How the Fed’s Rate Call Will Impact Multifamily
Multifamily professionals are on Federal Reserve watch this week as the central bank prepares to announce its next call on interest rates Wednesday afternoon.
The debate isn’t so much whether the Fed will decrease rates, but whether it will be by a quarter-point or half-point. Assuming that it happens, the cut would represent the first since 2020. Equally important will be Fed Chair Jerome Powell’s comments on the path of interest rates for the remainder of 2024 and next year.
This move would also come at a time when key economic indicators remain steady. The Fed is trying to execute a so-called “soft landing” as inflation cools slightly and some workers face the threat of layoffs.
Here’s what ‘futures pricing’ says
According to 30-day Fed funds futures pricing via CME FedWatch, the probability of a 25 basis-point cut is 69 percent, with a 31 percent expectation of a 50 basis-point cut.
“Even as many in CRE have looked to rate cuts as a bailout from the difficulty of refinancing, it’s unclear how much favorability they can expect and how quickly,” said Doug Ressler, manager of business intelligence at Yardi Matrix.
Ressler noted that the amount of any cut to start will be small. But the same FedWatch data shows a 77.5 percent chance of cuts totaling between 100 and 125 basis points by the Federal Open Market Committee meeting in December.
“Is that enough of a rescue? It would partly depend on how much of a spread lenders decide to maintain,” Ressler said. “This move could lower borrowing costs and stimulate economic activity, including commercial real estate. However, the impact on asset values is complex. At the same time, lower rates generally make financing more affordable. Still, the extent to which this will drive up property prices remains uncertain, especially given the Fed’s cautious approach to inflation.”
Ressler said investors should recognize that while borrowing costs might decrease, cap rates don’t adjust immediately; the correction roughly takes six to nine months. That creates a brief window of opportunity where higher cap rates and lower borrowing costs could offer attractive investments.
“Yet it’s essential to understand that waiting for rates to drop to previous lows, such as those seen in 2021, might be unrealistic, as the current economic environment and the Fed’s strategy differ from past crises,” Ressler said. “Before cap rates tighten in response to lower borrowing costs, savvy investors who act now could secure better yields, positioning themselves advantageously for the future.”
Paul Waterloo, managing director at Interra Realty, told MHN that multifamily transactions have increased 46 percent yearly in the markets his team covers, although the average deal size has decreased by nearly 20 percent.
Lisa Flicker, senior managing partner & head of real estate at Jackson Lucas, observed that investors’ mood is generally optimistic. “The prevailing sentiment is that this cut will create more compelling opportunities in the market,” she said. “Expectations are set for a reduction of 25 to 50 basis points. However, there is concern that anything below this range could lead to significant disappointment across all real estate classes, including the multifamily sector.”
One cut won’t be enough
Eric Brody, managing principal, ANAX Real Estate Partners, suggested that a single rate cut may not significantly impact the multifamily sector. With banks remaining hesitant to lend, financing can be difficult to come by. And while lower rates ease borrowing costs slightly, to truly move the needle, multiple cuts will be necessary.
“Developers and investors are likely to hold off on major decisions until there is more clarity around the election and its economic implications,” Brody said. “The election outcome could drive significant shifts, as policies could influence lending environments and market confidence more than a single rate cut.”
The Fed seems to be signaling that inflation is stabilizing, and with economic growth moderating, “there’s reason to believe we could see some easing in monetary policy,” said Doug Faron, co-founder of Shoreham Capital.
“The last quarter has shown positive movement in the multifamily space, and a rate cut would only enhance that momentum,” Faron continued.
Greg Fedorinchik, managing director, equity capital markets, NexMetro Communities, who told MHN he believes many positive results would result from a half-percentage point cut now, followed by at least 100 basis points by the end of the year. “But we guess this week’s cut will be just 25 basis points,” he said.
Industry facing record-high debt levels
Pierre Debbas, managing partner, Romer Debbas, LLP, emphasized that with record levels of debt reaching maturity by the end of next year, it’s imperative that rates come down to enable borrowers to refinance at current cash-flow levels.
“The real estate market needs to see a 50 basis-point cut to spark activity with a commitment that there will be at least 100 basis-point reduction in the aggregate by the end of the year,” Debbas said. “If the Fed only reduces rates by 25 basis points, that will not move the needle, and activity will remain stagnant due to the fears the Fed will not reduce rates as much as they should.”
Paul Rahimian, CEO, Parkview Financial, believes that any rate cuts will help the multifamily sector, as a rate cut, or even the expectation of one, leads the 10-year Treasury to drop.
“The 10-year Treasury is directly correlated to mortgage rates on multifamily assets,” he noted. “So, when they drop, there is more availability of lower-priced mortgages. Notably, the 10-year was close to 5 percent less than a year ago, and now it is down below 3.75 percent. This drop directly helps multifamily owners who need to refinance their mortgages and eventually increases the valuations of multifamily assets.”
Jonathan Treble, founder and CEO of WithMe, told MHN that he sees this cut as the first in a series over the next 12 months to help rein in debt-servicing costs and jump-start deal activity.
“So many properties were financed or refinanced in the frenzied market of 2021 that the Fed’s tightening campaign since then made many of our client properties face real struggles with cash flow when their debt-service costs rose, along with record cost increases in labor and insurance premiums,” Treble said.
Decision likely to bring ‘relief’
According to Jay Remillard, co-head, CP Capital US, the industry has been craving stability over the past 18 months because rapid swings in the 10-year made it difficult for buyers and sellers to know what a property would be worth at closing.
“Expectations of a 25- to 50-basis point cut have been telegraphed for several weeks now, which has helped to stimulate Q3 transaction volume and overall confidence within the real estate market,” said Jeff Brown, founder & CEO of T2 Capital Management. “While the multifamily market has been resilient as evidenced by sustained occupancy, those who have financed their property with floating rate debt—and hung on to this point—are likely breathing a sigh of relief.”
Lei Farrand, managing director, Kingbird Investment Management, predicted that rate cuts will likely bring a general sense of relief and optimism across the industry.
However, she cautioned that the implications for construction of real estate investment portfolios are more complex. “Pay close attention to the ‘top-down’ macroeconomic signals like the interest rate decisions,” she advised. “Our strategy is further rooted in a deep understanding of the micro (‘bottom-up’) dynamics at the property and market levels.”
Looking ahead, Farrand isn’t sure that the relief many owners are hoping for will be as forthcoming as some believe. Despite the Fed’s efforts, Kingbird Investment Management’s analysis indicates a significant portion of the market will still face challenges. But banks are exploring creative solutions that better align with their balance sheets, unlike the foreclosure crisis from 2007 to 2009.
Jaime Sturgis, CEO of Native Realty, expects the rate cut to bring relief on the refinance side of the market, as the 10-year Treasury has been dropping in anticipation of it. If the Fed were to come in with a larger-than-expected rate cut, the markets would react with a sharper reduction in the cost of capital, providing additional relief to those trying to refinance.
Sturgis observed that many multifamily transactions traded over the past few years have had very thin margins between the cost of capital and the in-place cap rate. Furthermore, “many investors were buying on these thin margins, assuming rental rates would continue to climb at year-over-year rates achieved through the pandemic,” he said. “We are now seeing a leveling in rental rates and some rents retreating, adding additional pressure on these assets.”
While rate cuts are needed, Sturgis strongly believes that for some assets that were bought with thin margins and reliance on continued rent growth, it could be too little too late. In some cases, the key might return to lenders.
For developers, today’s rate is too high
Jake Geleerd, CEO and co-founder of Tortoise Properties, told MHN that the Fed’s anticipated 25 basis-point call recognizes that current rates are unsustainable for market-rate new construction projects and for refinancing loans where loan-to-values require equity paydowns.
“While a quarter-percent drop may not lead to a significant surge in new construction or refinancing activity, it could result in more efficient refinancing processes where floating and fixed-rate loans become more available,” Geleerd said. That gives developers a lower-rate environment and the opportunity to refinance or swap floating-rate debt into fixed-rate debt. “If rates gradually fall to around 6 to 7 percent, it will create a more favorable financing landscape for enhancing the feasibility of new projects,” he added.
It isn’t just new projects that are facing challenges due to high interest rates and increased labor and development costs. Refinancing existing multifamily properties is difficult too, as existing property owners face lenders that are requiring additional equity because of the current environment.
J.C. de Ona, Southeast Florida division president, Centennial Bank, told MHN he expects the Fed to lower rates by 25 basis points, but caution will remain. “It will be interesting to see if increased activity pressures construction costs,” de Ona said. He speculates that some developers may accelerate their projects to avoid rising costs and bring them to market more quickly.
Michael Huerta, co-founder and CEO, PearlX, noted that the Fed will want to see whether and how a quarter-point decrease impacts the markets before continuing with any further reduction.
“(A cut) will hopefully improve market sentiment and stimulate deals that were previously on the fence,” Huerta said. “There is still strong housing market demand at the regional level. Especially considering the ongoing housing shortage, we anticipate that increasing rents in California will eventually get deals flowing again.” Interest rates are still high enough to make buying harder than renting for many residents.”
A ’compelling’ case for older assets
David Fletcher, Excelsa Properties’ managing director, said that interest rates are higher than going-in cap rates on a simple basis, indicating speculation on both great rent growth and lower future cap rates.
“Despite this questionable pricing, we have found compelling value in older assets, where buyer pools are more dependent on floating-rate financing structures and, therefore, less able to speculate on future asset price appreciation,” Fletcher said.
He anticipates that a cut will generate more speculative investing by floating-rate borrowers, in turn driving up asset pricing and unlocking distressed asset trades that might be too underwater to sell now.
EisnerAmper Director Robert Martinek noted that some observers believe the Fed doesn’t want to be late with rate cuts since it was late with rate hikes. Many are calling for a 50 basis-point cut but some also feel political overtones with this move.
“The multifamily sector, as well as all real estate sectors, should benefit from a rate cut,” Martinek said. “Multifamily properties have seen recent increases in inventory, vacancy rates and cap rates. An easing of interest rates should benefit both borrowers and lenders.”
Effects on consumers, student housing
Greg Freedman, BH3 Management’s co-founder & co-CEO, told MHN the initial impacts of a rate drop would be felt primarily among consumers rather than across the capital markets.
“Unless a borrower faces a time crunch, the instinct is to wait to take on debt until there is clarity about where rates will ultimately stabilize,” Freedman noted. A project or asset’s fundamentals are more important than rates when underwriting an asset and placing debt, he added. “This means adding weight to factors like sponsor quality, an asset’s location and the underlying real estate, and a borrower’s equity position.”
JJ Smith, executive vice president and partner, residential, CRG, told MHN that for student housing, interest rate uncertainty has made cap rates and valuations harder to predict and financials more challenging.
“A rate cut would help make it easier to forecast financials,” he said. “Additionally, developers may not need to inject as much equity as financing becomes more accessible, which could further drive activity on both the development and acquisition fronts. It won’t happen overnight but it positions the market for a new growth cycle in the coming quarters.”