It's Finally Happening — Rising Interest Rates and Multifamily Real Estate

If you have been paying attention to the financial press, you have no doubt been bombarded by discussions on the effects of "tapering," which amounts to the end of the Federal Reserve’s active bond buying program that has been stimulating the economy via lower interest rates. So far, 10 year treasury rates (which are important as they typically impact mortgage rates) have risen approximately 25 percent from the 2 percent range to the 2.5 percent range. This is not that significant in any long-term context, but the chance that rates continue to rise to the 3 or 4 percent range is very real and very much on everyone’s mind. The question is what will this potentially mean for multifamily real estate?

The downside is somewhat obvious: the ability to borrow and very low rates to finance acquisitions and development of multifamily projects will be reduced as debt becomes more expensive. Cheap debt, often backed by a federal agency, has allowed much needed new development of apartment units to commence after a multi-year hiatus in many markets and especially those in Florida. I have already seen challenges for developers attempting to get loans approved in mid-2013 that would have gotten an easy stamp of approval back in 2012, due to these rate moves and related fears. The related fear is that capitalization rates will also rise, causing values of all multifamily assets to fall. Thus, if you are looking to sell an asset in the near term, you may want to consider bringing it to market sooner than later. If you are a buyer or holder, lock in financing at these still relatively low rates for as long as possible.

What is less obvious is the potential upside in rising interest rates upon multifamily real estate, especially the existing properties. First, the fundamental reason the Fed is considering "tapering" and rates are rising, is that the economy is fundamentally much, much stronger than in recent years. Employment is better, incomes are better, even the stock market is much higher. Thus, the raw demand from renters is likely to increase as job growth has always been a key driver in apartment demand. Vacancies will continue to fall and rental rate increases will likely get stronger and stronger, improving net operating incomes. Florida is very well positioned in this recovery and will likely do better than the nation on average.

The final benefit to multifamily is a bit dubious, but nonetheless true. Higher interest rates lead to less affordable home ownership and thus more families choosing to rent versus buy. The for-sale market is very strong, in part because owning is in fact cheaper than renting in many cases, if one can qualify for a mortgage. The effect of even a 1 percent increase in mortgage rates in today’s market will reduce the ability for many to qualify and thus increase tenure in their rental unit.

In conclusion, are rising interest rates good or bad for multifamily in Florida? It depends! Net operating incomes will likely be strengthened while capitalization rates could rise: thus, the net effect will be different for each property and each owner. Personally, I do not fear a rising rate environment, if properly positioned; I find the benefits to outweigh the costs.

Dr. Joshua Harris will be one of our Education Conference & Trade Show speakers. He's scheduled to speak on Friday, October 18, 8:45-9:30 a.m.