‘Trying To Hang On’: Multifamily Roller Coaster Rides On After Rate Cut

The 50-basis-point interest rate cut enacted by the Federal Reserve last week was greeted with relief and joy in basically every corner of commercial real estate. Multifamily owners are among those with particular reason to celebrate, though, as headwinds gather and financial stress mounts.

There’s a sense of optimism in the multifamily sector following the long-awaited cut, but there is also belief that reckonings are still on the horizon for a growing number of owners with distressed loans attached to their properties.

“People are trying to hang on as long as they can,” Colliers Midwest Multifamily Advisory Executive Vice President Tyler Hague said. “For some investors, it’s going to take a lot more than a 50-basis-point cut to help them refi or sell at a price that’s going to make any monetary sense. I think it's going to breed a lot of opportunities and kind of break the dam. I also still expect there to be problems in the apartment business.”

The long-awaited cut just adds to the roller coaster the multifamily market has experienced. During a historic run-up in 2021, the sector enjoyed double-digit rent increases and a surge in construction starts as developers sought to cash in on shifting population patterns. But beginning in 2022, as adjustable-rate debt caused payments to balloon and the flood of new units depressed rent growth, apartment owners were faced with a rude awakening.

Distress among multifamily loans grew at an alarming rate over the summer, climbing to 8.4% in July from 2.6% in January, according to CredIQ. Meanwhile, a staggering 759,000 apartments were delivered in buildings with two or more units in August, a 50-year high.

As rates decline, asset values go up and the bid-ask spread narrows, making more deals possible. Improved buying conditions are good news for owners trying to offload distressed assets, and major investors are ready with a stockpile of capital. Investment giants Waterton and Cortland closed funds in the last month totaling $1.7B and $1.5B, respectively.

Waterton will target distressed assets with its fund, and Cortland is known for buying value-add properties in the Mountain West and the Sun Belt, where a sizable portion of the country’s new apartment delivery is concentrated.

Multifamily property trades, like the greater investment market, started to pick up even before the rate cut as opportunistic investors deployed capital in what many believed was the bottom of the market. 

In the second quarter, multifamily sales volume hit $38.8B, a 20.4% year-over-year gain and a jump over the 2005-2019 quarterly average, as larger institutional players and those with cash reserves started buying and selling properties. Interra Realty co-founder Jon Morgan already predicts 2022-like transaction numbers this year. 

“This is a market that's been extremely ready to transact for the majority of the year,” said Cortland Executive Vice President and Head of Research and Strategy Lee Everett, who says value-add, core-plus market plays present the most opportunity today for multifamily investors. “I think once the major portfolios started trading over the course of this summer, you had a lot of the other fairly large institutional players such as ourselves reenter the market.” 

The recent rush, which RPM Living Chief Economist Brad Dillman characterized as a chance to get great deals, already has some feeling like they missed out. But there’s more tour activity on the market right now, he said, suggesting more transactions and a desire to be on the right side of this shift. 

Developers pulled back hard on new projects after rates went up, leading to a 6.2% year-over-year drop in multifamily starts as of August, Multifamily Dive reported.

That falling rate of new construction will help supply burn off in many markets in the coming months, improving supply-demand fundamentals and signaling future rent growth that makes increasing asset pricing more attractive to buyers. With the new interest rate reality, owners can borrow more when they refinance a construction loan and have a better chance of refinancing. 

“This doesn’t help anybody in the sector more than developers, because they have faith the rate will continue to move downward, and they can start getting financing again,” according to Everett. “On Fed Day, if you will, they were out partying.”

Three months ago, with rates in a different place, financing construction loans proved more difficult, Slate Property Group Real Estate Credit Managing Director Daniel Ridloff said. Now, the firm can lend with less constraint and provide more money for projects.

He is in the middle of reworking a construction loan for a client that is close to maturity, and while the 50-point cut by itself won’t radically change their financial picture, the signal of more cuts to come and a lower cost of borrowing makes him confident to move ahead.

“There’s no magic number or silver bullet,” he said. “I think the trend will continue, and I think the trend will lead to momentum, and then momentum will lead to volume. Some people will be happy. Some won’t be as unhappy as they thought. And some will stay miserable.”

Rising costs have conspired to create a challenging environment for multifamily developers and investors regardless of the rate, PearlX Vice President of Origination Jack McKee said.

Supply chain disruptions, increased operating expenses, an ongoing housing shortage and growing demand for sustainable practices in multifamily communities have made business difficult. Rent grew by just 0.2% in Q2 compared to the previous year, according to Newmark. This is all before factoring in the looming maturity of multifamily loans, an estimated $669B of which mature between 2024 and 2026, per Newmark.

The biggest question around multifamily’s long-term health remains how much, and how fast, these cuts bring relief for loan maturities we know are coming, Dillman said.

The real problem happened when the market got hot in 2021 and early 2022, Hague said. People paid low cap rates that were 100 basis points lower than they should have been. Then the market blew up, and now the rates are 200 basis points away from where cap rates are, and there’s no hope of getting out. 

Another economic bellwether multifamily players are paying attention to is the labor market, which in many ways is a proxy for rental housing demand. The recent Bureau of Labor Statistics job revision, which found over 800,000 fewer jobs this past March than previously thought, suggests the labor force isn’t as strong as suspected. 

Dillman thinks too drastic of a cut too fast might cause a supply wave and even renewed inflation, reamplifying the Covid-era volatility that everyone wants to avoid. 

Hague agrees that things might be more tenuous than they seem, suggesting the multifamily roller coaster isn’t finished quite yet. 

“I think the last cut signals more weakness of the economy and sends a signal that perhaps things aren't as good as everyone thinks that they are,” Hague said. “So I view it a little bit more of a negative.”