The Federal Reserve and the Federal Open Markets Committee paused interest rates today. For at least the time being, the federal funds rate will remain at a range of 5.25 percent to 5.5 percent.
In June, after 10 consecutive hikes, the committee took its first pause in a rate-raising campaign that has been going on since March of 2022. Multifamily executives predicted with accuracy July’s 25-basis-point rate spike, and foresaw the second rate hike pause of 2023.
“Recent readings on consumer spending have been particularly robust,” Federal Reserve Chairman Jerome Powell said at the Sept. 20 FOMC press briefing. “Activity in the housing sector has picked up somewhat, though it remains well below levels of a year ago, largely reflecting higher mortgage rates.”
For those in the multifamily industry, this interest rate pause comes with only some relief. Although almost all multifamily executives anticipate further rate hikes in the future, had the Central Bank chosen to raise rates again at today’s meeting, there could have been a further limit on borrowing.
“If they did raise the rates, this would just add to the costs for landlords with a variable-rate mortgage or any landlord needing to refinance,” Robert Gilman, partner & co-chair of real estate services with Anchin, told Multi-Housing News prior to the Fed meeting.
Multifamily experts predicted correctly
While the general public was correct in assuming that Fed Chairman Jerome Powell would announce a pause, multifamily experts were similarly on the same page.
Prior to the chairman’s press briefing, Ryan Severino, managing director, chief economist & head of U.S. Research at BentallGreenOak, told MHN that the Fed was enabled to pause this month due to core inflation continuing to decelerate on a yearly basis through August.
“While recent inflation readings ticked up a bit, that largely stemmed from resurgent energy prices, which proved to be quite volatile,” Severino said.
Jason Bordainick, co-founder & managing partner of Hudson Valley Property Group, said that the market expectation was for a pause in this September meeting followed by one further rate hike before the end of the year. “The market really needs rates to stabilize along with the projections on inflation,” Bordainick said. “This will reduce the tepidness in markets. Even if rates don’t go down, the market will benefit from a ‘new norm.’”
Justin Shay, managing director of multifamily investment sales at BermanCRE, sees little relief for multifamily in the near term. “We will simply be dealing with this higher interest rate environment for longer, which will continue to impact both transaction volume and construction starts,” he said.
How a pause impacts financing
Despite most experts anticipating the Fed’s pause on interest rates this month, there are still impacts to be felt. However, the implications for multifamily will be marginal compared to the effects being felt from previous interest rate increases.
“The multifamily industry is still feeling the impact of the rate hikes earlier this year that have caused a decrease in sales volume and deteriorating borrowing environment for both equity and debt financing,” explained Shay. “This is also impacting new construction starts.”
A volatile rate environment has also led to supply and demand shifts, construction price increases, and a slowing of unit deliveries. Also, increased cap rates have led to a reduction in multifamily asset valuations. Perhaps most significantly, financing has been uniquely difficult to acquire.
Brandon Harrington, Northmarq managing director, Multifamily Debt and Equity, told MHN that previous rate hikes are making it so that interest rates on new acquisitions and refinancings are up, causing buyers to be cautious and conservative on their debt assumptions.
“Additionally, the rising cost of capital is making it tougher for new development projects to pencil,” he explained. “Lenders are more cautious about new construction loans, the costs are often prohibitive and this is restricting new development.”
For existing operators, this could be a near-term positive, with competition from future construction potentially beginning to ease in the latter half of next year and into 2025, he continued.
There is no doubt that going forward, high interest rates and the potential for further increases will make refinancing and financing difficult. Bordainick expects preferred equity players to realize opportunities to capitalize with hundreds of billions of dollars of debt are coming due in real estate markets nationally.
“If maturities on expiring low interest debts are coming due in the near term, it will require owners to either put additional equity into deals if the owners want to maintain them, or if they don’t have the equity or are unwilling to invest the equity, it’s going to create motivated sellers from either owners offloading or lenders looking for a new general partner with fresh equity,” he said.
Carey Heyman, managing principal of the real estate industry at CliftonLarsonAllen, said that a similar opportunity for non-bank entities, such as life insurance companies and private credit managers, has risen from a decrease in lending from institutional bank lenders. Specifically, regional banks have been impacted, as larger money-center banks have additional sources of revenue.
“While the near-term trajectory looks to put a pause on interest rate hikes for the September and November meetings, further rate hikes will continue to affect CRE lending in the near-term,” he said.
Multifamily to remain favored
However, there are still many positives to observe. Within multifamily, demand remains strong with potential homebuyers being priced out of purchasing new homes. In general, units are not staying on the market long. However, Gilman explained that for rent-controlled properties, the market is posing some hurdles not experienced by market rate homes.
“Rent-controlled properties have been limited to what they can raise rents to,” he said. “All costs are rising so interest rate hikes affect variable-rate mortgages and any refinancing.”
Contrarily, while the rent controlled space is facing certain downsides, the affordable housing space is finding ways to benefit from a volatile rate environment. Higher interest rates are driving multifamily investors into the affordable housing space due to a “drive to safety (reliable cash flows) and prioritization of inflation protected assets,” explained Bordainick.
Certain property types within multifamily are experiencing higher interest rates differently, but multifamily at large is expected to continue forward with strength.
“[Multifamily and industrial] boast the strongest space-market fundamentals, making them an easier sell to finance in a challenging market environment,” Severino explained. “This dynamic holds true for these property types on a widespread geographical basis, but property types in the South continue to benefit from structural demographic and economic changes.”
A look at the rest of the year and into 2024
Multifamily deals are still getting done and will continue to do so, executives say.
“Loan assumptions with favorable remaining term are attractive to investors and much easier to execute in the current environment,” Shay said. “I am finding other situations where seller expectations have come back in line with the new market cap rates. There is no shortage of capital waiting to be deployed, but in the higher interest rate environment, buyers need to bring more equity to the table.”
With debt coming due, there are also more workouts and distressed opportunities to be seen over the next 12 months to 18 months, Bordainick explained. “Owners have been hoping for rates to come back down and have been delaying refinancing or sale transactions, possibly buying extensions with their lenders,” he said. “I think owners are realizing rates may stay higher longer than they originally expected, so they are revisiting whether they have the runway to wait longer or whether they should transact now.”
As sellers come to terms with the current pricing environment, Harrington said that he is seeing more selling activity across the board. “Buyers believe we’re nearing the end of interest rate hikes and feel more comfortable putting capital to work,” he explained. “Further, we’ve seen better-than-expected operational performance. Renter demand has topped expectations and vacancies have remained tighter than many of the earlier forecasts.”
Until the Fed reaches its mandate of price stability (inflation of 2 percent), rates could remain high for a while. For now, multifamily is expected to remain resilient and deals will still pencil.
Severino believes that, along with industrial, multifamily will remain favorable for the foreseeable future, especially considering the housing shortage that is not likely to get resolved anytime soon. Multifamily will have to wait and see what will come next but will do so from a relatively stable place.
“If the market isn’t sure that the Fed is done, it will remain cautious,” said Severino. “In a world where interest rates remain volatile, price discovery proves elusive and, therefore, it is relatively easy to make a mistake. A pause brings us closer to stability, but we aren’t there yet.”
Gillian Executive Search is a leader in Affordable Housing Development, Financing, Design and Construction recruiting. www.gessearch.com