While rates are undoubtedly moving up, the Fed’s long-run estimate is for the rate to stabilize around 2.4%, leaving the 10-year Treasury below the 4% range.
From a multifamily sponsor’s perspective, staying attuned to borrowing costs is key to successful acquisitions during periods of rising rates. Targeted risk-adjusted returns on new acquisitions can be achieved by adjusting underwriting assumptions and applying stress tests and scenario analysis across a range of factors, including interest rates, inflation, and cap rates.
In an effort to control borrowing costs, seeking acquisitions with fixed-rate debt or using derivatives on existing floating-rate debt, such as swaps and swaptions, can limit rate risk over the life of the asset.
3. Multifamily assets with greater earnings potential, or NOI growth, should be able to withstand drastic rate hikes.
In today’s rising interest rate environment, a common real estate investment concern is that when Treasury yields rise, so do capitalization (cap) rates—which in turn declines property values and dampens total investment returns. In reality, rising rates have a complex impact on the performance of multifamily investments.
Historically, when examining multifamily cap rates and 10-year US Treasury rates, multifamily assets have shown a healthy potential for NOI growth amid a rising rate environment.
For example, a recent report from CBRE notes that over five quarters ending in Q3 2021, long term interest rates more than doubled, rising more than 70 basis points, while cap rates for the multifamily segment compressed by roughly 75 basis points over the same period.
Additionally, 2003-2006, 2012-2013, and 2016-2018 provide examples of prolonged upward rise in interest rates, where 10-year Treasury yields rose by more than 100 basis points each time, yet cap rates remained flat or even compressed.
How can the unquestionable rise in Treasury rates result in stabilized or compressed cap rates? In this case, investor appetite for multifamily investments was, and is now, the driving force behind asset valuation. When investor interest is high and the climate is competitive, it can lead to more aggressive valuations, offsetting interest rates through strong capital inflows.
4. It is of foremost importance to account for the current economic environment as well as geographic market when considering investment strategy.
In today’s environment, there are challenges on the horizon with the Fed’s bullish interest rate hikes, yet the outlook for the multifamily real estate sector in particular calls for continued growth.
Nationally, robust multifamily rental demand is being driven by a healthy labor market, rebounding household formations and would-be buyers exceedingly priced out of the single-family home market—with rising mortgage rates making homeownership even less affordable. Consequently, vacancy rates are near cyclical lows, renters are actively leasing apartments, and operators are implementing healthy rent increases.