The market consensus was that the Fed was going to raise 50 basis points at the latest FOMC meeting. The Fed announced that 50 basis point hike and now fed funds rate is going to move to 4.30%.
So, what does this mean for Multifamily investing? I recently gave a talk at a local Texas meetup in McKinney and went over what I think we are going to see next year.
Interest Rates
I opened with a discussion on interest rates and what has happened with Multifamily in the last few years. I noted that interest rates dropped to practically 0% right during Covid and stayed there for 2 years.
This allowed for real estate to appreciate because people were able to pay more. Bridge lenders entered the space and offered attractive, high-leverage financing with additional capex dollars.
Competition got so competitive in multifamily that people were buying stabilized deals with bridge loans. Bridge lenders said you can hit a 1.25 DSCR in year 3 at this trajectory and then refinance out to agency.
Read More: How Bridge Lenders Inflated the Multifamily Market
However, that is only the case if interest rates remain low. They have risen sharply this year so a lot of those bridge loans might run into maturity risk because agency proceeds are lower.
Inflation
JP Conklin of Pensford came out and spoke at our most recent Old Capital Conference. He shared some insights into what happened in the 1970’s with inflation. He noted that inflation was entrenched for 6 years before really spiking up.
The Fed had to raise rates to get it to come down, but they started cutting too soon. Inflation came back stronger, and it required the Fed to raise interest rates up to 20% to get it to come back down.
I noted in the talk that the Fed did not want this to happen again, so they won’t talk about cutting anytime soon. At the latest meeting they did raise rates by 50 bps despite CPI coming in lower than expected at 7.1%.
They also said they were going to continue to hike next year albeit with smaller increases. This is not great news for multifamily investors on floating rate debt with short-term maturities.
Unemployment
The Fed has been open about their plan to increase unemployment to further reduce demand. This is the only path they see to stomping out inflation. When all you have is a hammer, everything looks like a nail. I think that’s the saying? So, they will continue to hike until inflation comes down.
We are seeing a lot of headlines about corporate layoffs, and they will continue next year. Companies are bracing for a recession and the Fed is entering restrictive territory with their increases. Some of the biggest layoffs come from Meta and Amazon.
This also continues to hurt commercial office real estate as some of the bigger companies are not leasing or abandoning their leases.
Multifamily Outlook 2023
We have more refinancings in commercial real estate in 2023 than any year through 2032
Danielle DiMartino Booth
The graph on interest rates in the previous section showing rates held at near 0% for 2 years caused a lot of short-term lenders to enter the space. Now those short-term loans are coming due next year, and the interest rates are significantly higher than anyone expected.
This is going to present opportunities for Multifamily investors. Unfortunately, this also means that some assets are not going to perform as well as they have in the past. Each situation is different but there are a lot of operators that are going to be in trouble.
If there are capital calls to try and save a deal, make sure they are solving the problem and not kicking the can down the road. The last thing you want is to invest $100K into a deal, have a capital call to put in another $100K and then lose the deal. Ask about the solution and what the capital is going towards.
Is Now a Good Time to Invest?
What recession? Dallas-Fort Worth adds 19,500 jobs in October, 255,000 in the last year
Dallas Morning News
One of the questions I got asked was if it was a good time to invest. I think there will be deals next year and I still like the DFW market. There are a lot of jobs and population growth in this market and a lack of affordable housing. At some point that equation will work out.
You must be able to hold assets to profit during this time. I predicted next year that people will start getting back to basics. Investors will look for in place cash flow that covers the debt payment they are going to have. Not pro forma cash flow.
If you look at a business plan and can determine whether the GP team can hold the deal, then it will be a good investment. I like deals that have longer term financing and a well-capitalized, experienced sponsor.
We are also becoming a renter nation. During the 2008 housing collapse a lot of owners had adjustable-rate mortgages. They bought multiple homes with no income. Now most people that bought the last couple of years or cashed out have 30-year fixed around 3%.
Underwriting standards also increased so while their may be a dip in single-family homes it is unlikely a flood of supply will hit the market like it did in 2008. With higher rates comes higher mortgage payments so a lot of people will become renters.
Apartment Investor Mastery – AIM – McKinney, TX
If you are interested in getting information like this, I highly recommend joining Jeff and Carrie Johnson’s meetup in McKinney, TX. They have a fun group that meets up once a month. Jeff and Carrie are passionate about multifamily investing and teaching the group.
Check out the group here:
Apartment Investor Mastery – AIM – McKinney, TX (McKinney, TX) | Meetup
Conclusion
Interest rates will continue to rise or at least hold at current levels. Of course, I also noted that no one really knows what is going to happen. I predict the Fed will remain Hawkish based on the 1970’s analysis up until the last minute. They might even say they are going to raise rates up until the day before they cut.
However, a Fed pivot should not be anyone’s business plan. We should at least prepare to weather a higher interest rate environment. Those who prepare to hold for the long term will likely come out as winners. If the Fed turns dovish next year, they will still benefit from appreciation. Just look out for yield maintenance or defeasance penalties.
