Multifamily loan originations will likely be less impacted by rate hikes than other CRE. The underwriting of multifamily loans by Fannie Mae, Freddie Mac, and the FHA have yet to see a significant decline as of the writing of this article. Many underwriting agencies have even seen a slight uptick in multifamily originations over the past several months.
But the Federal Reserve has indicated that they will continue to raise rates for the foreseeable future. On July 27th, the Fed raised rates another 75 basis points. With inflation consistently exceeding expectations, and the American economy adding more jobs than expected month after month, we can expect that it will be the Fed’s position to continue to attempt to wring inflation out of the economy.
How will these rate hikes affect investment in multifamily? Will multifamily cap rates widen as a result of these hikes? What can investors do to mitigate the risk of investing in multifamily?
Will Multifamily Cap Rates Widen?
It’s probably safe to assume that multifamily cap rates will widen in the next 12 to 18 months. The amount of discomfort this will cause investors financing HUD multifamily, or Fannie and Freddie multifamily loans, might be less than you might assume. (We will leave aside non-government-sponsored loans for reasons that will become clear below.)
One reason that multifamily will do better compared to other asset classes is because these transactions serve a defined market. As an investor in multifamily properties, you can rest assured that Americans will still need housing regardless of what occurs with the rest of the economy and the stock market.
The market fundamentals that made multifamily a solid investment in a pre-inflation environment haven’t changed. As you might be aware, America has been experiencing a housing supply shortage that began shortly after the end of The Great Recession in 2008 that has continued to the present day.
So the good news is that the demand for housing is not going to decrease in the longterm even if America tips into a mild recession, with this likelihood increasing as a result of the amount of household savings and consistently strong job reports.
The bad news is that investors and lenders will likely be more conservative going forward in multifamily. This is bad news because this will only exacerbate America’s ongoing housing shortage crisis, particularly when it comes to affordable housing.
Fannie Mae’s most recent report from May of this year shows a $781 million dollar dip in net income on loans originated by the agency in Q1 of 2022 compared to Q4 of 2021.
This combined with the Fed hikes indicate that buyers of multifamily are likely to determine if they will accept a lower yield, and sellers will need to reduce their asking price on these properties.
Below, we will explain some of the things you can do as an investor to mitigate the impact of Fed rate hikes in taking out multifamily loans in the months ahead.
Multifamily Interest Rates and Risk Tolerance
The essential question investors have to ask themselves when investing in a multifamily property involves risk tolerance.
What is your risk tolerance as an investor?
Some investors might seek floating rate loans if they expect that the interest rate will decrease significantly over the life of their mortgage. You might also want to consider an IO (interest-only) loan, which frees up capital so you can diversify your investment portfolio.
Fixed interest rates in multifamily, and in any CRE investment, will of course be less desirable in a high-interest environment. But the fundamental question remains: how much risk are you willing to tolerate in your commercial real estate investments? As you know, floating rate loans can certainly go down, but they can also go up.
One of the primary benefits of agency loans is that they offer a number of built-in safeguards against declining economic conditions. If you’re worried about the possibility of a more severe recession or don’t want your money tied up in an investment with the possibility of a lower yield when the market picks back up, HUD financing for multifamily might be a good option.
HUD, Fannie Mae, and Freddie Mac offer two important benefits that loans from other Lenders don’t.
All loans originated by Fannie, Freddie, and HUD are non-recourse loans. If for any reason, your multifamily investment goes south, you can simply walk away without jeopardizing the rest of your portfolio. For obvious reasons, in times of economic uncertainty such loans are more attractive to borrowers.
Agency loans are also completely assumable.
Potential buyers of multifamily properties can assume Agency loans at their origination interest rate, which may offer a far lower interest rate than you would be able to find with the climbing interest rates today.
The Future of Multifamily
While we don’t believe that the Fed is capable of engineering a soft landing, we want to express cautious optimism that any economic downturn in multifamily that comes in 2023 (if it comes) will be mild and brief.
At the same time, the fundamentals of the market for multifamily real estate are strong, and we firmly believe that they will continue to be strong despite any temporary economic dips or setbacks.
We also, as mortgage underwriters with a specialty in Agency and FHA underwriting, think that there are numerous ways to mitigate your risk and exposure to investing in multifamily CRE.