Last week Old Capital had JP Conklin, the founder of Pensford and host of The Rate Guy Podcast as a guest speaker. He went over inflation expectations, rates, and cap costs. It is relevant information for multifamily investors to know moving forward in a rising interest rate environment.
Inflation Expectations
The Fed is expected to stomp out inflation by raising interest rates, which will likely bring down the stock market and curb aggregate demand. The only tool the Fed has to slow inflation is raising interest rates. The forward projection is inflation expectations seem to be waning.
Financial Conditions
The figure below shows monetary conditions that are accommodative and restrictive. In an accommodative environment, money is easy to come by and the cost of debt is cheap. In restrictive territory, interest rates are higher which makes the cost of capital higher. If the plan is to hike at the next Fed meeting in June, we will likely be in restrictive territory and moving towards recession territory by October of this year.
Interest Rates
The forward-looking interest rate curves typically underestimate the path of floating rates during a tightening cycle. This means they will likely tighten further than expected with a tendency to overdo it. This is based on what has happened in the past. It will be interesting to note what will happen now given the fact that the US government has a tremendous amount of debt that will not be cheap to service if rates widen.
The average time to cut from the first hike is 2.2 years and does not exceed 3.2 years.
Rising Cap Costs
Last year cap costs were not expensive compared to today. Many borrowers thought they were throwing away money by buying a cap, but a $75,000 cap bought one year ago may be worth almost $1,000,000 today. It is dependent upon loan amount and strike. Volatility and uncertainty are why we are seeing such escalated cap costs.
Multifamily Observations
There were some general observations at the end of the presentation that Old Capital went over as to what we are seeing in the Debt Markets.
Debt Markets Have Changed
As commercial mortgage brokers, we underwrite, quote, and shop many deals. We are getting real-time feedback from the lenders that fund these large multifamily acquisitions. The feedback has been that the same leverage last year is not available. Deals are sizing more to 70% leverage and the interest rates are up almost a percent over last year. This makes deals at the current cap rates and prices not pencil as well. Sellers and brokers will be in denial about this for 6 weeks to 6 months.
Re-trades Happening
With the lower leverage, higher interest rates, and increased cap costs, there are re-trades happening now. The values on B &C apartments are likely down 8% to 12% since the beginning of the year and more apartments are expected to come online for sale. The majority of loans for the last 2 years have been bridge loans and they will be coming due in the next year or so. Many buyers are not in the market right now as we are seeing fewer buyers on best and final. This may be an opportunity for someone who did not have a chance at the beginning of the year to get a deal.
DFW Overview
Rent growth in DFW over the last year is still strong coming in at 17% and is projected to be 5.9% still at year end. Occupancy for apartments nationwide is still high at 96.2% because there is a shortage of housing. I have seen several articles and data that suggests the US is short around 5 million units so there are still some strong market fundamentals. Also, with the interest rates going up it will be harder for first time home buyers to afford a house keeping them in the renter pool.
Conclusion
It is an interesting time for apartment investors. There are headwinds and tailwinds in the market. It would be best to stick to fundamentals and focus on cash flow and operations. Buyers will have to prepare for lower leverage and higher interest rates so they should model accordingly. This may be a great opportunity to buy while many sit on the sidelines.
