We are coming up to the end of what has been a very eventful year in multifamily real estate…!
It seems a long time ago now, but the first quarter of 2022 actually saw prices for multifamily assets increasing at an accelerated rate compared to 2021! Even whilst chatter of interest rate increases began in late January and early February, some investors continued to bid up prices of assets in that first quarter of the year.
Then interest rate increases began, and over the course of the year, the Fed went on to increase interest rates at an astounding pace. The impacts of this have been an increased cost of capital for all, lower transaction volume, general price reductions across all markets and an abundance of capital sitting on the sidelines waiting for the dust to settle.
Below we provide an overview of the major issues that we will be watching in 2023…
1. Interest rates to plateau
Opinions vary about how much further the Fed will increase interest rates and when interest rates will start to plateau. Although some in the industry are expecting the Fed to change course and start to reduce interest rates soon after they plateau, we think that rates are likely to remain at their elevated level for a while before the Fed starts to reduce rates again. It will all depend on the state of the economy and the soft or hard landing that may eventuate.
2. Unwinding of the bridge bubble
Many deals were done in 2020 and 2021 using short term bridge debt and most of these deals were underwritten on the basis that refinances would be available in years two and three, using agency debt at 75% leverage.
Unfortunately, where interest rates stand today, and where they are likely to be in 2023, it is very unlikely that the agencies will be offering anywhere near 75% leverage on their refinances due to debt service coverage ratio (DSCR) constraints. The agencies typically require a DSCR of 1.25x or 1.3x when sizing their loans. When factoring in current interest rate levels, some of the loan sizing is now expected to be only 50% or 60% leverage. This means that some sponsors will find it hard or even impossible to refinance out of their bridge debt.
So, what choices will they have?
Well, some may be able to extend their bridge loan and hope that interest rates fall in the following year or two. Some may find new and creative ways to refinance into another short-term debt instrument. And some may be forced to sell in a not so favorable market environment… we expect this to create some buying opportunities.
3. Opportunities to buy at pricing that makes sense
One factor that we have seen in the market in the second half of 2022 is that the cost of capital has increased for all buyers in the market, yet sellers have not yet lowered their expectations of how much they think their assets are worth.
As more and more offerings have gone unsold, as more and more buyers have retraded their offers and as more and more brokers are working to reset their seller’s expectations, we expect that those that need to sell will be forced to lower their pricing expectations, and this will lead to a further correcting of prices.
It remains to be seen how quickly seller price expectations fall and also whether capital inflows into the market will start to reverse that trend (see below).
4. When will capital on the sidelines re-enter?
As soon as volatility hit debt markets, a lot of capital decided to sit tight on the sidelines. This may have been because they were trying to avoid having to navigate a changing debt environment whilst trying to close deals, or it could have been because they were waiting for prices to fall to try to snap up some bargains.
Either way, there remains an abundance of capital that still views multifamily as a very attractive asset class, and at some point, when the market becomes more attractive to them, these players will start buying again and that will serve to put upward pricing pressure on multifamily assets again.
Will that be in 2023? 2024? We will have to wait and see.
5. Economic recession, stretched budgets and emerging unemployment
And finally, many pundits are speculating about the impacts of these increasing interest rates and whether we will have a hard landing, a soft landing, a shallow recession or a deep recession.
Whatever kind of downturn we may have over the next period, there are always factors at play that need to be watched closely from a multifamily perspective.
All of us are feeling the effects of inflation already, and the impacts are even more pronounced on the working-class population. As budgets are stretched, many renters are finding it harder to meet their monthly obligations, including their rent payments. So, delinquencies and bad debt are factors that need to be watched and managed closely.
If unemployment starts to increase, that will likely also start to impact delinquency and bad debt. The impacts of unemployment will vary by market and by industry and its impacts will likely vary by asset class as well.
In a changing market environment, there are always plenty of opportunities. Multifamily remains a fundamentally attractive asset class, and we are positioning ourselves to take advantage of some of the market opportunities that will present themselves in the near future, as best we can.
In a changing market environment, there are always plenty of opportunities. Multifamily real estate remains a fundamentally attractive asset class, and we are positioning ourselves now to take advantage of some of the market opportunities that will present themselves in the near future, as best we can.
2022 has been interesting. 2023 should be just as eventful!!