The Ridgeview Report
Investing in a High Interest Rate Environment
In March of 2022, the Federal Reserve embarked on an aggressive interest rate hike campaign to combat inflation, implementing record-paced rate increases. As a result, lenders raised their rates in tandem and the real estate market was immediately impacted.
Today, multifamily lenders are offering rates between 6-7%. To put this into context, back in the summer of 2021 I managed to secure a 10-year loan at 3.51% for the acquisition of the Pineview Townhomes. At the time, that rate was relatively high compared to the previous months. Looking back, however, it's clear that we may not see rates that low for a very long time.
While the increase in interest rates has proven effective in curbing inflation, its effects have echoed across various business sectors, leaving virtually no industry untouched.
How The Multifamily Sector is Affected
Financing Costs:
The rise in interest rates has a direct impact on borrowing costs for developers and investors, who are financing and acquiring multifamily properties. This increase in costs creates a higher price tag for acquiring or developing new multifamily properties.
Property Valuations:
The upward trend in interest rates can significantly influence the valuation of multifamily properties. When underwriting deals, there are 2 direct consequences of increased interest rates: cashflow is reduced, and the lender will require more money down to keep the Debt Service Coverage Ratio (DSCR) in check. As a result, investors may seek a lower purchase price to compensate for the increased costs of borrowing and the higher down payment. Looking at multifamily sales over the past 6-12 months, buyers today are willing to pay 85-90% of what they paid in 2021.
Potential Home Buyers Turned Renters:
Elevated interest rates can have repercussions for prospective homeowners. With higher interest rates come increased mortgage rates, making it more costly and challenging for potential home buyers to secure financing. This can increase the demand for multifamily properties as some individuals may choose to rent instead of buying a home.
Sales Volume:
Building owners had the optimal opportunity to maximize their sale prices in late 2020 and early 2021 when interest rates reached rock bottom. However, since then, building values have experienced a significant decline. Many sellers are choosing to postpone the sale of their property and wait for prices to rise again. This situation has resulted in a substantial 65% decrease in multifamily transaction volume in the Spring of 2023.
The Rental Market:
Apartment rents are impacted by the rise in interest rates as well. With higher mortgage rates, renters face greater obstacles in transitioning to home ownership, leading many to remain renters for longer than anticipated. As a natural consequence of the increased demand for multifamily housing, rental rates may experience an upward trend. Separately, developers might become less inclined to undertake new multifamily projects, leading to a potential decline in the housing supply in 2024 and 2025.
How Ridgeview Property Group is Affected:
Due to the current market conditions, it takes more time and patience to source investments than in past years. Many buildings that hit the market today do not end up selling; instead, the owner often chooses to delay the sale in hopes of a better market in the future. While finding properties to buy is difficult, we are thoroughly enjoying the opportunity to invest at reduced prices For instance, the Champlin portfolio, purchased in late 2022, was obtained at a 14% discount compared to the offer price of another buyer eight months prior (they failed to close the deal).
These discounted prices present the additional potential for upside. An acquisition that makes financial sense at a 6% interest rate will "hit it out of the park" if interest rates end up falling to 3 or 4%.
In Summary:
In order for investors to achieve a return with higher rates, they are lowering their offers. As a result, multifamily sales prices have decreased over the past 18 months.
Home buyers are turning to renting, as they are priced out of the market by interest rates. This increases demand for multifamily properties and drives up rental prices.
There has been a decrease in the number of properties hitting the market, as numerous potential sellers are choosing to wait for better conditions.
Reduced prices mean you can buy more real estate for your money. If interest rates drop in the future, the opportunity to refinance into cheaper debt would boost the performance of the investment.
Market News
The commercial construction pipeline in New York City narrowed substantially in the first half of the year as construction starts declined precipitously.
The value of commercial and multifamily construction starts in the Big Apple declined by 31 percent year-over-year from January through June, the New York Business Journal reported.
The value of the first half of commercial construction starts in the city was $10.8 billion, which still towered over all other metros the report analyzed. But that value looked meager in comparison to last year’s $15.5 billion. In the same period from 2021 to 2022, commercial construction starts in the city rose 22 percent. https://therealdeal.com/new-york/2023/07/27/nyc-commercial-construction-start-values-fall-30/
Tips and Tricks
Terms: Debt Service Coverage Ratio
Debt service coverage ratio – or DSCR - is a metric that measures the borrower’s ability to service or repay the annual debt service compared to the amount of net operating income (NOI) the property generates.
DSCR indicates whether or not a property is generating enough income to pay the mortgage. Lenders use the debt service coverage ratio as one measurement to determine the maximum loan amount when a real estate investor is applying for a new loan or refinancing an existing mortgage.
The larger the DSCR ratio is, the more net operating income there is available to service the debt.
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