Multifamily properties are real estate investments that many still consider robust in several parts of the world. Currently, the sector is coping with sluggish economic growth and more interest rate increases. This reality came after the industry experienced rent cuts in critical regions during the early stages of the pandemic, followed by rent growth nationwide due to several variables.
Long-term inflation control and worries about refinancing have made lenders cut leverage, and demand has fallen. All these factors, plus increasing loan rates, have significantly reduced the amount of multifamily real estate.
However, despite all these worries, demand for multifamily real estate remains high. It is also a fantastic investment choice for savvy investors. In this article, we’ll examine the effects of rising interest rates on multifamily real estate investments and help you understand more about this reality. In the end, you’ll feel more confident about your investments. Let’s go!
Impact of Rising Interest Rates on Multifamily Investments
1. Debt Cost Increase
Investors in multifamily real estate are mainly worried about the rising cost of loan capital, stricter underwriting, declining prices, and disappearing deals. However, multifamily real estate may be less affected than CRE asset groups since it consistently experiences rental growth. As a result, cap rates should remain stable as long as rent growth keeps pace with inflation.
Although it may seem apparent, higher loan costs can result in one of three outcomes: poorer investor returns, lower price demands to sustain the same rate of return, or lower debt usage. Moreover, the market dynamics may shift significantly if any of these occur. For instance, the number of transactions can decrease, or investors might decide to find a quick financing option and hang onto their properties longer in anticipation of a more favorable seller’s market.
Expensive debt may also cause investor returns to decline and investor demand for lower prices to increase so that the rate of return remains constant. Investors will borrow less as a result.
2. Rise In Unemployment
In any industry, increasing interest rates often lead to job losses. The multifamily market is no exception. In order to keep funding multifamily real estate investment, investors and property managers may slash employees because of growing operational issues. Although this is a temporary fix, losing a job might lead to late payments and collection expenses, reducing the property’s value.
3. Crisis for loan holders with variable rates
Investors may be taken aback when variable-rate debt resets since a property that produced a positive cash flow at 3% interest may not do so at 6%. Investors will only have a few choices once a loan covenant has been broken or the company has used up its operational reserves.
As a result, those adversely affected by these rate rises may see a rise in bad loans and bankruptcies.
5 Strategies Multifamily Real Estate Investors can use to Deal with the New Interest Rate Environment
1. Increase capital buffer reserves
To strengthen their operating buffers against future unpredictability, investors should raise funds. This can provide a cushion for significant occupancy and collection cost increases.
2. Strengthen underwriting standards
Growth rates will be less intense for investors trying to buy during this time. Therefore, it would be preferable to base assumptions on historical facts and then put those assumptions under stress to observe where they crumble.
3. Examine the leasing approach
By filling their premises with renters who pay their bills on time, operators can weather a contraction. Review the lease requirements, such as the minimum credit score or debt-to-income ratios. More renters may be attracted to multifamily residences with less stringent standards.
4. Changing from variable-rate debt
Investors with variable-rate debt that will soon be adjusted should consider refinancing to a fixed rate in the medium to long term. By selecting specific options, investors can prevent rising interest rates.
5. Be innovative with your financial choices
Property owners might get creative by renting out the additional space in their multifamily complex as storage units. To minimize tenant barriers, they may even eliminate advance security payments in favor of compounding monthly fees and rent.
According to forecasts, there may be a recession soon. For experienced and highly informed investors, this would bring a wealth of chances. Understand that even in the middle of a difficult situation, there is always a chance.
Several economic issues, including rising interest rates, significantly impact the multifamily real estate market. Both can dramatically affect the economics of owning and managing a multifamily property.
Increasing interest rates have several effects on multifamily properties. The two major ones range from lower occupancy rates to higher borrowing costs for debt servicing and operating expenses.
While these effects can take their toll on different people, investors can mitigate these consequences by raising rents or lowering operational costs through cost-cutting strategies like energy conservation or other means.