How Interest Rates Affect Multifamily New Developments
Late last year, the Federal Reserve finally admitted that the inflation prices were not as temporary as they claimed. It was finally time to raise the interest rates. In June 2022, the Federal Reserve increased interest rates in its largest move since 1994. Rates were increased a startling amount of basis points, moving the target federal funds range from 2.255% to 2.5%. Every time interest rates are raised, speculation starts to spread about the impact on property values.
A three trillion dollar industry, multifamily housing provides more economic value than even the tech industry. About 14% of the GDP, multifamily housing is an important cornerstone of the country’s financial infrastructure. Housing will always be an essential commodity. People will always need a place to live, no matter the economy. Multifamily housing provides a place of residence for millions of families and individuals alike across the United States.
Why Invest in Multifamily Developments
Multifamily developments are real estate properties with two or more dwelling units under the same roof and over the same structure. This can be a building with two units, three units, four units, or a multiplex with five or more units.
Any building with four or fewer units is considered a residential property. Their value will be assessed differently than the properties with five or more units, which is considered to be a commercial property. The residential property is assessed by the average similar surrounding properties as well as property features. These features include bedrooms, bathrooms, a pool, an elevator, and more. Commercial properties are assessed by the amount of cash flow they produce and the rate of return used to discount present value.
This property type in general is the only real estate asset group that protects investors in the short and long-term. Both office spaces and hotels were hit hard during the pandemic. With all employees sent home and travel restricted, the only buildings guaranteed to still be in use were in the residential space. This also resulted in many office towers being transformed into apartment buildings instead.
Hedge Against Inflation
Since central bank officials have acknowledged the continually rising prices, they are tightening credit to stop the trend. The Federal Reserve has begun to wind down the pandemic bond purchase program. By the end of July 2022, they raised interest rates for the fourth time this year, with possible further hikes in the future.
Higher interest rates and inflation will require a risk assessment due to the belief that the rates threaten real estate’s value. On the other hand, rising interest rates are an indicator of a growing economy. There is a higher demand for living space as cash flow for goods and services continues to increase. According to the National Association of Real Estate Investment Trusts:
Multifamily REITs were some of 2021’s best performers through October. They generated a return of 46.7%.
The assets that tend to perform exceptionally well in an inflation period are multifamily real estate investments. These are defensive stocks that will perform the same in almost any scenario. The demand for housing is driven by the employment and higher wages of economic growth. The housing market also deals with a regular shortage of available units. The average shortage at any given time is about five million units. This ensures a regular demand for these investments.
The demand for housing and the unit shortage continue to drive rental rates higher. This offsets the higher construction, labor, and increased interest rates. It allows multifamily properties to protect against inflation. In the five recession periods since 1982, rent levels never decreased. According to the Consumer Price Index for All Urban Consumers: Rent of Primary Residence in the US City Average, rents actually continued to increase. In February 2022, rental rates had risen 4% on average across the US over the last year. These numbers easily surpass the 3.3 average annual increase seen over the previous five years.
The constant need for shelter ensures multifamily housing is a historical stand out when it comes to performance during any economic cycle. Experts are predicting that new developments will double by 2024 to keep up with the demand for housing. The demand will keep investments in multifamily housing secure for the foreseeable future.
While inflation may be at its highest since the 1980s, interest rates are actually still fairly low. According to the Head of Research for Commercial Banking at JPMorgan Chase, Ginger Chambless, the pandemic has put us in financially “uncharted territory.” The Federal Reserve is slowly raising rates throughout the year to get a hold of inflation without causing unnecessary panic. This allows them to test to see how the economy is holding up to each increment, in a way a drastic increase would not.
Despite inflation being at a 40-year high, interest rates haven’t even gotten close to the previous year’s record highs. In 1980 there was a record-breaking high of 20%, and the 2000s had a high of 6.5%. Compared to historic levels, we are still at extremely favorable numbers. Mike Kraft, Head of CRE Treasury at JPMorgan Chase says, “Generally, I would say this is a great time to do business—before additional rate movements kick in.”
Despite some uncertainties like the war in Ukraine and possible Covid variants, most signs of the American economy remain strong. We are in unprecedented financial times with no models to give accurate answers for our current situation. Despite this, people still need homes to live in, so the demand will continue to validate investments in multifamily homes.
Leveraging the extensive experience of Veloce Capital, the firm invests in opportunistic real estate projects, seeking revitalization of under-developed urban and opportunity zone markets across the United States. The national spread of investment balances out the differences in local real estate markets across the country. Investments offer the potential for growth, capital appreciation, and the preservation of principal.