Last year the Federal Reserve began an unprecedented drive to reduce high inflation levels through interest rate hikes.
Inflation spiked from 1.4% in 2020 to 7% in 2021. When it failed to correct itself in 2022, the Federal Reserve took action.
After 10 consecutive increases, May numbers delivered promising news. Inflation rates fell to around 4%, down from the high of 9% in July 2022.
Considering the recent bank failures and improved inflation numbers, the Federal Reserve paused rates for now, which could provide needed relief for real estate investors.
How Rising Interest Rates Affect Multifamily Real Estate
Interest rates play a critical role in shaping the landscape of commercial real estate. Higher rates have directly impacted multifamily housing in several ways.
- Increased financing costs: Not only does it cost more to buy a new property, but rising rates increase monthly payments on variable-rate loans.
This affects the overall affordability (and profitability) of commercial properties as well as monthly expenses for existing property owners.
A rate pause holds current debt costs steady for now.
- Reduced buying power: Higher interest rates lower purchasing power because of higher borrowing costs.
As the cost of borrowing becomes more expensive, the loan amounts investors can qualify for decreases. Lower buying power limits the size and scope of potential investment properties.
- Lower property valuations: A slowdown in inflation tends to stem appreciation for real estate properties in some parts of the country.
Real estate tends to be regional in nature. Slowdowns do not occur in every market. However, national trends show slower growth of both property valuations and rents.
How a Rate Pause Impacts Commercial Real Estate
The Federal Reserve’s pause in rate increases stabilizes the above factors.
It can also indicate that we are at or near the bottom of the current economic cycle.
Rising interest rates cause the economy to retract.
But it can take up to a year to see the full effect of today’s Fed decisions.
When the markets turn around, it will produce new opportunities for those prepared to take advantage of the changing economic conditions.
Opportunities include:
- Increased affordability: A pause in rate hikes provides a window of opportunity for investors looking to acquire multifamily housing.
When rates are stable or falling, costs become more manageable, making properties more affordable. This can enable investors to pursue attractive opportunities and expand their portfolios.
- More favorable financing terms: The Federal Reserve does not set mortgage rates. However, rate changes influence the mortgage market.
Mortgage rates follow supply and demand along with other economic indicators. So, while it is not in lockstep with the Federal funds rate, it is influenced by their decisions.
Lower rates encourage lenders to offer better terms to compete with other lenders in the market.
More favorable terms can include lower rates, longer loan terms, reduced down payment, and lower rate cap escrows.
Improved lending conditions empower investors to secure financing that aligns with investment goals and enhances the overall profitability of multifamily investments.
- Enhanced cash flow potential: The rising interest rate environment over the past 14 months has crushed cash flow for many multifamily investments.
Steady or falling rates will provide tangible relief for existing owners. Lower inflation could reduce operating expenses and loan costs, restoring cash flow and profit margins for existing deals.
At McKee Capital Group, we have experience managing multifamily properties in various economic climates and understand how to capitalize on opportunities. To learn more about real estate syndications and how we choose and manage properties, watch our introductory video.
