How the Fed’s Latest Rate Hike Will Impact Multifamily

While this increase is likely to have a dampening effect, its predictability may be a plus.

Federal Reserve Chair Jerome Powell announcing an earlier interest rate hike in 2022. Image courtesy of the Federal Reserve via Flickr

The Federal Reserve‘s 25 basis-point interest rate bump was a foregone conclusion by the time it was announced by Chair Jerome Powell on Wednesday and, while this newest increase is likely to have a somewhat dampening effect on multifamily investment, the central bank’s apparent deceleration is providing some optimism.

The odds seem in favor of an identical hike in March, which is expected to be the final rate increase of the year. While the market has priced that in, increases beyond March “will be a surprise and tighten the market more,” said Wei Luo, senior economist for CBRE Investment Management.

Doug Prickett, senior managing director at Transwestern, likewise expects the Fed’s next rate bump to be its last of 2023. “They’re getting the results that they want” in terms of fighting inflation, he said, noting that the move’s impact on cost of capital will be tempered by its predictability. “This was so telegraphed, this 25 basis points, that it was already baked into most of the cost of capital.” Regardless, he said, it will give lenders the power to keep the price of debt elevated.

Much of the overall impact from the Fed’s rate increases was felt by borrowers well before this last hike. Starting in the third quarter of 2022, Prickett noted, debt quickly became more expensive across all sectors, which contributed to the construction slowdown. “The cost of debt is no longer accretive to your returns, so a lot of people just put their pencil down, and I’ve definitely seen that in the multifamily world,” he said.

The appetite for opportunistic investment remains strong, “but lenders are less willing to take risks,” Luo observed. Two key benchmarks, LIBOR and SOFR, have tracked the federal funds rate closely, and will continue to increase with each rate hike by the Fed. “Therefore, the financing costs will continue to rise but at a slower pace than last year,” he said.

Slowdown in ’23, rebound in ’24? 

The National Association of Home Builders, which anticipates a housing downturn in 2023, expects stabilization of interest rates in the second half of the year as the prelude for a rebound in 2024. The group is hewing to the conventional wisdom that another 25 basis-point increase is due in March and that it will be the final rate hike of the year.

“Roughly 40% of the CPI is based on housing, and the Fed can do little to tame housing inflation,” Robert Dietz, NAHB’s chief economist, said in a statement. “The only way to bring down housing inflation is to build more affordable housing.”

In the NAHB’s view, the cumulative effect of the Federal Reserve’s rate hikes in 2022 and 2023 will be a peak rate of just above 7 percent. Mortgage rates are expected to fall below 6 percent by 2024, “[setting] the stage for a housing rebound later in 2023, and a better affordability environment will lead to a recovery of housing demand,” Dietz said.

The organization noted that construction in the multifamily sector was up an estimated 15 percent from 2022. However, it predicts that due to “slowing rent growth, rising unemployment, tighter financing and a decades-high level of inventory in the pipelines [and] supply constraints that have caused a large backlog of projects,” multifamily starts will fall 28 percent this year before stabilizing in 2024.

“The multifamily market is not following its traditional script already,” said Prickett. “You can see that in the absorption numbers. Usually the second and third quarters are the best quarters of the year and they were negative this past year, so we’re on three quarters of negative absorption. That’s really surprised the market because the job market’s still pretty resilient and the incomes are up.”

“The yield expansion for stabilized class-A assets will be limited going forward, including the preferred growth sectors such as single-family rental and student housing,” said Luo. “Liquidity will take time to recover but these assets are better positioned than lower-quality or riskier assets.”

The confidence factor

Monetary policy’s impact on consumer confidence in the multifamily space may be the longest-lasting legacy of this series of rate increases. Lower-income households could be impacted, considering the high cost of credit and the relatively high amount of existing credit card debt. With those consumers more strapped for cash, there could be reduced demand for more expensive housing, according to Prickett. “It might take a bite out of the rent increases,” he said.

Meanwhile, mortgage rates declined for the fourth consecutive week, falling almost 40 basis points over the previous month, according to comments made in a statement on Tuesday by Joel Kan, vice president & deputy chief economist at the Mortgage Bankers Association.

While the Fed may be pumping the brakes, it is an open question when—or whether—interest rates will return to where they were just one year ago. The Fed’s most recent move “indicates that markets should anticipate that the Federal Reserve will keep short-term rates higher for longer,” noted Mike Fratantoni, MBA senior vice president & chief economist, in a separate statement on Tuesday.

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