How the Federal Reserve Rate Hikes Impact the Multifamily Industry

With inflation at a 40-year high of 7.9%, the Federal Reserve’s recent decision to raise interest rates is bound to have an impact on the multifamily industry. According to Federal Reserve Chairman Jerome Powell, the Central Bank is prepared to aggressively raise interest rates by half-percentage points over a series of steps to curb the economy and reduce inflation. If necessary, they’re willing to tighten measures into a more restrictive stance to restore price stability that has been impacted by supply-chain bottlenecks caused by the aftereffects of the pandemic and the recent war in Ukraine.

For now, the Federal Reserve has hiked the interest rate from almost zero to a range between 0.25% to 0.5%. This ended the period of no rate hikes since 2018. Officials also added additional rate hike increases that will raise interest rates to almost 2% by the end of 2022. By 2023, these rates are forecasted to be around 2.8%.

So, what do these Federal Reserve rate hikes mean for the multifamily real estate industry? Read on to find out.

Impact on Commercial Properties

With interest rates rising, commercial properties will likely be affected by the sizes of loans. We’ll likely see loan sizes shrinking due to higher debt service payments as well as a reduction in property cash flow.

However, since rent growth is currently strong throughout many regions in the United States, this could potentially help reduce the impact borrowers face on debt service payments. Also, with higher interest rates, renters may be discouraged from becoming homebuyers and taking out mortgages on properties, resulting in them continuing to remain renters.

REIT Performance and Interest Rates

REITs have historically been shown to perform well during periods of rising interest rates. In fact, 84% of the months between Q1 1993 to Q2 2021 showed positive REIT returns when 10-year Treasury yields rose and often outperformed the S&P 500.

For 2022, real estate investors can likely expect to see their earnings continue to grow as the Federal Reserve continues to raise interest rates. In addition, since REITs are a fixed-rate debt, interest expenses will likely not rise too much.

Expansion of Cap Rates

As the Federal Reserve implements rate hikes, real estate investors need to be aware of the potential implications it has on capitalization rates (“cap rates”) and investment capital. Real estate investors should know that there is potential for cap rates to expand on multifamily real estate properties such as residential rental units due to the cost of capital increases.

It is worth noting, rising interest rates could make fixed-income securities look like a more attractive investment for portfolios focused on high-yield and fixed-income since there could be a reduction of capital flowing into real estate investments. However, institutional capital will most likely continue flowing into this sector since there is such high demand in the US market for rental units. If this happens, we’ll see a curb on capital being reallocated into fixed-income securities like bonds. Instead, capital will be invested into rental assets like build-to-rent and single family residences that are owned and operated as rental properties.

How to Navigate the Effects as a Real Estate Investor

As a real estate investor, it is vital to be aware of these potential implications and factor them into your decision-making process. Doing so will help you make more educated and informed investment choices and potentially avoid costly mistakes.

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