How Interest Rates & The Economy Impact Demand for Multifamily Housing

In the past seven months, the Federal Reserve raised interest rates five times for an aggregate increase of three percentage points. The agency indicated they expect to continue raising rates until inflation abates. While rate hikes tend to make front page news, just as inflation does, it’s often less clear what these actions mean for consumers and investors.

Consumers with existing debt or those who need to borrow for a major purchase are most affected because banks charge higher interest rates on loans. Lenders can raise rates on credit cards and home equity lines of credit almost immediately. Variable rate mortgages increase at the next interval, which is often annually. These surges directly impact borrowing costs and monthly payments.

Indirectly, rising interest rates affect the cost of consumer goods. Businesses tend to pass higher borrowing costs to consumers by raising prices, which reduces demand and slows economic growth.

For investors, particularly those with money in multifamily housing, the relationship between rising interest rates and profits is less defined. Due to the indirect correlation between housing and rates, it is not as simple as understanding supply and demand. Here is a closer look at how rising interest rates affect multifamily housing from an investor perspective.

Impact on Home Buying

Rising interest rates drive up housing costs. Despite the recent rate increases, home prices continue to soar. Add in higher borrowing costs, and many potential buyers can no longer afford the home they want. The average mortgage payment rose by 76% since 2019 while wages continue to lag, making affordability a major issue for first-time homebuyers.

Rising rates also affect sellers. Homeowners who locked in low rates would need to acquire a new loan at a much higher cost if they chose to trade up or downsize their current home. These market pressures keep the housing supply tight and continue to elevate prices, driving demand for multifamily housing.

Other Economic, Employment, and Demographic Trends In-Play

Increased access to remote working environments, millions of undocumented immigrants crossing the southern US border, and companies moving headquarters all impact housing demand. When families transition to new regions, it drives demand regardless of interest rates.

Remote workers may seek more affordable locations, better weather, or proximity to family. Where immigrants and company relocations centered decisions around access to employment. Regions with growing populations will see strong demand for multifamily housing.

How Interest Rates Affect Housing Demand

The logic behind raising interest rates is to reduce demand and slow inflation. In theory, that should lower demand for housing and result in stalled or even lower rent rates. However, the housing market dynamics do not support this conclusion. Currently, there is a severe shortage of rental units. Higher interest rates will slow construction and increase the cost of building, which will prop up rent rates for at least the next decade.

Impact on Multifamily Investors

Landlords are not expected to suffer much in the current economic environment. They will incur higher borrowing costs on new purchases and adjustable-rate mortgages. While both inflation and higher interest rates erode buying power, these conditions tend to increase demand for rental units.

Add in a severe housing shortage and economic trends, and investors can find areas of the country that are seeing double-digit rent increases despite the threat of a recession. These areas feature strong employment, a net influx of new residents, and a stable housing market.

If you are interested in learning more about investing in commercial real estate syndications, we created a short introductory video.

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