buy, my company wants to buy, everybody wants to buy, but there is not one seller. And I think a lot of it stems from the fact that we're not seeing the distress forced sales that everybody expected to see so far this year. And because of that, we've actually seen downward pressure on cap rates, as you know. And it's a seller's market. There are more buyers and sellers. It's tough to make things happen unless you're willing to push into mid-fours.
Willy Walker: What do you think makes that price capitulation happen? In other words, you had Paul Thrift on your podcast last week. We sold an asset for Paul in the south of Denver last week at a four-and-a-half cap. That was a great sale on his part. But what's your sense as it relates to what's holding back transactions and what makes it flip? Clearly, one would sit there and say, “Once we get back to positive leverage, people can start to actually transact.” But we saw cap rates slowly move up. But now, all of a sudden, we've seen borrowing costs start to catch up with cap rates. And we were, for a quick instance, in Q3 with a significant margin for positive leverage. On a lot of deals right now, both selling and financing were back at either equilibrium or potentially negative leverage. Rates stay high, do transaction volumes stay low, even though there's this big pent-up demand for products.
Jay Parsons: I still think eventually we have to see sales volumes pick up. There's so much appetite for housing, both multifamily and for SFR/BTR. I think we're seeing more buyers. We've seen some institutional players say, “Hey, we're going to accept a pretty weak year one in the pro forma because we believe in the mid and long-term story for multifamily.” I think you're gonna see more capital start to move in that direction, particularly now. The other thing that happened, by the way, as you know, was earlier in the year, I thought we'd see rate cuts earlier than we did, and it didn't happen until much later in the year than people first thought. Now, that started to happen a little bit. The Treasury is still a little bit sticky, but I think as that happens and supply goes down, we still see great demand in the market. The fundamental story is there. I'm still pretty bullish on the overall direction. The second part of that is I think a lot of the reason volumes are so low is because the value-added guys are out of the market completely right now. A lot of the short-term buy, fix, flip, that's completely gone, and we've not really seen, while the class A market, the stuff the merchant builders that's settling in the mid-high fours. We don't know where this busted Class C value-added stuff's going to go. I think that still has to play out, and where you know at what point that has to be pushed into the market. I think that'll be a big story next year as well.
Willy Walker: You mentioned rates, and you want to give your outlook on them. It's so interesting because the Fed came out with their 50 basis point cut, and all we've seen is that the rates have gone up subsequently. Clearly people were sitting around saying, “It's the fear about tariffs and what might happen on the tariffs front.” You also have plenty of people doing reports related to the inflationary pressures that would come from the broad, across-the-board tariffs that President-elect Trump has talked about. There are plenty of people who sit there and say, “That was just rhetoric during the campaign, and he won't implement all of them.” But there was a really interesting, I think it was BofA research report that CNBC put a slide up on last week, which showed those products that have been impacted by Trump's first term tariffs and those that hadn't and what happened in the CPI. Clearly, those that have been impacted by the tariff's costs went up, and those that hadn't went down. And it's hard to think that we're going to get away, if you will, with broad-based tariffs and not have that be inflationary. At the same time, there's also this general outlook that the economy picks up and continues to grow at a high rate. What's your take? Should the ten year stay in this 4 to 450 range? Do you think that it's a 450 to 5 range? Do you think that there's something that says that it comes down materially because China is weak?
Jay Parsons: First of all, I think that the two things that make every forecaster look foolish are oil prices and interest rates. Take everything with a grain of salt here, but I still think we're going to see it come down. The reason is while the Fed is supposed to be immune to political pressure. They are people, and there's so much pressure right now related to mortgage rates. We're a country. We're still American Dream is homeownership. We want to keep two-thirds of American households as homeowners. I think that there's going to be enough pressure to reduce rates. We see people buying homes again. That will continue to cut rates a little bit. I don't think we're going to get back to where we were before. I don’t think anybody thinks that. But I'm still a glass half full, thinking that we're going to get back below four at some point.
Willy Walker: I so hope you're right. One of the other things in your post-NMHC analysis last year was the heads-on-bed strategy of how operators would try to maintain occupancy levels even as rents went flat. We have a slide that shows this Jay. Talk for a moment about that strategy and how that's played out for operators this year.
Jay Parsons: Sure, I was very bullish on demand going into this year, the front door demand. And that's proved to be true. The back door story, I think, has been a really interesting surprise. In fact, Joe Fisher at UDR mentioned the same thing and to the surprise of retention this year. We have a 50-year high in apartment supply. You'll have more options than ever, and retention rates will keep going up. People are staying in place. And the instant gut reaction is people say, “The move-outs to purchase are at low levels, that's why.” Move-outs to purchase, even in boom years, are less than 20% of move-outs for apartments. That's only a part of the story. Most moves are for more normal things. People move to different apartments, different cities, whatever. I think a lot of what's happened is what you mentioned; it is heads on beds strategy going into this year. Everybody knew their retention was an issue. You knew you were competing for these new leases, all the supply. You knew that you had other companies trying to get your renters out and they're offering concessions to lure them away. And I think there was a very purposeful strategy throughout the industry to say, “Hey, look, we've got to get back to the basics. Occupancy is always important, but especially right now, we've got to protect that back door.” Your demand is not just for the front door; it's also for the back door. We've seen, and I've talked to property managers throughout the country who have really prioritized doing all the little things, not just the renewal pricing, but if you're sending out your renewal 30, 60, 90 days. Whatever it is in advance, it's a manageable number. And that tenant, that resident is having a good experience, they're more likely just to renew and not shop around. And I think that strategy, there are a lot of other factors, but I think that the heads-on-bed strategy throughout the industry has really paid off.
Willy Walker: I guess the question I'd have there is, first of all, mobility. The September number of 285,000 jobs scared a lot of people. And one of the reasons why we see rates go up so much is that people thought that the Fed was going to slow it down. But I was at a Real Estate Roundtable meeting last week with the head of the Richmond Fed, and he was talking about the fact that right now, they're seeing about 100,000 monthly job ads, but that he watches the firing rate and the firing rate is at almost a 25 year low. What you're getting right now is the 100,000 jobs per month is looking back to 2014, as far as a corollary goes, that's not robust job growth by any measure. At the same time, with almost a quarter-century low firing rate, employers are standing still, and therefore, employees are standing still. Therefore, not moving from Charlotte to San Francisco and staying put gets you into that renewal strategy. But then talk about the amount of supply because you're very straightforward. We have a slide in here that shows the dramatic amount of new supply that's come on. We've delivered more units through Q3 in 2024 than we have since 1987, I believe, is the stat that you put out there. When someone's sitting there in the market, they're staying in, and there's all this new supply. Why is it that people are able to get renewals at 3% to 5% growth rather than someone moving across the street to a brand-new apartment building?
Jay Parsons: I think some renters are not making the smartest financial decision. They're choosing what's the easiest decision and that the friction of moving is outweighing what's really a relatively small financial benefit of moving in terms of a lower rent. Now, those who are moving a lot of times are getting a similar rate and a newer, better, higher monetized property for a pretty good rent. We're seeing that demand moving up in the market. But again, you're still preserving a pretty good portion of your renter base. The supply is an incredible story. We are, as you mentioned, nine months into the year, the highest number since ‘87. We are going to finish the year with the highest number since the mid-'70s. The fact that we're seeing this much supply and yet still seeing demand that's not fully on par with supply. But we're going to have the second-best year for absorption other than 2021, going back three-plus decades. It's a really remarkable story that speaks to the resiliency of this sector.
Willy Walker: Does it also speak to the cost of housing being completely uneconomic for someone making the median income in America? Therefore, the gap between what it costs to rent and the cost to own right now, given where rates are and given supply on a single-family side, is such a big bridge. But you said the move-out is only 20% of the market on a typical basis.
Jay Parsons: Yeah, of the move-outs. That's for the high end; it's definitely a factor. But I look at it too. The best years for the apartment market were great years for the home sale market. 2021 record year absorption, a great year for the home sale market. Ultimately, I have a counter-contrarian view on this. I think that long term, we need to see the for-sale housing market get healthier again or sustain the type of rental demand we're seeing. Because of the impact that home sales have on the broader market in terms of buying homes and all the impact on consumer spending going to Home Depot and Lowe's. Doing stuff, hiring contractors, and everything else that happens downstream that boosts apartment demand. I think it's a part of the story on retention side. But again, in the long term, I tell people time, I think every rental housing investor in America should be rooting for a stronger for-sale housing market long term.
Willy Walker: It's interesting because I had Ryan Marshall, the CEO of Pulte, last week. And when I dove into exactly what you just talked about, and I talked about undersupply on multifamily in the next three-year outlook, what was interesting to me was Pulte is going to build 29,800 homes this year. And I pushed him on, is that going up to 1.5 times that number? You're going to be building 40 plus thousand homes like they were in 2003, ‘2004? And he was, “No, right now there's no desire on their part to try and raise their output and get back to a business model that they were in early 2000, which was to grow, share, and produce a lot.” And we actually put up a slide during that conversation, which talked about how incredibly they've done in slowing down their growth as far as units but then continuing to increase their margins. One of the things that you talked about in your outlook after NMHC was that expenses will outstrip revenue growth in multifamily. Have we seen that this year? One of the things that Ryan did say that I thought was very interesting was that their cost of manufacturing is on the single-family side are down in the low single digits. Their inflationary pressures that we're very much in the single-family space in 2022 and 2023 are gone, except their land cost is still in the low double digits. And that's the only thing that's really pushing their costs up right now. Talk about multifamily in that rent growth versus cost growth piece.
Jay Parsons: On the operating side, it's been interesting because, obviously, rent growth preceded some of the massive expense growth we saw. Obviously, apartment operators, as you well know it's property taxes, it's insurance, but also payroll has gone way up. When you're in a down market, marketing costs go way up. That has moderated this year. We've seen after insurance skyrocketed, in some cases 50 plus percent, 100 percent in the last few years. It's been flatter for most investors this year. Property taxes have come in a little more favorable. But even that said, a lot of owners right now are happy with the moderation expenses. To your point, in a lot of markets, expenses are still growing faster than revenues because, in a lot of markets, new lease rents are negative, and there's occupancy pressure. And I would say it's probably not as quite as bad as people thought it would be going into this year again because of the strength of the demand and also the strong retention I mentioned earlier and being able to still get 3% or 4% renewal trade out. But it's still tough. Everyone's trying to figure out what everything they can do to save on the expense side. And there's been a lot of creative strategies to do it to protect NOI as much as they can.
Willy Walker: One of the things that I thought was interesting, Jay, is that if you look at the homebuilders, there's been massive consolidation into the public homebuilders. And you look at your comment as it relates to the management of multifamily. And I would think that the increased institutionalization of both, if you will, that multifamily institutionalization will mirror what's happened in the homebuilders' space in the sense of economies of scale, very professionalized management practices, and driving costs out of the system. Do you agree with that, or do you think that the middle market operator will be able to compete with the big behemoths in the future?
Jay Parsons: Yeah, that's a great question. I think obviously we're seeing some of that. I think we'll see more of it. I think the bigger impact is going to be on the development side. And you mentioned the home builder side. There's been, in fact, one other person I talked to recently, Hugh Frater, who made the point that there is so much consolidation among homebuilders. We have not seen that yet on the apartment developer side. But talking to Paul Thrift, another big builder with JPI, made the same point. Obviously, these are larger NMHC top 20 developers. They see an opportunity to really become bigger, relatively speaking, in the market because they can command more efficiencies of scale. They can take the same materials and take the same crews and start copying and pasting in different markets and locations much easier than a smaller builder. In the home builder space, where we saw so much consolidation, I think that there's going to be a lot of pressure -- apartment development is highly fragmented. I'm going to get the exact stat wrong, but it's something like the top 25 developers in the U.S. or something like less than 20% of start in 2022. It's going to go way up in terms of the big players and what share they have because they're able to buy and build much more efficiently using technology to find cost savings as well. We're seeing a lot of very creative things that your average local builder who builds a few projects a year is not going to be able to do. I think that's where we're going to see a lot of consolidation.
Willy Walker: Interesting as you think about that in the sense of secured and unsecured financing. Then, there is also the role that the banks play. Because if you look at single-family and multifamily, neither Fannie nor Freddie play right in the construction space. There's not a difference between the two markets on that. And yet, at the same time, in the single-family space, you have clearly seen massive consolidation into the big homebuilders. As you just said, you haven't seen it in multifamily. But then you think about secured versus unsecured borrowers. In the multifamily space, the large REITs right now are, generally speaking, doing unsecured borrowing off their balance sheet, which given where bond financing has been good but not great vis a vis the agencies. It's interesting to think about the future of the agencies and their role as it relates to secured financing versus unsecured financing. And whether there's something there from a cost of capital standpoint that would allow some of these major REITs, whether on the construction side or on the hold side, to better compete with those who are going out to do secured individual financing with the agencies.
Jay Parsons: You touched on so many big things that are going to happen is number one on the REIT side, going through the recent earnings calls I just went through. Almost all of them know they have a unique opportunity to build, but others can't because of their lower cost of capital. We're seeing AvalonBay, MAA, etc. They are starting projects. AvalonBay is building in Austin at a time when no one wants to build in Austin. But they see a long-term opportunity there. On the other hand, you mentioned the agencies. There's a lot of movement right now beneath the surface a little bit to create some national construction fund that's backed by the agencies that would then lower the cost of capital for other developers to build where there's some guaranteed exit to Fannie or Freddie after that project reaches stabilization, which takes up that takes out the lease-up risk. I think that's probably something we're going to see some bipartisan interest to eventually bridge that gap, whether it's directly injecting the agencies in construction lending or having some agency-backed construction fund that they are tied into. That could be a real game-changer.
Willy Walker: I was going to hold off on talking about the implications of the election, which you did a lot of work on pre-election. This is what a Harris presidency or a Trump presidency would mean. And I want to talk about that in a moment. But while we're on the agencies, let's just double-click on that for a moment. Do you think they get spun?
Jay Parsons: Some people thought they got spun during the first Trump administration, but it didn't happen. I hate to put out the typical economist, maybe, but I put it at 50/50. I think there's a real chance of it. But I don't know if its top priority is big. It takes a lot of willpower to make it happen. And I don't know if that's going to be a priority.
Willy Walker: Yeah.
Jay Parsons: I know a lot of people are rooting for it.
Willy Walker: I think there are plenty of people who are “Rooting for it.” There are a lot of variables there, as you well know. Mark Calabria, who was FHFA director in the last Trump administration, would tell you that they were on their path to doing it had the pandemic not hit well down that path. Whether Mark goes back to FHFA or whether he goes to Treasury to be the counterpart to whoever is in FHFA to work on it is a real question. And then I guess the other piece to it, which is one of the few Cabinet positions that has not been announced yet, is who the Treasury Secretary is because whoever goes into that role will obviously have a big voice in whether it's, “Let's do it through administrative action or let's go take the legislative route.” And then clearly, you look up to Hill to see whether French Hill will become the head of the House Financial Services Committee or whether Tim Scott will be the head of the Banking Committee. Those would be the two people in the House and the Senate, respectively, who would focus on a legislative solution. But the other piece to it, as you probably know, Jay, is that there's nothing in the legislation that says, “It has to go through a legislative reform.” In other words, they don't need a vote of Congress to spin them back out. Then, there's also that discussion about borrowing costs and the fact that borrowing costs will go up by 5 or 10 basis points because they would have an implicit government guarantee rather than an explicit government guarantee. And I talked to Calabria about this issue a couple of weeks ago, and Calabria said to me, “The issue with it, Willy, is that there actually isn't an explicit guarantee for them now that they're in conservatorship. The market thinks that because they're in conservatorship, there's an explicit guarantee, but there's nothing in the enabling legislation of Haro which says that there's an explicit government guarantee.” Mark's point was that if they got spun that 5 to 10 basis point, that lots of people would try to some degree, fearing the market may not materialize. It was an interesting discussion about what might happen. I think the other piece to multifamily that we have to be conscious of is if you look back to when Ed DeMarco put caps on the multifamily volumes, that was, I think, done to say, “Hey, private capital should have a place in this market and we don't want private capital in the multifamily space to turn into private capital in the single-family space.” Because you've got an 80% market share of Fannie and Freddie in the single-family space, and you've got a 40% market share in the multifamily space. The big question that I have is, let's just say that they get spun and spun in a way that's just to spin them back out and bring in private capital. What's the regulatory overlay, if you will, as it relates to the role they're supposed to play in the multifamily space? And do they keep the caps on them? Do they pull the caps back? Do they allow them to get into construction lending, as you pointed out, or not? There seem to be a whole lot of question marks about that. But I'm interested in your 50/50.
Jay Parsons: I actually think you can make a case that they could better achieve their mandate long-term by being spun out. That might be a controversial statement because we are on a path prior to the election of seeing more regulatory scope creep through Fannie and Freddie's debt. We saw a movement to attach certain start-off pretty basic things like notice periods for renewals. But there was a big push, as you probably know, among tenant rights advocates to attach rent control to Fannie and Freddie's debt. And I think eventually we probably would have seen some version of that for some type of it would look like something I don't know. And that would have pushed more, I think, borrowing to the private market as well. I think now that obviously elections, we don't know what's coming four years from now. There's still, I think, if it's spun out, I think that does in some way protect Fannie and Freddie from further politicization of its real mandate, which is keeping liquidity in the sector.
Willy Walker: I concur on that one wholeheartedly. One of the other themes of this year, Jay, which you rightfully pointed out back in February, was quite at that time a counter to what people were expecting, which was limited distress in 2024. Why is it from your analysis that we've had such limited distress in the multifamily space in ‘24?
Jay Parsons: This is a topic that's been really interesting, and I'll give you that. So this summer, there was a big headline in The Wall Street Journal, and it was all about distress in commercial real estate office and multifamily in the same sentence. A lot of it used debt funds and CMBS data to tell a story about rising distress. To the average layperson, it looks like, “Wow, these are big numbers.” It was 80-something billion dollars of potential distress, what they left out there's, I think, $2.3 trillion worth of multifamily debt.
Willy Walker: And we have a slide on that. We ought to put up now for people listening to this to see because you have a slide that shows 2.3 trillion outstanding and then 80 billion of potential distressed debt. It's 3% or something.
Jay Parsons: You well know this for those who are listening. A lot of people don't realize that CMBS and debt funds are just a tiny percentage of all the films. The reason we talked about this is because Fannie and Freddie are so big. The delinquency rates for the Fannie and Freddie stuff are still, I think, at 0.4 or something percent.
Willy Walker: We just did earnings. This is a public number, but we have seven defaults in our $63 or $64 billion at-risk multifamily portfolio. It's ten basis points right now for us as it relates to defaults in our portfolio. To your point. It's not a look. We don't like defaults. But the bottom line is, relatively speaking, it's a very small number.
Jay Parsons: Yeah. And we've seen lenders are generally able to work with borrowers on figuring things out. And it seems every time there is a foreclosure situation, it's always something else. There's some sticky situation that we had the San Francisco, one where there was a rent strike, and the city backed the property. Another one in Texas had a fraud story behind it. It's always something else. I think that people generally believe in the long-term story. Therefore, we're willing to work through the current issues we have related to short-term floating rate debt. There's going to be some mess that still has been worked out there. I don't want to totally downplay the stress, but it's not going to be my fingers crossed. Everything is probably not going to be the massive shock that some people think we're going to see in the market.
Willy Walker: One of the things that you did point out, though, on a recent podcast that I listened to was, I believe, in their Q3 earnings call, New York Community Bank talked about a massive step up in their multifamily default rate. And what you tied that back to was the inability to push rents up to market when a rent control unit comes vacant in New York, and that inability to push rents up to market has had a massive impact on some of the properties in New York. Talk for a second, Jay, about that, if you will. Many housing advocates would sit there and say, “Oh, we want to maintain affordability, and therefore, that rent shouldn't be able to be stepped up. And at the same time, it's having a pretty significant impact on some New York lenders.”
Jay Parsons: Yeah. For those we don't know, like in 2019, there was a big change in New York law, which basically installed vacancy control for rent-stabilized apartments. That's something half the New York City rental stock is under some form of rent stabilization or rent control. And with vacancy control, now they can't reset rents to market once somebody moves out. The problem was almost overnight, and these properties were devalued by something like 30% or 40%. In some cases, the property is worth less than the loan. And it had been considered a very safe loans for these rent-stabilized apartments. All of a sudden, coupon clipping-type stuff is high risk. New York Community Bank and some others had very high exposure to New York's rent-stabilized loan portfolio. And it's been a real drag on their entire bank, unfortunately. It's a really unfortunate situation. And I think we're at a point right now where one of the big stories, I think, in this next cycle, is going to be the challenge of these older properties that you're being put in a situation where if you invest the capital to improve the property, you have to raise the rent. You risk gentrifying your label. If you don't, you risk the absentee landlord label because these properties are being sold, and they can't. Some of these units in New York are sitting vacant because they can't afford to bring them back to market. And it's totally inefficient. Sadly, some of these rent-controlled properties in places like New York, Los Angeles, and elsewhere are becoming almost illiquid. Unfortunately, it's tough to make a strong investment case for some of these properties aside from a charity case.
Willy Walker: You talk about older properties and the ability to push rents or not, as the case may be. You have a slide here that we'll put up that shows the supply issues we've talked about the most supply year to date since 1987 and then what's supposed to be delivered in Q4. And yet, at the same time, Jay, last week you came out showing significant rent growth in undersupplied markets. And you looked at Pittsburgh, and you looked at some of the other Midwest markets that have had limited supply and, therefore, on renewals, are able to push rents 5%, 7%. Then you went into an analysis that showed that in those markets, you've had stable rents, and you're able to get high renewal rates today. And then you look at the oversupplied markets, and lo and behold, you're not being able to get that same type of rent growth. Talk for a moment about your thoughts on those markets and whether, for instance, would you put capital into Pittsburgh today because it's getting the best renewal growth in the country. Or are you looking, and is Madera looking at higher growth markets that today might not be getting the renewal growth that they once had but have a better long-term outlook to them?
Jay Parsons: Yeah, that's a great question. First and foremost, I think this topic is a great example of why there's so much noise around rental affordability right now. And I don't want to downplay it too much. There's obviously a shortage of affordable housing, but affordability is such a bifurcated issue. What we're seeing is that in the investment grade, institutional grade, rental housing market, affordability is becoming more of a tailwind than a headwind. The reason I say that is these markets are without supply to your point. We're still seeing rent growth. That tells you it's about supply, not about affordability. Now, the second thing I would say is that when you look at some of these markets that are seeing a lot of renewal growth, you mentioned Pittsburgh. As you know, Willy, the problem in these markets is it is very difficult to get scale. And everybody needs, especially nowadays, to talk about efficiency, operational efficiency. You're trying to build potting of properties for better management. It's extremely difficult to do that in a place like Pittsburgh or a lot of these other Midwest markets. I think there are a few Columbus, Kansas City, and Indianapolis; we're seeing those maybe emerging as exceptions. I think we'll see more institutional interest in those markets, but it's tough. In terms of what we're doing in Madera, and I think a lot of others, we're more interested in the long-term story of some of these Sunbelt markets, particularly the ones that are larger, more economically diversified, have great demand tailwinds and aren't going away. But we know at this point we're going to have significantly less supply over the next few years like those markets, and we could generate scale. Those are the markets that are particularly attractive to us.
Willy Walker: You have a slide that talks about Sunbelt versus Coastal. And then I'm going to, in a moment, have you talk about the difference between coastal cities and coastal suburbs? Let's talk about Sunbelt growth versus coastal growth. This slide very clearly shows that Sunbelt growth and rent growth are better than coastal growth. Talk for a moment about that disparity between these two. And the graph looks like it tracks closely, but there are some very significant points where they decouple. Talk about that analysis that you've done.
Jay Parsons: First, I'll tell you a funny story. If you go back to the early 2010s period, I remember I would sit in the office. I was invited to speak at one of the major life insurance companies in New York City. And I was making the case for, “Hey, I think we're seeing signs. Look at these demand numbers and early rent numbers. I think we're seeing signs that these bigger Sunbelt markets are going to outperform the coastal markets.” And I've probably been blowing up on plenty of things, but I'm going to pat myself on the back for this one. And they looked at me like I was crazy because, at that time, the view was, “Hey, the coastal cities are the safest places to be coming out of a great financial crisis and everything else.” But I think what we really saw throughout the great financial crisis and early on after that was really these larger Sunbelt cities graduating past the awkward teenage years and becoming more mature, stable markets, particularly the bigger ones, the places like Dallas and I know Denver, where we are now, is not typically Sunbelt, but generously lump in some of the mountains because they behave pretty similar. And I think sure enough, we ended up seeing that throughout that entire decade, people always talk about supply, particularly some of the Wall Street guy's supply supply supply. Until recently, the supply numbers were never that big. They were leading the country in terms of total units. But relative to demand, the numbers just weren't that big. The demand story was too big; it was outpacing supply. What happened is that throughout that period, we saw the better Sunbelt markets outperform on rents relative to these coastal markets. And a lot of that because it's not about supply; it's about supply and demand and the demand story which is that good. More recently, it's finally flipped like the broken clock. That's right, twice a day. Now we're at that point where there's so much supply that these coastal markets are outperforming. But the way we look at it at Madera, the way I look at it personally, and our partners at Madera have a very similar view as mine, is that supply is the easiest thing to forecast, and we don't know what's going on. We talk about rates and our stuff, about the economy. But we know the supply; we start to push forward a couple of years. Supply is going down. And then you think about the demand story; barring some type of shock, what could change the overall trajectory of the major Sunbelt markets? The affordability is still there. The rents are about 50% cheaper in these major Sunbelt markets relative to the major coastal cities for the most part. The jobs and the regulatory environment are factors that change over the course of decades, not years. We still feel really good about that. I think as we see supply start to come back down, these markets will be outperformers again.
Willy Walker: Now talk about coastal suburbs versus coastal metros. One of the things I thought was interesting was, when you were talking about renewal growth, some of the California markets, other than L.A., have actually got pretty good renewal rate step-ups, again, undersupply of those markets. But one of the things you pointed out recently was that the tech companies calling people back in the office may be driving a little bit of the step up in renewal rates in markets like San Francisco. But dive in for a second, Jay, on coastal suburbs versus coastal metros and the growth you're seeing there.
Jay Parsons: As we're getting to it, I think the Midwest is well positioned. I think the big Sunbelt markets can be well positioned compared to some of the smaller ones. And I think the third category, as you're alluding to, is these coastal suburbs. I've got to give credit to I think Avalon Bay really pioneered the strategy really focused on that. Because if you think about the whole investment thesis around the coasts, it's really based on high barriers to entry NIMBYism. The reality is that cities generally want housing; they want apartments. And it takes a ton of money. It takes a lot of time. But I have a lot of capital in these last couple of cycles, and more than willing to take the time and the capital to do that. It may take you a lot longer than those in the Sunbelt, but you still do it. We see high supply pressures in the institutional submarkets of places like Los Angeles and Seattle, parts of D.C., etc. What really stands out, though, is in the suburbs of these big coastal markets, particularly suburban Boston, the east side of Seattle, parts of the Bay Area, even parts of Southern California, and certain parts of typically northern Virginia. Some of these places are really difficult to get land and build. You have NIMBYism. People show up at the city council meeting and say, “No more apartment towers in my backyard.” They don't want any of that stuff. And that's where the real barriers to entry really are. And yet, you still can have great demographics and great affordability stories. You have all those factors, but you're truly insulated on the supply side. Then the other thing I put out there, too, is that I think that the smarter investors are looking for those suburban cities that have relatively sane city councils; red or blue doesn't matter. But you have to have a predictable operating environment. I have this conversation sometimes with some of the Yes, in my backyard, the NIMBY movement, and tried to say, “Look, if you really are serious about building more housing, it's not about creating an environment to build more, but it's also you think about you have to operate there, too.” You can't say, “Hey, we want to build more, and we're going to incentivize investors to build and then demonize you once you actually operate it.” You have to be part of a city that wants a more collaborative relationship with builders and operators where you can create compromise and win-win situations together. I think we're able to see cities in suburbs that are willing to have those productive relationships. I think we see in a lot of these suburban places it's not as hostile to apartment owners. Those spots, I think, could be very well positioned over the next couple of cycles.
Willy Walker: It's really interesting you talk about consistency. When I talk to our clients or when I'm asked by investors in Walker & Dunlop, it is 4.50,10 year problematic, and I'm 4.50, and 10 year isn't problematic as an actual coupon rate. It's that one moment it's 3.75, the next minute 4.50, then it's 4.25, and it's this inconsistency where rates are that make it so impossible for our clients to either establish a cap rate that makes sense or establish a financing cost that makes sense to them. And therefore, from 2022 into 2023, as rates were going up extremely fast at 75 basis points per Fed meeting. People couldn't transact. Their cap rate didn't make sense. And it's interesting to me, Jay, that you're talking about city councils, whether it's blue or red, forget about that. It's a consistency of outlook that allows developers to say, “I like this, I don't like this.” And I find it to be really incredible that there are plenty of city councils across the country that aren't getting that memo. Again, either side of the aisle says, “We're going.” And I think one of the other things about it that is an interesting backdrop to the next four years is that of all the things either good or bad about President Trump, the one thing we clearly know as far as his behavior is that he's not terribly consistent. He moves from one place to the next. I think that's a fair thing to say. As a result of that, it will be very interesting. The Wall Street Journal came out today and talked about the need for a Treasury secretary, it essentially was saying all these other nominations that you have, whether it's in the Energy Department or whether it's here, there, not that, but the capital markets need stability. They need a steady hand on the tiller if you will. And that they were trying to basically say to President Trump, please put someone in that job who will give us a steady outlook on the capital markets. And it is amazing to me, and that's what we're looking for.
Jay Parsons: Yeah.
Willy Walker: Is some forward plan that says, “If I put a shovel in the ground here three years from now or two years from now, when that delivers, I'm not going to be facing a completely different either local, state or national economic situation.”
Jay Parsons: Absolutely. Real estate today is local. You look at the tragedy of St Paul, Minnesota. One election cycle could completely torpedo the entire performance of every investment in a city. And I tell people all the time, “Would you rather do a policy risk or supply risk? And if you choose policy risk, I think you're crazy because policy risk is unpredictable and almost permanent. Supply risk is predictable and usually temporary.” I think a lot of investors, in my personal opinion, have historically underplayed policy risk. I think now is changing, especially through the COVID era. But you need that stability. You need to know what the environment is like. By the way, again, red or blue, whatever the rules are, you seem to know what the rules are going to be. And then you can adjust to make that work or not work. But you have to know where the playing field is. You can't change the rules in the middle of the game. That makes it a really tough environment.
Willy Walker: For those people who are listening and don't know what happened in St Paul. Just for a second, talk about what happened in St Paul and then what happened in Minneapolis at the same time.
Jay Parsons: What happened in St. Paul is there was a ballot initiative that was almost literally written on the back of a napkin. It was a 3% rent cap straight, with no exceptions unless you want to petition the city to make your case that you need more than 3% for some really extreme reason. I never heard about this until the local apartment association folks showed up at the NMHC fall meeting, and they said, “Hey, this is what's going on, and I really need your help.” At this point, I think it was September. The election was in November. And everyone's like, “That's kind of crazy.” Sure enough, it passed because it sounded good on the ballot, and no one really understood its unintended consequences. And what happened to St. Paul this was, I think, 2021. I think they completely took them. You look at starts and allow them to completely evaporate. You look at the greater MSA, and you take Minneapolis, you take the suburbs, just like the rest of the country starts and permits accelerate. St Paul does the opposite. They completely took themselves out of the biggest building boom in a generation. The ultimate way to really drive affordability and availability for renters. And it was a real tragedy. And they've tried to unwind some of that. The mayor has done a little bit to try to do that, but unfortunately, it's still been a very challenging environment. There's nobody who wants to build there right now.
Willy Walker: And it's been a boom for Minneapolis. It is like Fort Worth, Texas, and Dallas and saying, “Okay, let's pass Fort Worth and Dallas, and one freezes it while the other one doesn't. Watch what happens.” And obviously, that ain't happening in Texas.
Jay Parsons: The Federal Reserve Bank of Minneapolis wrote a paper showing that this process, the economists call filtering, has actually happened in Minneapolis. They built many apartments and actually even built a lot of smaller rental homes as well, small apartments, which led to downward pressure on inflation for the entire part of that market.
Willy Walker: Let's talk about trickle-down a little bit here because you just published something on rents and C assets last week. There's a sense a lot of people, particularly my age around when Ronald Reagan was president of the United States, that trickle-down economics was something a lot of people were like, “Trickle down doesn't really work.” But actually, what we're seeing in apartment supply is a significant trickle down from you building a lot of high end, which drives down to the Bs and then to the Cs. And let's put up this graph on where we are on rent reductions in C-class apartment buildings. And lo and behold, the greatest savings to C-class renters are happening in those markets where, news flash, you've had a big supply at the top of the spectrum on A class that has gone down to B, gone down to C. Talk about that for a second.
Jay Parsons: First of all, whenever I post about this on social media, I try to avoid trickle-down because it triggers people in the wrong way.
Willy Walker: Totally. I'm sorry for bringing it up. The moment I saw Jay, that trickle-down happening in the sense of you starting up here, and it works its way through the system.
Jay Parsons: You're totally right. But yeah, that terminology sets people up with it the wrong way because of the word. But it's true. That's what's happened.
Nationally, when you look at Class C apartments, they're still relatively steady, solid rent growth. But there's a real split when you look at these higher supplied markets that you have on this list. And the biggest rent cuts happening in places like Austin are building like crazy are actually in class C. Here's what's happening. When you build a new apartment building a construction economy is typically class A plus, as you know. And they're pulling higher-income renters out of your A minus B plus. They're cutting rents and pulling people who are your higher income, B minus C plus renters. They're moving upmarket. And then on the C side. Here's what we don't understand about Class C. The people look at us and say, “Hey, they have the most affordable rents, flight to affordability, etc.” It's not quite that simple. The problem is that when you lose your better quality tenants, and I say, “In terms of income level affordability,” you lose those who move up because all of a sudden, they can rent something nicer, newer, better located at a similar or slightly higher rent. They have to cut their rents the most. The reason for that is that they can't go down to the next level. They have to get to people who couldn't previously afford any market-rate rental. They were looking for some type of subsidized LIHTC Section 8. Now, they're in a position where they have to cut rents substantially. And that's what's happening. The whole idea of filtering or the trickle-down concept is that you pull up higher-income people out of the more affordable housing and open up units to those who really need it. That's exactly what's happening in these higher-supplied areas. Building luxury apartments has a direct impact on low-income households. And now on the flip side, I will tell you to investors, I think it puts a real question mark on the long-term trajectory of Class C in some of these spots because it's going to be harder to push rents with those dynamics.
Willy Walker: Yeah. And if you look at this list that we had up, the big markets like number two Austin, number five Phoenix, and number eight Salt Lake are the markets where everyone wants to be at the high end. At the same time, those are the ones that have gotten the biggest price concessions on C class, which is fascinating.
Talk for a moment; you have a slide, Jay, that we ought to put up here that just talks about the demand at the high end. You have it broken down on the various income levels, and where you're seeing the most growth in the renter base is actually at the high end. Talk about this slide for a second and what we're seeing there as it relates to real demand growth at the high end of the market.
Jay Parsons: Yes, this is a great chart. Actually, it was put together by the Harvard Joint Center for Housing, a team using some census data. And it really dispels a common myth, which is one of the things there all the time. I talk to people outside of the industry; they think people are renting because they can't afford to buy, and they're all lower income and know our stand is that this is not some industry data. This is public government data showing that the vast majority of renter household formation over this last decade has actually been households making $75,000 and above. And that's what explains all this demand for class-A products that we've seen over the last really 10, 15 years. I think this goes into a little more depth. What was talked about earlier is that the greatest untold story about rental housing is the bifurcation of affordability. And by that, there's been incredibly ample demand at the top end of the market for what we'd call institutional investment-grade apartments in SFR. At the same time, we have a significant number of people who cannot afford any type of market-rate apartments or SFR. By the way, the vast majority couldn't afford it even prior to the inflationary run-up after COVID. And it's like two things that are true. We have a shortage of affordable housing and we have a ton of demand for investment grade class A and Class B apartments. I think, a ton of data points around this as well. It's one reason why we see rent income levels are so much lower in the institutional and regrade apartments and SFR relative to census data; you see where it says, “Half of people are spending more than 30% of income on rent.” Very few people living in an investment grade market rate housing are spending more than 30% of their income on rent.
Willy Walker: Yeah, you bring up that stat, which is it's actually interesting you posted on that last week about the fact that in 2000 and what was it, 2012 or 2013, the average American was spending 30.8% of their gross income on rent. And in 2024, it's 31%. It's up by 20 basis points between 2012 and 2024. There's this narrative out there that the rent burden has gone up dramatically. And plenty of people on Capitol Hill sit there and talk about how housing is unaffordable. And look, in the campaign, it was this consistent mantra of housing is now unaffordable. One of the things I said a number of times was that there was this big narrative that inflationary pressures in housing have gone up tremendously, and therefore, people can't buy their single-family homes. You can flip that and say, “65% of Americans actually own their home, and 80% of those people have a fixed-rate mortgage.” Therefore, their most valuable asset actually appreciated by over 50% on average over the last three years. And the Democrats never turn that back around and say, “There actually is a flip side to this. This is actually quite good.” All they wanted to talk about was housing affordability. But talk about that number, Jay, as it relates to, we're looking at a very similar dynamic as it relates to how much income is going to rent today in 2012 versus 2024.
Jay Parsons: But one other point on that, just real quick on the campaigns, is like I'm obviously not a political strategist, but I think there was a real political win for the Democrats to say, “Look, this many apartments and rental homes got built, and this looks like what it did to rents.” But instead, they never embraced that message of downward pressure on rents because of relative supply. Instead, it was other stuff. And it's been that the ratio of income spent on rent really hasn't changed in more than a decade. But again, what has changed is that there's a growing number of people who cannot afford market-rate units. We have a million more market-rate apartment renters today than we had prior to COVID, and they're generally spending 20% to 23% of income on rent. And again, it's both things that are true. And I think one of the problems of the narrative today is that it's not targeted enough. A lot of times, we're focusing on the wrong parts of the market. Everybody wants to blame institutions, private equity, and Wall Street. But that's not really where the problems are. It's really having to do with a shortage and an underfunding of affordable housing. People who aren't actually living in institutional investment-grade apartments in SFR. Everybody wants a boogeyman. The data is pretty clear, it's not where the problems are.
Willy Walker: Yeah. There's one other slide that you have that we'll put up here, which is just talking about income growth versus the cost burden for rental housing. And the one thing that I would point out on this slide, Jay, is that this is market rate. It's not across the spectrum because you and I have just been talking about the cost burden being at 31%, and this is dropping down to the 20s. And that's basically due to the data that you're pulling from the REITs, you're pulling from SFR. And then this is all market rate not more broadly on affordable and high end. This is the market rate. But this slide clearly shows that the cost burden on rent and rents being flat recently and where incomes have gone. Actually, the rent burden is coming down in market rate.
Jay Parsons: Yeah. In fact, this has been a big theme among apartment owners everywhere. Another thing that AvalonBay talked about in their earnings call was rent ratios, I think the largest by market cap apartment REIT, their rent continue ratios have been coming down, and everyone's seen the same trend. Incomes are growing faster than rents because of supply. And again, I think we're 21 straight months, where incomes have risen faster than new lease rents. I think that's going to continue. We're going to raise the entirety of the hump. That was great in 2020 and early ‘22, when rents are going faster than incomes. And that's a great story. I think it's a great tailwind for the multifamily and SFR investment thesis. Again, it's important to point out, “Hey, we still have a problem on this side of the market. There's a lack of affordable housing. I'm a big fan of expanding LIHTC among other things. I think we need to do some real things there.”
Willy Walker: Which do you think is going to happen, given where tax rates are going to go and given the House in the Senate controlled by the Republicans?
Jay Parsons: Reagan is the one who signed the LIHTC into legislation. And so this should be.
Willy Walker: But Richard Nixon created the EPA as well. We have come to understand that sometimes, where things are founded, it doesn't necessarily mean that their party sticks with them for a long period of time.
Jay Parsons: What I want to make the case, though, is that the low-income housing tax credit should be the ultimate compromise because it solves a progressive concern using a conservative philosophy, which is to incentivize carrot and stick with the private sector to solve the problem. And it's a voluntary program. It incentivizes investors and developers to solve the problem. The problem is it's too much red tape. It's too complicated. It's not funded enough. All those things need to be solved. Now, I will say to President Trump's credit, in the first administration, they put a lot of focus on the opportunity zones. There's great data showing that that led to significant supply in some of those areas. But I do think that I don't know if they're going to propose this or not; I do want to see the LIHTC expansion proposed.
Willy Walker: You can't disregard opportunity zones and what that's done and what it did from a supply standpoint. You also can't disregard the fact that during the first Trump administration, Calabria made a change to Fannie and Freddie to allow them to aggregate capital and build a balance sheet rather than passing all that capital through the Treasury, which now actually positions them to actually be able to be spun if that's something they want to do. Had they not been able to keep that capital on their balance sheet. Fannie's balance sheet now is between $80 and $90 billion. Back when they had a $10 billion balance sheet, there was absolutely no thought that you could get them spun because you would have to raise so much capital to do it. I think it's very interesting that there are a lot of people who sit there and throw tomatoes at what Trump did as it relates to housing in the first administration. Those two things were very clearly were wildly positive for housing.
Jay Parsons: I'll give you one more thing. This is something I actually forgot about until recently I did my research late during the election. Going back to the NIMBY crowd, not in my backyard, a lot of them forgot that Trump actually started a task force on removing regulatory barriers to affordable housing. But the problem is he started very late in his term, and it never went anywhere. Unfortunately, the Biden administration did not maintain it. But I hope he brings that back because that's potentially another real game-changer.
Willy Walker: And COVID stepped in. And I think one of the big things that we all have to keep in mind is like some of these anti-eviction laws that are in place in the House actually have a bill that's up right now to try and limit the use of some of the COVID era, any eviction laws to make it so that landlords can actually get control of their properties again. But I do think people sometimes forget all that COVID brought about as it relates to. Look forbearance on all Fannie and Freddie and HUD-insured loans and a number of other things that came out; those are fortunately gone now. But it did turn the world on its head for a certain period of time. And we're still in some areas trying to play catch up to getting back to the economy and housing policies prior to COVID.
Jay Parsons: Your 100% right. You mentioned the eviction moratorium. I think what is really unfortunate about that even four years later, in a lot of cities, they still treat it like there's an emergency. An emergency means you didn't plan for it correctly. Do you think about planning for these things? I think one thing I'd like to see cities do is better differentiate between fraud and real need. Almost any apartment owner and they'll tell you, “Look, if someone's struggling to get by and pay the rent, they want to work with them to come up with a payment program.” The fraud issues have really exploded since COVID-19. There are stolen identities. People aren't who they say they are. You have somebody with a shared wall leasing next to somebody who doesn't know who they are. There's a real risk there. And it still takes, in some cases, 6, 12+ months to handle that situation. I wish that cities could really focus on identifying fraud and separating from your true needs. And I think you'd see more of a collaborative approach between the industry and the government if we can do that.
Willy Walker: You mentioned the boogeyman of private equity firms is easy to throw darts at. And clearly, Elizabeth Warren, in the last election cycle, loved to do both, and Sherrod Brown, for that matter, loved to throw the blame at housing unaffordability at some of the big private equity firms that have gone out and bought single-family housing. You recently published a paper written by Josh Koven at NYU that basically debunks all of that as it relates to the cost of housing going up due to private equity firms coming in and buying a huge amount of the single-family housing supply. Jump on that for a second.
Jay Parsons: Josh's paper really piggybacked on a lot of other research. A lot of people don't realize this, but there's been ample research. There is a paper written a couple of years ago by somebody from HUD. It was about the declining homeownership rate in Atlanta. And didn't mention the fact that the homeownership rate actually had gone up, throughout this paper. But it was talking about institutional investors buying up all these homes and not mentioning that homeownership went up over the same period of time. That's just dishonest. Homeownership has been trending up since 2016. It may go down a little bit this year because of all the issues with buying, but it's been going up. Anyway, his paper really showed number one, that when investors came in markets like Atlanta and Phoenix, etc., it actually put downward pressure on SFR rents. And rents rose less than they would have otherwise if these homes had not been purchased. Number two, he also pointed out that the impact of home prices was actually much less significant than people thought. Anytime you buy a house, and you take it out of the for-sale pool in the rental pool, there's obviously an impact. But he made the point that one thing that every headline misses is that they talk about investor purchases. They always ignore investor dispositions and sales, and they sell a lot. That got completely, and in fact, an Invitation and American Homes for Rent on the individual home side; they're selling more than they buy. Because they're all doing build-to-rent stuff now. Mom and Pop are selling more than they're buying. We actually added more homeowners, and we added for sale homes over the last eight to ten years in our country. That's why we have a real problem. Anyway, it was a great paper, it debunked a lot.
Willy Walker: One of the other things you pointed out, Jay, in your write-up on it was the fact that from 2010 to 2015, it was those institutions that were stepping in to provide liquidity to the market to actually bail out a lot of the mom and pop homeowners and bought a lot. From ‘15 to ‘21, it was very difficult for the institutions to play because they provided the liquidity. Then, people who had better capitalized at that point were stepping back in and actually buying the homes. It was very counterintuitive to the extent that these legislators were throwing darts at the big private equity firms that actually played a huge role between ‘10 and ‘15 in providing liquidity and then were basically priced out of the market between ‘15 and ‘21.
Jay Parsons: Yeah. I asked Dallas Tanner about his reason last week. I was joking with them. I said, “Hey, you went from being like a hero in early 2010. Now you're the boogeyman everyone's trying to blame. But you're right. A lot of them shifted because of not even the political stuff, but a lot of the homes got to a point. The pricing and individual home buyers are usually willing to pay more than an investor because they're buying as a home, not as an investment in investors looking for, you know, an asset that really nobody else wants at a great discount a lot of times needs a lot of capital improvement work. The individual homebuyer can't pay for it. They're looking for that.” You look at the big institutional guys as they've all really shifted to new construction to build-to-rent; they see more efficiency of scale. It's easier to do one big check versus a lot of smaller checks. There are a lot of reasons why that shifted. They own less than 1% of the single-family homes in America. They own less than, I think, 3% or 4% of SFR homes in America, it is still a mom-and-pop market. And ironically enough, Senator Brown lost reelection after he opposed that legislation. Not cause and effect, but that's probably not going to go anywhere, at least for the next four years.
Willy Walker: Interestingly, I understand that he actually may run again in two years because JD Vance's seat is now open. While many people thought that was the end of Sherrod Brown, he actually had a chance to run again in two years. He might try and get back in and on a nonpresidential year. He probably plays a lot better than he does in a presidential year.
Jay Parsons: And for those who don't know, just people know, his proposed legislation would have put, I think, a 5% red rent cap on anybody who owns 50 plus SFR homes and created basically a tax disincentive to own these homes. Ironically enough, I think it's the tariff conversation that puts upward pressure on SFR rents. Because all of a sudden, anybody who owns 50 plus they have incredible market power, and then there's some more demand and supply. It would have done its intended purpose.
Willy Walker: I was with Senator Tim Scott, who's the incoming chair of the Banking Committee, last week. I was also incredibly impressed with Tim Scott's knowledge of the housing market and the overall banking system. And he was speaking to the Real Estate Roundtable, and he was just as impressive as anyone I've ever heard. And in the one Senate Banking Committee hearing that Sherrod Brown held on housing when he was chairman of the Banking Committee. You get through everyone having their five minutes and the chair has as much time to talk about anything that the chair would like. And Sherrod Brown jumps into asset condition at two assets in the state of Ohio. And I'm sitting here going, we're supposed to be at 30,000 ft. on real housing policy that's going to move our country forward. Chairman Brown decides to raise the issue with the HUD secretary and the head of FHFA for about two assets in his home state. And it's you're trying to go back and say, “Hey, I held this issue up at the hearing. Let's stay on the real issues that are important to housing policy.”
Jay, we're now looking at an oversupplied market. But then again, we look forward to a very undersupplied market. There's a graph that you have that we'll put up here that shows how we've gone from the most oversupplied to a wildly undersupplied market. And we're right now looking at 250,000 starts in 2024, which is going to drop us from 600,000 this year right down. You sit there, and you say, “Why aren't people building right now? Why is it that this data says to you it's a great time to be putting a shovel in the ground?” And you went and looked. One of the interesting things that I thought that I saw was the American Association of Architects that you went and looked into there and them being hired to go build multifamily buildings, just like at some all-time low, which I thought was a fascinating way to look at it. You talked about banks still underwriting standards that are very tight. You talked about the fact that the economics don't work. There's a great graph that you showed that said that in a recent survey, 92% of developers basically said, “The numbers don't work for me to put a shovel in the ground.” Should people look beyond all that and say, “Go.” Because of this lack of supply, which is coming up in ‘26 and ‘27, as you said previously, “If you're going to bet on regulation or bet on supply, supplies are really easy for you to bet on.”
Jay Parsons: Honestly, I don't think it's a bad bet. I think you see some of the REIT's are willing to do that. I think a couple of problems is that the traditional way is not going to work. The debt there is just way too expensive. And you have to find another way to make it work. If you have cash or a lower capital cost like the REITs, that helps. If you have a property tax abatement, like in certain states like in Texas, we're trying to do some PFC, HFC type deals like that. That makes a lot, especially in a high property tax state, which makes a big difference. But there's only so much of what's going to happen. But the other factor, too, is that I talked to a lot of people in the industry, I was just at ULI a while back. And the problem is everybody's telling the story. Every developer in America is telling the story. Every GP is talking about this low supply. But the problem is, I think a lot of the LPs out there still look at it like, “Okay, it's cheaper in their minds to buy versus build. There's a more immediate return of capital, so why do I want to go build if I can buy?” Now, whether or not you can actually do that is a whole different question. But I think it's challenging. You talk to a lot of developers, and it is still challenging to raise capital for the development strategy. And the other thing I think is really hard to do that we won't talk about enough is that we're still seeing heavy lease-up concessions, not just concessions, but actually base rent cuts as well on lease-ups. That makes your target pro forma rent for a new project very difficult to pin down. At the same time, you have high costs. My personal opinion is that it's going to take until these lease-ups stabilize. You figure out what the rents are going to be; those class-A rents are going to stick out. And then, that's a year out. In the best-case scenario, you're delivering a couple of years of late ‘27 or ‘28, even if some pick up, and even then, I think it's going to be fairly moderate. It took a perfect storm to get to a million units under construction, cheap debt, cap rate compression between asset classes, the COVID era, inflation on rents, plus the peak demand. We're not going to have all those factors back together again. I think even on a rebound, it will probably look more like 2018 or 2019 than it will look like ‘22, ‘23, ‘24.
Willy Walker: What does that mean for valuations? Because that clearly shows you're going to be in a supply-constrained market, particularly in some of these high-growth markets where people, you mentioned, AvalonBay building in Austin. But Austin is that one market right now of high growth that has almost 9% new supply coming onto the market. And Austin has been tough this year. But even there, AvalonBay building and people saying, “Hey, this is a great long-term growth market, I'll go into it.” But what does it look like in your mind for ‘26 and ‘27 as it relates to national rent growth? Have we had 3% national rent growth, or have we had 5% national rent growth? What does it mean in such an undersupplied market?
Jay Parsons: I think there are two answers here. There's what you want to put on paper, and there's what you think's the upside scenario. And for us, it's like I think we can feel safe for the 3% to 4% assumption. But I think you look at it, and there's a real upside. I don't think it's going to be COVID air at peak double digits. But I think you can make a strong case that it'll be in the 5%, 7% range in those years. Again, I don't know if you want to assume it in your underwriting, but I think that the upside is there if we continue to see demand like we're seeing.
Willy Walker: Obviously, rates are going to have a lot to do with this, Jay. But what would you then project as it relates to cap rates and cap rate compression? You're talking in that environment, 25 basis points, you talking 50 basis points, you're talking 100 basis points?
Jay Parsons: I'm honestly, I've been surprised. It's really come down. You go back to the rates conversation. I think the first rate cuts are already kind of priced into where properties were trading because they knew they'd eventually see some rate cuts from the Fed. How much lower can they go until we see real movement in the 10 year? But now I think you're going to see so much capital that's still chasing these newer vintage, well-located class A recent construction. Everybody wants the same things. There's a great quote from the CEO of BSR REIT, Dan Oberste, and he said something like, “The gazelle that we're chasing are class-A lease-ups in the big Sunbelt markets.” Everybody's chasing the same gazelle. And I think, because you believe in that long-term story, I think we could very easily see those numbers go a little bit lower.
Willy Walker: What's the red herring? What's the thing that happens here that could make it so this outlook, which is from reading everything you've been publishing, is very positive on multifamily housing over the next 3 to 5 years? What's the curveball that the market isn't thinking about right now?
Jay Parsons: There's a few things. Number one is any kind of recession risk, obviously. We still need economic growth. Recessions like The Thief in the Night are hard to predict, but they eventually hit. Obviously, if we do see something like, all of these tariffs will go through. That's going to put more pressure on construction, which could then put upward pressure on rents, even in an inflationary environment. This creates more challenges. These could resurface all of these regulatory risks in other parts of the country that don't currently have them. In the long term, I think the biggest structural risk to rental housing is regulatory risk.
Willy Walker: And given the recent election, you think there's a period here where that tones down? In other words, had Harris won, I'm assuming that being a real risk would have stayed higher in your mind. With Trump winning, that comes down a little. Or do you think that given so much of this is at the local level, there might actually be a counterweight to a national Trump win that could actually get local regulation stepping up to try and offset what Trump's going to try and do at a national level?
Jay Parsons: I think both of them are talking about removing regulatory barriers and all those kinds of things, but it's hard to actually move the needle at the city level, I don't think. Harris talked about building three million units above baseline. That wasn't going to happen. Trump's not going to do that either. It's tough to really have that big of an impact. I think the bigger thing is going back to the conversation about the agencies. They're so important to the health of this sector. I think what we will probably see at least for the next four years, is there's a reduced risk of further politicization of the GSEs. But that can certainly change again. If we start to put strings attached to agency debt, that's going to make everything more expensive and to push borrowers elsewhere, and that can have a real impact on the market.
Willy Walker: I'm constantly amazed at the fact that a lot of people on the inflation and the health of the U.S. consumer throughout post-pandemic through the last great tightening. A lot of people discounted or didn't think about the fact that our secondary mortgage market is the envy of the world. The fact that 80% of U.S. homeowners have a fixed rate mortgage under 5% allowed them to continue to go out to Target and Home Depot and continue to buy. However, if you were in Japan or the UK, you typically have a shorter-term floating rate mortgage from your bank. And as a result of that, as rates spiked, your purchasing power went down significantly. One of the main reasons our GDP growth continued to grow throughout that period, well in excess of our large other developed countries, is the secondary mortgage market. And to your point, underscoring the importance of Fannie and Freddie to the overall health of our economy and our overall banking system is just...
Jay Parsons: Yeah. And on the rental housing side. I was talking to David Brickman recently, formerly of Freddie Mac, and he told me to rent a paper hoping to steal the thunder here. He's writing a paper about the success story of the U.S. multifamily and how it should be a model for the rest of the world. People don't realize, even in our industry, how unique the U.S. apartment property is. This is a unique concept; we're starting to build more in Europe and stuff like this. It's being copied, but it's a very unique American concept. And he said, “Part of the success story is the presence of the agencies, the debt structure we offer here, and then the lack of rent regulation like those factors have allowed us to build a lot more, and then put. Unfortunately, things still got more expensive, a more healthy rental market than much of the rest of the developed world.”
Willy Walker: Yeah. Final question for you. As you look out and say, “Okay, I got to pick, and I'm going to keep you from pinpointing exactly where you'd put it.” But if you sat there and said, “We're going to either build or buy, it's either going to be workforce or high end, and it's going to be either Coastal Gateway or Sun Belt.” Run me through what Jay is saying today, “We're putting our dollars.”
Jay Parsons: If I were making an upsell, first, I want to say it's like, “I think you could be successful anywhere. You and I have both seen that enough. I think with the right strategy, the right person, and the right location, you can be successful.”
Willy Walker: But you're looking at a lot of macro data. And so as the macro data says to you, if you're going all in on something, I got a roulette table in front of you, and you got to put all your chips on one strategy. What is it?
Jay Parsons: In terms of what I want to do with our team at Madera, we're really bullish on the larger Sunbelt markets. We love the demand story. Supply stores are going down. Texas, Carolinas, Nashville, parts of Atlanta suburbs, and a little bit of Florida potentially. I think those markets are starting to see the great demand story is going to be there. You have lower regulatory risk. You have a lesser supply going forward. I think that it's going to be more Class A and B plus, where you have healthier financial dynamics among your tenant bases. You've got a newer vintage that requires less CapEx work. And then, on the construction side, I think both can work. I hate to hedge, but I think you have the right location. There are not a lot of newer supply at the top of the market, especially since some of those good-quality suburbs are going to be less urban in certain markets. But I think you build the right good stuff in some of these urban locations. And then on the workforce side, if you can build that middle market rents where you're B plus/A minus and you're competing with properties that are 10, 15 years older, but newer construction. I think that's a great strategy, too. That's what I'd be chasing. And we will be chasing.
Willy Walker: You will be chasing. Jay, it's a real pleasure. I'm super thankful that you are coming into our offices to do this live. It's been great. Your data is fantastic. You've got 95,000 followers on LinkedIn, which is an incredible number of people who follow your research. And I'm quite certain that when we publish this on YouTube, there will be many people who watch it. I was actually just looking at Ryan Marshall, who I had on last week, CEO of Pulte. In his first five days, he matched General David Petraeus, who was on the Walker Webcast about a month ago. And I wrote to Ryan today and said, “You're doing really well, catching up to David Petraeus in only five days.” But thank you very much. It's been a real pleasure.
Jay Parsons: Thank you for having me.
Willy Walker: That's great.
