While rising interest rates and escalating costs are top of mind for borrowers, multifamily lending remains active due to the industry’s solid fundamentals.
“We are seeing strong demand, with a large focus on affordable and workforce housing,” says Liz Diamond, managing director and head of affordable originations at Berkadia. “There are many borrowers looking to acquire existing affordable properties as well as convert market-rate assets to properties encumbered with rent and/or income restrictions. These restrictions have taken different forms, some are sponsor initiated and align with environmental, social, and governance goals.”
Multifamily veteran David Brickman, CEO at NewPoint Real Estate Capital, adds that while demand is down from a year ago, he still is seeing a healthy level of activity.
“For those who like to talk in terms of cycles, I’m not sure that we are at the end of one yet,” he says. “We have not seen a trough-level slowdown as we did in 2009 and early 2020; but 2022 will certainly be less notable in terms of market activity than in 2021.”
Charles Ostroff, senior vice president and chief credit officer, multifamily, at Fannie Mae, says the firm’s economists lowered their 2022 expectations because of persistent inflation, rising interest rates, and a slowdown of global economic growth.
“At the same time, rising land prices and higher labor costs have impacted development costs. Add to that a shortage of construction workers,” he says. “Last month, our economists noted that the severity and duration of the pandemic-related supply chain disruptions contributed to the increase in multifamily building costs, as the prices of building materials have increased substantially over the past two years. Now added to the mix is inflation, and it’s expected to increase construction costs even further in the short term.”
Brickman says the rising rates affect multifamily lending in multiple ways, with several sets of dynamics at work. “To start, the increased cost of debt capital makes debt and levered returns on investment less attractive. One result is less demand for mortgages—both on new acquisition and discretionary refinances—as investors, developers, and owners tend to hit ‘pause’ as an immediate reaction to rising rates.”
He says that behavior is natural, but it does accompany a heightened level of uncertainty due to the changing environment.
“Market participants are not entirely on the sidelines, but they are much more selective in their transactions,” Brickman says. “I expect muted activity until there is renewed confidence in where rates, value, and the economy are headed. Lastly, rising rates are, of course, associated with higher inflation. Coupled with the prevailing view that multifamily represents a good inflation hedge, we can expect to see continued demand from domestic and global investors looking to deploy capital into our sector.”
In addition to rate increases, Diamond says rising hard costs and construction delays due to supply chain issues also are impacting new construction transactions.
Looking ahead, Brickman says hopefully the industry will find some stabilization in terms of value and return expectations.
“I anticipate that we will continue to see some upward drift in cap rates, which—coupled with rising rents, property income levels, and the stabilizing of long-term rates—should lead the market to reset. A new baseline of certainty will enable the market to gain momentum in terms of financing and investing activity.”
However, he says there is a possibility that the combination of Fed tightening and sustained global uncertainty could have a more significant impact on investment activity. “If that’s the case, we could be in for a more challenging year with the onset of a downturn.”
Diamond adds that she thinks rates will continue to be volatile with a bias toward increasing. “As this puts stress on deals, we will all continue to work to find creative solutions to filling gaps,” she says.
To mitigate rising rates, the lenders say there are some steps for borrowers to take.
“We’re seeing more interest in prepayment flexibility and creative structuring around interest rate protection on floating-rate deals,” says Brickman. “It’s also worth the time to explore new structures and options, which often unlock significant value. The market is simply less predictable than it has been in the recent past, which is one of the drivers behind the increased appetite for locking in near-term fixed-rate financing.”
Diamond also is seeing more use of both early rate locks with Fannie Mae and index locks with Freddie Mac. “The use of both of these products allow for borrowers to lock in their full interest rate with Fannie Mae and for Freddie Mac to lock in the Treasury index.”