What Will Happen to Multifamily Real Estate if Interest Rates Don’t Come Down

In must admit, I think that the Fed keeping interest rates in the 5% range is good for the economy in the long term and likely what is best. When rates were near 0%, inflation began to run red hot as there was so much money moving around in the economy (i.e., the velocity of money). Demand was going through the roof and companies knew that they could feed the demand through borrowing at low rates which allowed them to keep margins high. More so, people felt rich as they saw their investments in real estate, stocks, etc. sky rocket. However, all good things must come to an end. To fight the inflation, the Fed jacked up interest rates and brought the party to a halt. That brings us to today which has been colored by 11 interest rate hikes from the Federal Reserve from 2022 to 2023 and the current rate being the highest we’ve seen in over 20 years (see chart below). 

I would be lying if I thought that rates will continue to remain elevated. For that to be the case,  that would mean inflation will have persisted above the Fed’s target of 2% (last March reading was 3.48%) and the economy would have remained strong (wage growth, GDP growth, etc.). The truth of the matter is that know one really knows what will happen and as legendary investor Warren Buffet said, “There’s nobody whose predictions on interest rates I would pay attention to, even myself, even Charlie.”

All this is to say that there are somewhat drastic negative short-term effects from interest rates being at this level and the impact will only worsen if rates increase. Firstly, we will likely continue to see a heightened delinquency rate in commercial real estate loans (see Chart 2). The delinquency rate will increase if interest rates increase because as debt payments increase, the likelihood of property owners being able to make those payments decreases. Owners with fixed rate debt will be fine, but those with floating rate debt will feel the pain if rates are to move up. Secondly, the owners that are coming to the end of their loan terms will have two options both of which aren’t ideal compared to the previous lower interest rate climate. Those folks will either have to refinance for a higher interest rate or they will have to sell at what is a lower valuation to what they would’ve gotten in the past. Remember, debt isn’t the only expense that has gotten more expensive. Insurance, taxes, the cost of maintenance materials, and just about everything else are more expensive which in turn lowers cap rates and compresses valuations. Thirdly, I’m not sure when sellers will finely come to their senses and realize that they can no longer obtain the valuations they could a couple years ago. The prices that sellers are asking compared to what buyers are willing to put up is still very wide and multiple brokers we work with have confirmed that to be the case. Since most sellers are not forced to sell and can afford to ride out the interest rate market, the number of deals on the market has fallen and many sellers are opting to simply wait for better selling conditions. These effects of the heightened interest rate environment are certainly not ideal, but rather sobering and perhaps good in the long-term as I stated previously.