Our goal at Stelvio Equity Group is to empower investors to create passive income by offering stable investment opportunities through the acquisition and management of multifamily apartment properties.
Effects of acute inflation
Customarily, the Fed attempts to manage inflation around the 2-3% range, but recent data suggests the inflation rate is north of 8%. One of the plans by the Fed to curb this is to raise the rate of debt and make loans more expensive. A higher price of debt promotes lower demand. Lower demand leads to lower prices and lower inflation. As an example, the 30-year fixed rate in early 2022 was around 4%. Rates have risen to around 7% since then.
How interest rates can impact multifamily real estate investors
1. High cost of debt
The biggest concerns among multifamily real estate investors are the higher cost of loans, tighter lender underwriting standards, lower pricing for properties, and disappearing deals. Multifamily real estate experienced strong rental growth over the past several years, and as a result, may be far less impacted than other commercial real estate asset classes. As long as rental growth is on par with inflation, the cap rates should not fluctuate wildly.
More expensive debt can lead to lower investment returns initially, which can lead to investor demands for a lower price to level out returns. As a result, investors may find headwinds from sellers which ultimately leads to fewer deals and less borrowing until the market finds equilibrium.
2. Variable rate debt becomes bad
When variable rate debt resets, investors might be surprised because a property that was cash-flow positive at a 3% debt interest rate may become cash-flow negative if that rate doubles to 6%. If investors find themselves in this situation, once loan covenants have been breached or operations cash has been exhausted, there may be few options to consider.
3. Job loss
Increased debt load leads to increased operational challenges and higher costs. Property managers and investors may be forced to cut staff if the market slows too much.
Five ways multifamily real estate investors can mitigate the effects of the interest rate environment
1. Raise more capital
Investors should explore the possibility and reality of raising more cash to strengthen operational reserve account balances to provide a buffer against future uncertainty. In the event of sustained market volatility, increased vacancy, or higher collection costs, more cash can provide a lifeline to a short-term situation.
2. Fixed-rate debt
Investors who hold variable-rate debt with an upcoming adjustment may want to consider fixed-rate refinancing in the medium- to long-term. Depending on the life cycle of the investment, trading some basis points to stave off a large adjustment may be worth it.
3. Tighten underwriting criteria
For investors looking to purchase real estate during this more volatile period, growth rates may not be as strong going forward. It would most likely be better to get back to relying more heavily on historical data to make assumptions, rather than the lofty and inaccurate pro forma projections of the past few years.
4. Review the leasing strategy
Great tenants become more valuable during times of contraction. Operators should work to ensure properties are filled with tenants who are willing and able to pay rent on time. It would probably be a good idea to revisit and tighten leasing criteria. Less stringent criteria can invite undesirable tenants who can put stress on cash flow.
5. Shop vendors and contractors
Service providers account for a fair amount of the expense line items of a property. Inflation affects everyone, but it affects everyone differently. Operators should compare pricing from vendors and contractors on a regular basis, but concentrating on those items now may result in more favorable terms and pricing for the future.
Many are predicting a period of recession in the near future. The depth and length are subject to debate. What is not up for debate is that we are already experiencing many of the indicators and symptoms of a correction. Corrections present numerous opportunities for investors who are well-informed and well-prepared.
Just remember, “luck” is where preparation meets opportunity.
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