The Fed’s 7th Rate Hike: The Good, the Bad and the Ugly
Industry experts weigh in following the Federal Reserve's latest decision on interest rates.
To the surprise of few, the Federal Reserve has announced a new 50-basis-point interest rate hike, its seventh consecutive increase this year. Following last month’s hike, such a cooldown represents a more stable and less volatile pace of increases, especially in the face of inflation that is expected to persist well into 2023. The effects of climbing rates are leaving their marks on nearly all aspects of multifamily, but the smaller increase is a welcome development in a market that has been weathering its consequences for some time. Industry experts shared their latest insights with Multi-Housing News.
A broad view is that, on its own, the latest rate increase does not severely impact finance and investment endeavors in multifamily, but it compounds upon an already volatile dealmaking landscape. As such, the mood has shifted toward one of anticipation of when the hikes will stop. Brennan Degner, CEO at DB Capital holds such a view, expecting the procurement and movement of capital to speed up when the increases eventually slow. “My prediction is (that) most capital will remain on pause until the general market thesis is that rate hikes are over, even if it means higher rates are here to stay.”
In an unpredictable lending environment, Degner sees lenders as even more reluctant to issue loans, not for a lack of capital but due to constant fluctuations that have bred deep disagreements between lenders and borrowers over appropriate lending terms and rates. “We have seen the pendulum swing significantly in terms of how conservative lenders are when issuing term sheets. From our lenses, it looks like with rate hikes earlier this year, the goal post kept moving on lenders mid-deal, causing them to adjust terms mid-process, which can strain relationships even if they are able to execute and close,” Degner added.
Despite the chaotic lending environment, multifamily as a whole might be better equipped to draw up more attractive financing terms, with help from Fannie Mae and Freddie Mac. Noah Hochman, CIO & head of capital markets at TruAmerica sees the GSEs providing some respite from an overall difficult debt environment, despite capital still being expensive. “If the financing you need meets their mission-driven needs, targeting a certain income level, you can actually get more attractive financing. … It’s just materially more expensive to get loans today,” Hochman told Multi-Housing News.
Deals in decline
Like the lending environment, the instability brought about by consecutive hikes has shifted attention in the deal making sphere towards one of anticipation of financing equilibrium. In fact, the industry is expecting further hikes. “It’s more of a question of when it stops. … To transact today, you have to live with the potential for neutral or short-term negative leverage on your asset or acquisition,” Hochman explained to MHN.
In the meantime, deal and transaction volumes are likely to remain on the downswing, if not frozen entirely, due to persistently elevated bid-ask spreads, with borrowers and lenders incapable of reaching a consensus. DJ Effler, president at Bellwether Enterprise believes that it is only when such volatility dies down that a “real price discovery (can) take place. “It’s high volatility that has prevented this from occurring,” Effler said.
Degner expects dealmaking to stop entirely and doesn’t think the increases will thaw frozen capital anytime soon. “At this point, we think the fear and understanding of rate hikes have generally frozen the market. I don’t know that additional hikes will see a high order of magnitude in impact, given (that) a majority of capital is already on the sidelines anyway.” Still, he sees thew bid-ask gap as peaking imminently, in turn accelerating timelines for consequential capital decisions. “Given the amount of uncertainty we see bid-ask spreads as likely peaking in Q4 2022 and into Q1 2023, we take the position that that will change once owners enter a stricter timeline where they need to make a capital decision.”
Others are taking a broader view, acknowledging that the current landscape as difficult, yet not unique in the context of historically inflated interest rates. John Williams, President & CIO at Avanath Capital Management expressed dismay at the increasing rates but views them as being a continuing hurdle, though not an immovable obstacle, to dealmaking. “Rates are high compared to the last five years but still relatively low historically. We are still getting deals done,” Williams told MHN.
Development is also feeling the impact of interest rate hikes and the accompanying stagnant lending and dealmaking environments. The multifamily sector will also likely suffer further from inflated material costs and a shortage of labor. Effler sees development suffering in the same way the capital markets sphere has. “A major increase in the cost of capital coupled with high construction costs and now a significant slowdown of anticipated rent growth causes plenty of development deals to be put on the back burner,” Effler detailed. Hochman has witnessed such a trend directly. “My peers in the merchant built space will tell you that they’ve already dropped many projects and have delayed starts of others. A lot of what was in the pipeline to be built will not get built.”
Williams sees an acceleration of office-to-multifamily redevelopments taking place, as the office sector appears to be suffering the most in the current climate. “Given the issues in the office market and the work-from-home trends post-COVID, I think repurposing of existing offices into residential space is going to accelerate,” Williams concluded.