How Multi-Family Borrowers Are Adjusting to Rising Interest Rates


With the recent Federal Reserve rate hikes, borrowing costs for multi-family assets are also rising. This is disrupting sales volume, as higher rates cause some potential apartment buyers to factor higher debt costs into the assumptions they made when considering buying an apartment. Potential buyers are likely to want to reduce the amount they’re willing to pay, relative to the property’s income, but it’s still too early to say how much and whether sellers will want to renegotiate.

“Our brokers tell us that a certain amount is being retraded,” says Dave Borsos, vice president of capital markets for the Washington DC-based National Multifamily Housing Council.

Apartment buyers are demanding higher returns on their investments, according to negotiators and economists. They drive prices down as acquisition loan interest rates rise.

It is too early to see this change in the latest national data. In May 2022, investors agreed to an average cap rate of 4.8% for apartments, according to New York-based MSCI. This is a decrease of 20 basis points compared to the previous year. This is the lowest average cap rate – and the highest price to property income – ever for apartments. The record low largely represents apartment sales that had been traded months before, well before interest rates began their recent rise.

Anecdotally, investors are demanding higher cap rates, but not as high as the more than 200 basis point rise in long-term interest rates. The net result could be a tightening of the risk premium – the spread between cap rates and 10-year Treasury bond yields.

“The average cap rate hasn’t risen as dramatically as lending rates,” Borsos says. “There are countervailing market forces that keep cap rates lower.”

Interest rates have risen sharply

Investors in apartments have to pay higher interest rates when taking out permanent fixed rate loans.

“The overall cost of debt has increased by more than 150 basis points compared to six months ago; interest rates starting north of 4.5% for both fixed and floating rates due to a dramatic rise in the underlying indices,” says Kelli Carhart, head of multifamily debt production for CBRE.

Interest rates on most permanent fixed rate apartment loans are based on US Treasury bond yields. Ten-year Treasuries returned 2.99% on July 11, 2022. That’s an increase of more than two full percentage points from less than 1% for most of the first year of the coronavirus pandemic. . Yields have remained near 1.5% for most of 2021. Benchmark yields have soared in 2022 as Federal Reserve officials signaled they would raise overnight interest rates. day to fight inflation and cool the overheated US economy.

Fed officials have already hiked rates and the yield on Treasuries shows that bond investors are expecting more rate hikes in the future.

“Everyone expects the Federal Reserve to raise rates another 75 basis points because inflation (in June) was 9.1%,” Borsos said.

In the past, to help keep interest rates relatively low, lenders have sometimes reduced the amount they add to interest rates. That hasn’t happened yet in 2022. But neither have lenders significantly increased the amount they charge in response to capital market volatility.

“Spreads have remained relatively consistent in the realm of apartment investment lending over the past 30-45 days,” says Jonah Aelyon, director of JLL Capital Markets, Americas, working in the firm’s San Francisco office. .

However, lenders also provide smaller loans. “The decrease in leverage is significant from 75% to less than 65% and often much less,” says CBRE’s Carhart.

Most permanent loans are now limited to the amount of debt service the property can afford to pay using rental income. As interest rates rise and the cost of debt service payments increases, the amount of loan the property is able to support decreases.

Apartment buyers should also worry that price inflation will affect the cost of labor and utilities in the properties they buy – and that this will also affect the yield of their investments. “People take this inflation into account and start their calculations again,” says Borsos.

However, borrowers still have plenty of choices when looking for financing. This is partly because demand for apartments is still strong and apartment rents have continued to rise in 2022, even after a very strong year in 2021.

“Liquidity in the debt space is not an issue today, rather it’s pricing and interest rates that have changed,” says JLL’s Aelyon.


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