In this week’s issue, we explore how rising interest rates affect multifamily investors.
This Week’s Top Headlines
We start off with the week’s multifamily insights and then dig deeper into multifamily in a rising interest rate environment. Let’s start with the top multifamily stories from this week.
- Happy Earth Day! Sixteen multifamily complexes in Dallas-Fort Worth will soon be powered by solar in the nation’s largest apartment solar panel installation project — Bisnow
- NYC: Multifamily continues to remain hot in this market, but a new report suggests a cooling ahead — CO
- Broader Cooling: This expert believes multifamily is in for a cooling due to the buyer-seller gap widening and a decline in sales velocity — MHN
- Steady Lending: Despite this projected cooling, MBA projects that the total commercial and multifamily mortgage borrowing is expected to hold steady at $895 billion in 2022 ($891 billion was 2021 total) — MBA
- MBS: The Fed’s pullback from MBS’ will spur short-term uncertainty in the market — HW
- Rents: Jumped 20% between March 2020 and March 2022, with Sunbelt metros rising the fastest — Realtor
- Affordability: Higher rents are leading to lower affordability, with rents eating up an average of 29.7% of household income, up from 24.8% last year — WaPo
Impact of Rising Rates on Multifamily
Main Takeaway: Interest rates are rising, and it’s time for multifamily owners and investors to reassess their risk and exposure to rising interest rates. But, this is not necessarily a bad thing for robust portfolios that have adequate cash flow and aren’t over-leveraged. Rising rates may serve to bring balance back to the market, which will tame the rapid rise in prices, and over the long term bring stability back to the real estate sector as a whole.
The 30-year mortgage rate has hit its highest mark since 2011, and has increased at a pace not seen since 1987.
The imbalance we’ve seen in the housing market over the past several years coupled with rapid inflation has finally caught up to interest rates. For multifamily, there are several implications we want to outline, starting with lending.
Multifamily Lending Robust
The Mortgage Bankers Association (MBA) projects that lending in the apartment sector will remain stable throughout the year, despite a rise in interest rates. This highlights the robustness of this asset class.
Cap Rates Compression Continues?
In Q4 2021, cap rates in the sector reached a low of 4.7%, a drop of 30 basis points year-over-year. Interest rates directly affect borrowing costs more so than cap rates. With historically low vacancy rates, rent growth, and investor appetite for this sector, the outlook for cap rates in multifamily points to continued compression. As interest rates and inflation rises, multifamily owners can increase rents, offsetting the negative impact of higher borrowing costs.
According to Matt Vance, Americas head of multifamily research at CBRE, rising interest rates shouldn’t have much impact on cap rates. “Considering the amount of capital targeting this real estate sector, there is sufficient spread between the cap rate and bond yield to allow for modest continued compression in cap rates as we saw in 2021.”
Inflation: Not A Bad Thing
Inflation, among other things, implies economic growth. With rising prices, wages rise, and so too do asset values including multifamily. Further, inflation eats away at historical debt that was locked in at low-interest rates. According to Adam Kaufman of ArborCrowd, “Together, those conditions give multifamily owners the ability to raise rental rates and offset higher construction, labor, insurance, taxes and other costs, potentially allowing multifamily properties to hedge the effects of inflation.”
Watch out for this. According to a Yardi Matrix report: “Low cap rates caused little concern when the risk-free rate was 1% and the typical mortgage coupon was 2.5% to 3.5%, but when the cost of capital gets more expensive, low yields can complicate transactions and refinancings.”
“The rapid rise in interest rates is expected to take some wind out of the sails of new lending activity, but healthy property fundamentals and strong property values should support the markets and keep commercial real estate mortgage demand at strong levels. Borrowing and lending should still match last year’s record levels.” — Jamie Woodwell, vice president for commercial real estate research at MBA.
Chart: Building Materials Costs Increase
According to NAHB, the price of residential construction materials increased 1.4% in March, following a jump of 2.2% in February, and another 4.1% increase in January.