Inflation And Rising Interest Rates: What Is The Impact On Multifamily Investments?
After months asserting that inflation was temporary, Federal Reserve officials in late 2021 acknowledged that, in fact, prices would likely not return to previous levels, and it was time to raise interest rates.
Any time the Fed mentions hiking interest rates, it fuels a more volatile stock market, as happened in late November and into December. It also sparks widespread speculation about how property values will be impacted as well as opportunities it could create for investors.
Inflation is defined as the general rise in the price of goods and services. The Fed attempts to stabilize the inflation rate at roughly 2% annually by balancing employment levels and the federal funds rate, a target rate at which banks lend excess reserves to each other overnight. More importantly, the rate serves as a benchmark for interest rates in general. The Fed lowers the federal funds rate to spur spending and fuel inflation and raises the rate to tighten credit and slow inflation. The rate has been near zero since April of 2020 when the Covid-19 pandemic caused global financial disruption and uncertainty.
Rising inflation can signal an expanding economy, as employment grows and demand for goods and services outstrips supply. But inflation can also result from the supply of money increasing faster than economic output. While complex, the theory generally posits that a greater amount of money chasing a limited amount of goods and services drives up prices. As the Fed’s balance sheet more than doubled to $8.5 trillion from February 2020 to November 2021 in reaction to the pandemic, the consumer price index rose nearly 8%.
Regardless of its cause, inflation erodes the purchasing power of the dollar. As a result, investors typically divert funds into inflation hedges, such as hard assets like multifamily real estate. A Dow Jones exchange-traded fund that tracks real estate investment trusts nearly doubled from March 2020 to December 2021. Multifamily REITs have been some of the best performers in 2021, generating a total return of 46.7% through October, according to the National Association of Real Estate Investment Trusts.
Multifamily Real Estate As A Hedge Against Inflation
By acknowledging that the rise in prices is likely to continue, central bank officials are now tightening credit to try and stop the trend. In mid-December, the Fed indicated that it would wind down its pandemic-era bond purchase program at an accelerated rate. It also signaled it would incrementally raise the federal funds rate to nearly 1% by the end of 2022 and to about 2% by the end of 2024.
For real estate investors, an environment marked by higher interest rates and inflation will require a reassessment of risk. It is widely believed that rising rates threaten the value of real estate; however, because rising interest rates are indicative of a growing economy, landlords often witness more demand for space as spending on goods and services increases.
Multifamily assets in particular tend to perform well in an inflationary period. Economic growth fuels employment and higher wages, which in turn drives demand for housing. At the same time, the housing market, in general, faces a chronic shortage of some 5 million units. Together, those conditions give multifamily owners the ability to raise rental rates and offset higher construction, labor, insurance, taxes and other costs, potentially allowing multifamily properties to hedge the effects of inflation. Additionally, multifamily properties may have mortgage loans with fixed interest rates, keeping debt service payments stable as rents increase.
The appeal of this inflation hedge should drive more investment demand for apartments, which could help sustain values while simultaneously preventing interest rate spikes as lenders compete for deals by keeping the cost of capital as low as possible. Through three quarters in 2021, multifamily loan originations were up 52% over the same period (download required) in 2020, and in the third quarter alone, they were up 105%, according to the Mortgage Bankers Association.
Multifamily Has A Proven Track Record
Multifamily housing has historically stood out for its stability and performance in all economic cycles. This is as true for single-family rentals (SFR) and build-to-rent (BTR) as it is for apartments, due to the constant need for shelter.
Apartment rental rates grew 13.7% year-over-year in October 2021, according to Yardi Matrix, and the average occupancy was around 96%. Some Sun Belt markets like Phoenix, Charlotte, Atlanta and Las Vegas reported rent growth of more than 10%. Single-family rental occupancy ended the third quarter around 90%, according to CoStar Group.
Beyond apartments, SFR and BTR communities continue to drive significant investment for a variety of reasons, including strong demand for suburban housing among Millennials forming families and workers leaving urban areas to do their jobs remotely. Some experts predict that by 2024, the number of BTR units developed each year will be twice the 42,000 under construction today.
Comes Down To The Deal And The Right Professionals
Favorable fundamentals combined with more limited development have created an appealing rental housing investment landscape. While these investments can help lessen the punitive effect that inflation has on purchasing power, environments that appear promising are not immune to disruptions in operations and rental income. But just as bad deals can occur in good times, those that have the experience and foresight to underwrite for potential change can execute on good deals in challenging times.
Read this article at Forbes.com