How Rising Mortgage Rates Affect Demand for Apartment Housing

Housing markets operate in microcosms. Trends in one state or region often do not mirror the country as a whole. For instance, what happens in New York or San Francisco may not reflect markets in Saint Louis or Dallas. Generally, urban centers have different supply and demand challenges than rural communities.

When evaluating a particular region or metro area, company relocations, population trends, and politics (specifically laws impacting new construction, landlords, etc.) directly impact housing demand. Even though rising interest rates affect every market, the end result differs by region.

Federal Reserve and Interest Rates

When the Federal Reserve changes the interest rate, what does that actually mean?

The Federal Reserve controls the federal funds rate, which is the rate banks charge partner institutions for short-term (overnight) loans. The Prime rate, the rate banks charge for loans to their best customers, moves in lockstep with the federal funds rate. Banks also routinely use the Prime rate as a benchmark for variable debt. For example, credit cards and HELOCs offer prime rates plus a margin. The margin is fixed, but the rate changes whenever the Federal Reserve raises or lowers the federal funds rate.

For all the influence of the Federal Reserve, it is not the driving force for mortgage rates.

Who Sets Mortgage Rates

Mortgage rates change daily based on the following factors:

  • Supply & Demand
  • 10-year US Treasury
  • The health of the overall economy
  • Inflation
  • Job Growth
  • The quality of the applicant

Although the Federal Reserve does not establish mortgage rates, the federal funds rate influences 10-year treasury yields, meaning the Federal Reserve affects fixed mortgage rates indirectly. And it directly affects variable mortgage rates using Prime as the benchmark.

For instance, as of September 1, 2022, the Federal Reserve had raised the federal funds rate by 2.25%, but fixed mortgage rates had risen by over 3%.

Rate Changes in 2022

The Federal Reserve tends to lower rates when the economy struggles and increase them when it grows. In theory, lower borrowing costs result in businesses taking out loans, hiring more people, and expanding production. Higher borrowing costs lead to companies relying less on loans and scaling back expenses, contracting the economy and controlling inflation.

In response to record high inflation, the Federal Reserve began raising interest rates in March 2022 and increased them by three percentage points by the end of September 2022. The goal is to increase borrowing costs, slow demand, and get inflation under control. The risk is throwing the economy into a recession.

Outlook on Demand for Apartment Housing

Rising mortgage rates in 2022 decrease demand for single-family and condominium ownership due to higher borrowing costs. Potential buyers have more difficulty qualifying for a mortgage, leading consumers who cannot buy to rely on apartment complexes to meet their housing needs. In this case, higher mortgage rates become an economic driver for multifamily housing.

A 2021 Freddie Mac report exposed a shortage of 3.8 million housing units in 2020. Major metro cities face challenges keeping pace with demand. The Freddie Mac report estimates it will take decades to rectify the shortages due to challenges in issuing permits, approving new construction projects, labor shortages, and supply chain issues.

For multifamily investors, the housing shortage translates to lower risk and more profits on effectively managed real estate syndications. If you are interested in learning more about investing in commercial real estate syndications, we created a short introductory video.

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