In what is considered the biggest series of hikes since the 2000s, the Federal Reserve raised interest rates by 75 basis points yet again. The Federal Reserve further informed that the interest rates could be increased further as needed. While this is a welcome move in curbing inflation in the long term, the short-term implications of the interest rate’s impact on the multifamily real estate landscape are quite challenging.
Dynamics behind the inflation
Usually, the Federal Reserve tries to manage inflation within a 2-3% range, but recent figures have it at around 8%. The plan is to curb demand by making loans more expensive. Lower demand equals lower prices and lower inflation. As an example, the 30-year fixed-rate mortgage rate in early 2022 was around 3.8%. Rates have risen to around 6% since then.
Therefore, lenders are reducing leverage due to concerns over refinanceability, and demand has dropped to an all-time low for the first time in 20 years. The rising lending rates have cooled off the multifamily real estate volume by a good margin.
3 ways the interest rates are impacting multifamily real estate investors
1. High cost of debt
The primary concern among multifamily real estate investors is the higher cost of debt capital, tighter underwriting, lower prices, and disappearing deals. As a property type that continuously witnesses steady rental growth, multifamily real estate might be far less impacted than CRE asset classes and the cap rates should hold strong, as long as the rent growth is at par with the inflation.
Expensive debt can lead to a fall in investor returns, and an uptick in the investor’s demand for lower prices so there is sameness in the level of return. Resultantly, investors shall borrow less.
2. Disaster for variable-rate debt holders
When variable-rate debt resets, investors might be surprised because a property that generated positive cash flow at 3% interest might not do so at 6%. Once a loan covenant has been breached or their operational reserves have been exhausted, investors will have few options.
Therefore, those caught on the wrong side of these rate increases may experience an, increase in loan defaults and foreclosures.
3. Loss of jobs
Due to rising operational challenges, investors and property managers may cut staff as the multifamily market slows. Job loss can result in late payments and collection costs that can further impact property profitability, even though this is a short-term solution.
5 ways multifamily real estate investors can navigate the emerging interest rate environment
1. Raise buffer capital reserves
Investors should raise cash to shore up their operational reserves against future uncertainty. In the event of significant increases in vacancy and collection costs, this can provide a buffer.
2. Transition to fixed-rate debt
Investors who hold variable-rate debt with an upcoming adjustment may want to consider fixed-rate refinancing in the medium to long term. Investors can avoid interest rate increases by switching to fixed options.
3. Tighten criteria for underwriting
For investors looking to purchase during this period, growth rates won’t be as robust going forward. It would be better to use historical data to make assumptions and then stress test them to see where they fall apart.
4. Review the leasing strategy
Operators can ride out a contraction by making sure their properties are filled with tenants who pay their rent on time. Therefore, it might be a good idea to revisit leasing criteria such as required credit score or debt-to-income ratios. Less strict requirements can invite more tenants to multifamily properties.
5. Get creative with their investments
Property owners can get creative with the unused space in their multifamily estate by renting the same out as storage units. They can even waive of upfront security deposits in lieu of monthly fees compounded with the rent, to lower tenant barriers.
As widely projected, there could be a period of recession in the near future and this would present numerous opportunities for investors who are well-informed and well-prepared. Remember, there is always an opportunity amidst a challenging scenario.
If you are looking for more information on how to manage your investments and prepare to seize emerging opportunities, get in touch with us: https://fwcinvestments.com/contact/