Rising Interest Rates and What’s Next for Multifamily Lending
Bankers, advisers and analysts weigh in on the impact of the Fed’s planned hikes.
Multifamily investors are bracing for an uptick in mortgage rates and other forms of real estate finance as the Federal Reserve bumps up interest rates in 2022. As an inflation-fighting move, the Fed plans three hikes of 25 basis points each. And in December, the Fed announced that it would wind down its bond-buying program by March.
But the consensus among mortgage bankers and economists is that increases in the cost of capital will be modest and will not dampen the availability of financing or the surge of investment. Multifamily lending volume will rise 3 percent to $421 billion this year as the economy continues to rebound, the Mortgage Bankers Association projects.
“The change in interest rates is not expected to reduce demand for multifamily housing this year. A lot of demand is driven by property values and fundamentals, both of which are extremely strong right now,” said Jamie Woodwell, MBA’s vice president of commercial real estate research. Strong property income and low vacancy are combining to push valuations upward, he added.
Another key factor is the national housing shortage. Construction is expected to increase by 5 percent this year to nearly 500,000 units, reports Robert Dietz, chief economist at the National Association of Home Builders. “Demand is especially strong in growing southern cities such as Austin, Nashville and Phoenix as urbanites in high-cost markets move to less densely populated areas,” he noted.
All things considered, multifamily rent growth is unlikely to repeat the performance of 2021, when rents increased 13.5 percent year-over-year through November, according to Yardi Matrix. Yet lenders will be underwriting deals against the backdrop of a market with solid—if less sensational—potential. For 2022, CBRE forecasts 6.5 percent rent increases and continued low vacancy in both urban and suburban markets.
Now mortgage bankers are assessing the impact of the Fed’s actions in the months ahead. Predictions vary as to how much the average 30-year fixed rate mortgage (currently at 3.05 percent) will rise in 2022. Some bankers predict a 25- to 30-basis-point uptick. Fannie Mae, for example, expects the average 30-year fixed rate to come in at 3.3 percent by the end of the year. In contrast, MBA forecasts a 4 percent increase.
But student and senior housing, in particular, could see more of an uptick if the omicron variant stalls those sectors’ recovery. Any lockdown could hurt the short-term outlook for those sectors, say observers. Affordable housing, which is highly attractive to banks and the government-sponsored enterprises, should get the most aggressive rates this year.
That’s largely because Freddie Mac and Fannie Mae are on a mission to help alleviate the housing shortage and are incentivized to give the best terms on these deals. Each agency raised its 2022 cap for multifamily loans to $78 billion. Banks also earn a community reinvestment credit for arranging packages.
A $107 million Fannie Mae credit facility arranged by PGIM Real Estate last fall for a national affordable housing operator exemplifies the trend. The deal financed nine properties that will offer more than 1,200 affordable units in Colorado, New Mexico and Texas.
It was structured as a 30-year fixed-rate loan that the operator intends to use to repay existing debt and provide capital for expansion. PGIM Real Estate’s client hopes to increase the credit facility by $100 million over the next three to five years to pay for property acquisitions.
Fixed or Floating?
While mortgage rates should not soar this year, there will be a spillover effect in the real estate finance market.
“The general expectation is that interest rate hikes will most directly affect short-term borrowing and floating rate finance and have less of an effect on the cost of longer-term fixed-rate mortgages,” said MBA’s Woodwell.
Floating-rate finance will probably rise to 75 basis points above the federal funds rate, predicts Michael McRoberts, chairman of agency lending at PGIM Real Estate. “That will drive a migration of investors to fixed-rate finance in 2022,” he said. As a result, investors will have to weigh the pre-payment flexibility of a floating-rate structure against the cost, he adds.
The choice between fixed-rate and floating-rate loans hinges on the borrower’s investment strategy and circumstances, points out Gregg Gerken, executive vice president & head of commercial real estate at TD Bank.
“If an investor plans to sell the asset in the near term, they may opt for a floating-rate loan and put a cap like an interest rate hedge on it to take advantage of the current low rates with some upside protection for the future,” he said. That’s a good approach for a buyer planning a three- to five-year hold for a property that isn’t yet fully leased, Gerken added.
Moreover, there are multiple tradeoffs to consider. “It all depends on the type of asset you are financing and what your investment plans are,” observed Jeff Wilcox, a principal at Gantry. “If you are a generational holder, a fixed-rate product with a rate certainty might make sense.”
One trend that may emerge, experts say, is that more investors will opt for shorter five- to seven-year fixed-rate terms for acquisition loans, rather than three-year, floating-rate bridge loans.
Cap rate trends
Another concern is whether rising interest rates will affect cap rates, and if so, how much. “We don’t believe rising interest rates will have any impact at all,” said Matt Vance, Americas head of multifamily research at CBRE, noting that cap rates and bond yields don’t necessarily move in tandem.
“Considering the amount of capital targeting this real estate sector, there is sufficient spread between the cap rate and bond yield to allow for modest continued compression in cap rates as we saw in 2021,” when rates declined about 10 basis points.
An encouraging sign is that rising interest rates probably won’t significantly impact key loan-to-value or interest-only provisions. “Over the last 18 months, many nonbank lenders have been lending over LTV, since rental rates are moving up so rapidly and the overall debt service ratio is getting better,” Gerken noted.
As an example of interest-only trends, PGIM cites a $44.5 million loan for a property in Georgia. With a spread of 258 basis points over SOFR, the 10-year Freddie Mac financing starts with five years of interest-only. “We were able to get a good spread since it’s 100 percent mission business” for the GSE, noted Lee McNeer, PGIM Real Estate’s executive director of agency originations.