How the Fed’s Pause on Interest Rates Impacts Multifamily

Interest rates are the highest they have been in more than 15 years. However, for now, they will remain as they are.

In May, the Federal Reserve raised interest rates by 25 basis points bringing the target interest rate range from 5 percent to 5.25 percent. As of last month, the repetition of rate increases brought about by the Central Bank came of little surprise. However, for this month’s meeting, some multifamily experts were anticipating a shift. Many correctly hoped that consecutive rate hike number 10 was the last, at least for a while.

A number of factors weighed into the Central Bank’s pause: recent bank failures; sticky inflation data; worries of a potential recession. While there was argument for another rate hike, such as overall inflation still running high, hiring remaining strong and consumer spending failing to significantly cool down, none of them outweighed the need to hold off and investigate the impacts of previous rate spikes.

Anticipations were running high

Before the decision released at the latest Federal Open Market Committee’s meeting, multifamily experts gave their predictions as to what the outcome would be.

“I do not expect the Fed to raise rates in June,” Stephen A. Sobin, president, Select Commercial Funding LLC told Multi-Housing News. “The recent bank failures coupled with lingering concerns about recession cause me to believe that the Fed will wait to see what develops before increasing rates any further.”

Carey Heyman, managing principal of the real estate industry at CliftonLarsonAllen (CLA), was of the same consensus, noting that the markets were pricing in an 80 percent chance of a pause.

“Our CLA Outlook highlights that the rationale behind a Fed pause is clear: inflation data has trended down from a high of 9 percent last year to around 5 percent in the latest readings,” said Heyman. “This gives the Fed some room to pause and assess economic conditions before resuming any further rate hikes.”

While Sobin, Heyman and other multifamily and commercial real estate experts anticipated a pause in the Central Bank’s interest rate hikes, there was uncertainty as to the final outcome of the decision. Spencer Gray, CEO of Gray Capital, noted that he wouldn’t have been surprised if, given the recent jobs numbers, Wednesday’s meeting resulted in an additional 25 basis point increase.

“There’s still a chance the Fed may plateau and pause at the current level, but I believe Powell believes that in order to reestablish Fed credibility they have to send a strong message to markets that they are serious about bringing inflation back down to their 2 percent target,” Gray previously noted.

For those that were uncertain about just what to expect, the hope was that a pause was on the horizon.

“There’s really no way to anticipate or predict with total certainty what will happen next week but our hope is that the Fed does not raise interest rates further at this point,” Matthew Dzbanek, senior director, capital services, at Ariel Property Advisors said. “Holding steady will allow the previous interest rate hikes to continue to take effect.”

What now?

While there was some variation as to the anticipated results of June’s FOMC meeting, there is also discrepancy among experts as to what the rest of the year holds.

It is true that in some respects the multifamily industry, as well as the larger economy, is already feeling the effects of interest rate hikes. What is uncertain is if the Central Banks believes these are enough to pause in the long term.

“If the Fed pauses they will likely communicate that future rate hikes are highly possible,” Gray explained before Fed Chairman Jerome Powell announced that this month would not result in another increase. “However, given the declining trend of inflation and the lagging indicators seeping into inflation data, they will most likely plateau rates for several quarters before reducing rates, assuming inflation stays at bay. Rates could come down even sooner if the US economy is pushed into a recession in the 4th quarter of 2023 or 1st quarter of 2024.”

A potential recession would greatly influence future meetings’ outcomes, likely towards an overall pause and possible decrease in interest rates. On the contrary, should inflation fail to subside, further tightening is a possibility. During the press conference following the announcement of a pause, Powell indicated that more rate hikes are the greater possibility.

As the Central Bank has previously stated, they will react to further meetings based on economic data. “With inflation trending lower and other economic data points showing resilience, we expect the Fed to pause while reassessing any further rate impact,” Heyman said.

A timeline of multifamily reactions

While the future is foggy, one thing that is certainly here is the beginning of the affects of previous interest rate hikes. “The impact of the previous rate hikes was expected to take nine months to a year to fully develop and we’re hitting that mark right now,” said Dzbanek.

So far, the impacts on multifamily have been seen in a plethora of different ways, some good, some bad. The industry is known to react quickly to market and economic changes. First, sales volume in multifamily has significantly fallen in the first quarter of 2023 when compared to the first quarter of 2022, Heyman explained. He noted some estimate the volume decline to be as much as 60 percent due to high interest rates increasing financing costs.

“Development activity at a standstill has also resulted in low availability of new construction in multifamily, further exacerbating the supply-demand imbalance that this industry subsegment is experiencing,” Heyman continued to explain of the impacts multifamily is already facing.

Sobin agreed that the outcomes of previous interest rate hikes are already affecting the market. “The spread between seller’s asking prices and buyer’s bid prices has never been greater. With such a buyer-seller disconnect sales volume is way down,” he said.

Despite starting to feel the effects now, the full impact on multifamily is yet to be. “By the fourth quarter of 2023 multifamily will feel the most pressure from rates still being high and a wave of debt maturities for troubled assets purchased with high leverage, low interest rates, and low cap rates,” Gray said.

What the impacts on multifamily really are

Multifamily is feeling the affects of rising interest rates in a multitude of ways. On a positive side for investors and developers, potential homebuyers may be renting for longer as higher interest rates push them out of the market for a new home. Further, rising costs of construction are keeping the numbers of new unit deliveries lower, as are construction delays, which is in turn driving up demand. However, there is also downside to these factors.

Partner & Co-Chair of Real Estate Services with Anchin, Block and Anchin, Rob Gilman, explained that while a pause on interest rates certainly impacts multifamily, the big concern is on where the lending is coming from for multifamily.

“The fallout from Signature Bank has left a void on the multifamily lending,” Gilman said. “While other lenders are doing some deals, no institution has come out to say they are getting more involved in the area to take over the void.”

He continued that while the good deals will continue to get done, many are needing to be structured creatively and finding a lender is going to prove difficult. Further rate hike increases would only further reduce buying power, making multifamily transactions difficult to execute.

It’s not just financing new deals that has multifamily investors and developers in a bind, however. Existing loans and rising cap rates are affecting current multifamily communities as well.

“Right now, rates of return on many apartment investments are below going interest rates,” said Sobin.  “That means that many apartment loans no longer cash flow adequately to cover mortgage payments. If rates continue at this level, we will see a major drop in values as cap rates will have to increase.”

Gray told MHN that he believed that a pause in interest rate hikes would reduce some anxiety among multifamily investors and developers. Not all of it, though, considering interest rates are still far above those from when borrowers acquired their assets.

“With rates still higher, albeit not growing, the loan maturity wave is still a growing concern that multifamily and CRE must still tackle,” said Gray.