Pictured is Terrace Hill, a 310-unit apartment community in El Paso that was built in 1983. Greysteel negotiated the sale of the property in late 2021.
By Jack Stone, Chief Investment Officer, Greysteel
It seems like every month a new sales record is broken in the El Paso multifamily market. But with interest rates officially rising, how long will this streak last?
El Paso was on a tear. Greysteel has sold about 4,000 units there in the past 36 months. It’s an impressive number, but it’s not surprising. Between 2012 and 2014, approximately 20 properties with more than 25 units were exchanged in El Paso. This number skyrocketed to 69 properties between 2019 and 2021.
Jack Stone, gray steel
But why?
We have followed the El Paso market closely and brought many early buyers from out of state to the market. The main reason they are interested in El Paso is the competitiveness of other markets like Dallas and Austin, where cap rates have simply compressed too much. With lower cap rates and cash yields, investors have started to flock to secondary markets where they can earn higher returns.
But El Paso, despite being a secondary market, has several factors that help it stand out from the crowd: (1) it is one of the 20 largest cities in the country, which surprises many; (2) it is well diversified, having withstood the recession better than many other markets; (3) it is ranked among the safest cities in the country; and (4) it’s in the great state of Texas, where there are favorable economic policies and not a lot of restrictive rent regulations.
But demand has also put more pressure on prices. Just a few years ago, we were selling deals at average cap rates of 7%. These same properties are now trading at 5-caps. Much of this compression, of course, has been driven by historically low interest rates that we haven’t seen in decades, but there is also natural demand pressure that cannot be overlooked.
So what do higher interest rates mean for the El Paso multifamily market? While there may be cap rate adjustments, there are other factors that bode well for continued interest and competition in El Paso.
First, there are macro factors that have more to do with commercial and multifamily real estate in general. There is generally a correlation between interest rates and capitalization rates; when interest rates rise, capitalization rates also rise, and vice versa. But there is an abundance of dry capital in the market that can help keep the market under pressure.
In fact, we regularly speak to new investment groups with new funds looking to deploy capital. And while we can cite a number of times when cap rates have risen in response to rising interest rates, that’s not always the case. The 10-year Treasury yield rose more than 100 basis points between 2003 to 2006, 2012 to 2013, and 2016 to 2018, but cap rates during those periods managed to hold steady or compress.
Multi-family assets also generally provide a hedge against inflation. Inflation is accompanied by higher rents, and higher rents are accompanied by higher growth in net operating income. So even if cap rates increase (depending on their magnitude), inflation can potentially help offset price corrections.
There are also several El Paso-specific factors that can help offset a higher interest rate environment. El Paso is a major trade hub between the United States and Mexico, which means it stands to gain from recent supply chain disruptions caused by COVID-19 and our current conflicts with Russia. and China. BlackRock’s Larry Fink even noted recently that Mexico could benefit and that supply chain disruptions “could lead companies to further expand operations onshore or near it.” Ciudad Juarez, across the border, is already home to more than 300 American manufacturing plants, and many of those workers live in El Paso.
Finally, in these uncertain times, the very resilience of El Paso will help to continue to drive interest in the market. El Paso weathered the Great Recession better than most markets due to its unique combination of public and private sectors. As one of the largest centers of international commerce in the Western Hemisphere, 70 Fortune 500 companies have footprints in El Paso. Fort Bliss is estimated to generate billions of dollars in economic impact ($26 billion for all of Texas), while employing 47,000 people.
Additionally, major federal organizations such as the INS, DEA, and US Customs & Border Protections all have major operations there. The University of Texas El Paso and Texas Tech University Health Sciences Center (along with its new dental school) also continue to breathe new life into the market.
While interest rates may have some impact on prices and demand, we remain very bullish on El Paso. It has been proven time and time again that this is a market to pay attention to, and there is more than enough reason to believe that the market will not be affected too much by a rise in interest rates. interest.
— This article originally appeared in the April 2022 issue of Texas real estate business magazine.
