Multifamily has been on a roller coaster over the last few years. From rent declines in key markets during the early days of the pandemic followed by rent growth across the board from a variety of factors, the sector is now dealing with slowing economic growth and further interest rate hikes.
In order to battle high inflation the Federal Reserve has boosted interest rates multiple times this year. Any time the Fed raises interest rates, people are uncertain about how the real estate market will be affected.
The first two rate hikes took place in March and May which was followed by the largest federal funds rate hike since 1994, in June. Since then there was another three-quarter percentage point rate hike in July and most recently on September 21st, another 75 basis points increase.
While rising mortgage rates may not be good for those seeking to buy single-family homes, the demand for multifamily and single-family rentals is expected to strengthen along with rents. But the rise in interest rates and volatility has led to a sharp uptick in the cost of funds for both borrowers and lenders As a result, lenders are reducing leverage primarily out of concern for refinancing ability
Now, what does this mean for you as a real estate investor?
Do Home prices go down when interest rates go up?
While the Fed doesn’t set mortgage rates, lenders do watch the central bank and that has an effect on the cost of home loans. Normally this is what happens: home loan rates rise, the total cost of home ownership becomes less affordable, demand for mortgages goes down and the cost of housing is forced to decrease.
This year is unique due to a series of factors such as recovering from the COVID pandemic, millennials reaching the home-buying age, and supply chain issues. Though the cost of housing is down from June it still remains high and unaffordable for many consumers.
What is the latest Interest rate hike impact on Commercial Real Estate?
With the latest interest rate hike, the real estate market will continue to be in a volatile state. We have already seen higher mortgage rates, increased costs of materials, higher borrowing costs, and difficulty getting approved for loans. After this latest announcement, you will likely continue to see an increase in mortgage rates but not at the same rate we have been experiencing.
This is especially true in the private lending space. Direct lenders have already taken into account the possible Fed rate hike so their borrowing rates are already adjusted for this eventuality.
Investors were hopeful that the Fed would not risk impacting the economy and keep rates at around 2.5-3% but that doesn’t appear likely. The Fed is staying aggressive in its fight to bring down inflation despite risking a recession or job losses.
The unique circumstances of 2022 have kept housing prices high despite facing downward pressure due to high-interest rates. This will eventually change because if the Fed continues raising rates into 2023 at some point the price of housing will have to come down to be more affordable.
Another possible impact this latest rate hike could have is a slowdown in the rental market. If the economy does get affected and there’s even a slight increase in the unemployment rate, you may see a slightly less amount of demand for rental units since people will be moving in with family and friends. For the most part, the rental market should stay stable considering how they have performed historically during recessions.
Is Commercial Real Estate a good investment when interest rates rise?
The simple answer is yes but it depends on what asset classes you are investing in. The long-term growth of real estate is unaffected and serves as a good hedge against inflation so certain projects such as rentals and multifamily remain good investments.
Since the Fed is battling inflation so aggressively the risk of a recession or job loss is something you have to take into consideration. We may see a continued increase in foreclosures which provides great opportunities for investors.
Rental Properties
If you are a residential property owner this may be a good time for you since the demand for rental units could go up. Many people who would normally qualify for home loans will not be able to in this economy which means they will most likely have to continue renting. Less qualified home buyers mean more potential rental tenants.
Even if you are able to qualify for a mortgage, with interest rates as high as they are, the typical monthly mortgage payment will also be much higher. This makes the idea of buying a home less appealing resulting in people postponing home ownership. These people will still need a place to live so if you buy a rental property you will be able to generate consistent monthly cash flow with all the new renters in the market.
For portfolio residential investors, this is also a time to take advantage of renters that prefer to rent single-family homes, opportunities to add to your portfolio more residential purchases.
Real Estate Developers
Real estate developers have to consider both the rise in rates and the supply and demand pressures of the consumers. The rise in rates could result in many new construction projects not even being possible. These types of projects have slim margins, to begin with, so higher rates mean that they will no longer be profitable.
That being said, this doesn’t mean there’s no opportunity for new construction. As we discussed earlier, if rising interest rates are causing fewer people to buy new homes there is now an increase in the number of renters in the market. To accommodate this shift in demand real estate developers should implement the build-to-rent development strategy. Focusing their efforts on building multi-family homes and apartments instead of single-family homes can end up being much more beneficial in a market full of renters.
Rents are Leveling Out
The multifamily outlook remains somewhat positive given that the current new supply is comparatively limited in relation to demand due to the ongoing elevated costs of land, labor, and construction related to supply chain pressure leading to a spike in the cost of raw materials. Apartment rent growth will remain reasonably strong.
On the demand side, the Fed increasing interest rates yet again mean the cost of borrowing continues to go up, which, along with heightened inflation, prices out more would-be homebuyers who then must stay with the multifamily alternative. This squeeze also shakes out by degree within the apartment sector itself with some would-be luxury renters more likely to adjust their sights and switch to B and C-class apartments, while in the most extreme situations, lower-level renters might have to make roommate arrangements or stay with parents. Luxury apartments will likely see lower demand. Class B and C apartment absorption have been outweighing the Class A segment by a very big magnitude.
An Affordability Crisis Lingers
The need for affordable housing is growing, and people are increasingly being squeezed out of markets that, until recently, they could afford. Lenders have also tightened their underwriting standards resulting in lower loan-to-values. That also means operators need to bring more equity to the table, which will hurt investor yields because of higher debt.
The rising interest rates, which began with a 25-basis point hike by the Fed in March and continued with a 50-basis point increase in August, have already resulted in a shift in behavior due to concern about where rates are going to land in the next 12 months.
Both lenders and borrowers are going to continue to be more cautious going forward. Investors are going to be seeking higher returns on debt and equity and the cost of capital will go up. Meanwhile, cap rates will likely widen over the next 12 to 18 months to reflect what’s happening in the capital markets.
CONCLUSION
The Fed’s actions indicate it’s aiming for an economic soft landing that would slow the economy without a recession. That would enable growth to continue on the demand side for housing and commercial real estate. The situation has created a dynamic where buyers are determining if they will accept lower yields and if sellers will accept lower prices. The multifamily property is still a great asset class for investors despite the hike in rates.
As informed investors we should understand the risks associated with real estate investing and that there is no guarantee. Please do your due diligence.
Do Home prices go down when interest rates go up?
While the Fed doesn’t set mortgage rates, lenders do watch the central bank and that has an effect on the cost of home loans. Normally this is what happens: home loan rates rise, total cost of home ownership becomes less affordable, demand for mortgages goes down and the cost of housing is forced to decrease.
This year is unique due to a series of factors such as recovering from the COVID pandemic, millennials reaching home buying age and supply chain issues. Though the cost of housing is down from June it still remains high and unaffordable for many consumers.
What is the latest Interest rate hike impact on Commercial Real Estate?
With the latest interest rate hike the real estate market will continue to be in a volatile state. We have already seen higher mortgage rates, increased cost of materials, higher borrowing costs, and difficulty getting approved for loans. After this latest announcement you will likely continue to see an increase in mortgage rates but not at the same rate we have been experiencing.
Is Commercial Real Estate a good investment when interest rates rise?
The simple answer is yes but it depends on what asset classes you are investing in. The long term growth of real estate is unaffected and serves as a good hedge against inflation so certain projects such as rentals and multifamily remain good investments.
Since the Fed is battling inflation so aggressively the risk of a recession or job loss is something you have to take into consideration. We may see a continued increase in foreclosures which provides great opportunities for investors.
