When the Federal Reserve raised interest rates in mid-December for just the second time in a decade and announced rates were likely to rise another 0.75 percentage point in 2017, it suggested a positive economic outlook.
However, it also sent a ripple of uncertainty through the apartment market, as multifamily investors and traders wondered to what extent rate hikes would affect both the cost of capital and property valuations. Higher financing costs and sliding asset values could potentially slow deal flow and disrupt the transactions market.
But not so fast, said a panel of researchers participating in an apartment markets panel discussion at the 2017 NMHC Apartment Strategies Conference. The rise in interest rates is likely to be a headwind but not a game changer in the year ahead-especially because the economy keeps expanding, inflation remains in check and a number of pro-economic growth policies appear to be on the horizon.
As a measure of multifamily asset values, Jeanette Rice, head of multifamily research for the Americas at CBRE, said cap rates for multifamily have remained not only very low but relatively stable. In fact, according to CBRE’s most recent cap rate report, multifamily properties have the lowest overall cap rates of any major sector. However, what movement there has been has mostly occurred in primary metro markets and Class A product, where new deliveries are pressuring rent growth.
“B and C [products] are holding their perception of value a little better than A,” Rice said, “As are secondary and tertiary markets.”
But with the rise in interest rates after the November election, Rice said her team looked at their pending transactions-72 in total-to see how many had a price adjustment as a result of the rate adjustment. Of the 72, only 19 (26 percent) had a price adjustment. The average adjustment for those deals was 3 percent.
It was there-we did see a market reaction,” said Rice. “But it was tempered.”
Jeff Adler, vice president of Yardi Matrix, said his outlook was similar in that he was expecting that a 50 bps interest rate increase would trigger between a 3.0 percent and 4.0 percent clip to valuations. However, additional analysis showed that a 50 bps increase in rates would be netted out with 3.9 percent rent growth and a 75 bps jump with 5.3 percent rent growth.
But both Adler and Rice said that multifamily firms could probably make up the margin by accessing different financing programs, such as the Fannie Mae green programs, or taking a shorter financing period as an offset.
Rice and Adler also discussed how higher interest rates might affect returns. According to analysis by Adler, which assumed 3 percent revenue growth, a 75 bps rise in rates would trim approximately 2.0 percent off of the internal rate of return (IRR).
However, moderating apartment rent growth and concessions creeping back into some markets are also giving executives cause for pause in the rising rate environment. However, both Adler and Rice said they believed any pain in the market would be temporary as new apartment supply moderated and demand remained strong.
After rising for the past five or six years, “deliveries will hit a crest at 325,000, 350,000 this year,” said Adler. “There will be some amount of localized pain. But if you look at overall demand, household formation and demographics, we’re still in a great place. ... The fact that the pipeline isn’t growing is a positive.”
Driving the strong demand outlook is the combination of the millennial generation peaking, Gen Z starting to come into the mark and boomers coming back into the picture.
“We have to remember that half of [the millennials] are now in their 30s. And there is a cohort, even though they are delaying getting married, having kids, that is buying homes,” explained Rice. “That said, the younger kids are coming into rentals. And it’s not a big drop off between millennials and Gen Z. There’s about a million of them every year. But the question is when baby boomers will come in.”
Check out the full presentation here.
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