If you’ve been keeping an eye on the latest developments, you’re likely aware that mortgage interest rates have climbed substantially, surging from around 3.75% in late 2022 to a range of 7-8% in Q4 2023. Additionally, there’s over $26 billion in multifamily properties currently carrying debt via bridge loans, some of which are nearing expiration. Depending on factors like Net Operating Income, Occupancy rates, and the Debt Service Coverage Ratio, some of these deals may face foreclosure or require capital infusions.
This can be bad for investors in these deals and an opportunity for those with cash on hand.
I recently attended a class with a prominent $4 billion real estate investor, and his primary message was clear: you can’t always time the market. Sometimes you’re hunting for cash flow, occasionally you come across a valuable property in a less desirable neighborhood, and lastly, you might be willing to pay full price with limited cash flow at the onset. What’s crucial is understanding the markets and their dynamics.
For those who find themselves waiting on the sidelines with liquidity in the bank, here are some essential factors to think about:
Cost of Borrowing: With elevated interest rates, financing costs have risen, potentially eating into profits and heightening the risk of falling short on debt service.
Diminished Cash Flow: The higher interest expenses may reduce cash flow from your property, making it more challenging to achieve positive returns. Consider this: Is the cap rate lower than your loan’s interest rate? If so, cash flow may be elusive, and your investment may pivot toward a focus on equity appreciation. If you’re participating in a syndication, are you comfortable making this bet over a 5-year horizon?
Market Volatility: Turbulent markets can introduce uncertainty into property valuations and rental income, making it difficult to assess risk versus reward accurately. In the last few years we have been accustomed to 10-15% organic rent growth. Now, even in a prime markets, historical rent growth in such a volatile market with inflation hovers around 2-3%, Always stay vigilant and well-informed when contemplating investments in multifamily real estate, especially during times of interest rate fluctuations.
Limited Financing Choices: During periods of elevated interest rates, lenders may become more stringent with their lending criteria, making it harder to secure favorable financing terms. Unless you have a great track record, lending options can be limited.
Waiting for Opportune Deals: High-interest rate environments sometimes lead to distressed sellers and more attractive purchase opportunities when market conditions stabilize. Please note: There is a ton of money waiting on the sidelines!
Risk Mitigation: By avoiding investments during volatile times, you can reduce your exposure to market downturns and economic uncertainties.
Reevaluating Investment Goals: This downtime offers an opportunity to reevaluate your investment objectives and strategies while considering shifting market dynamics. Are you looking for cash flow, legacy properties or equity?
Building Liquidity: Accumulating cash reserves while awaiting more favorable market conditions allows you to deploy capital strategically when the time is right. T bills are at an 5.3% as of this writing. AND there are high interest bearing money market accounts which pay up to 5.5%.
Diversifying Investments: During market turbulence, exploring alternative investment options in various asset classes can help distribute risk effectively.
The decision to remain on the sidelines or invest in the multifamily market during these challenging times should align with your financial objectives, risk tolerance, and investment timeline. You get to decide if it might be wise to wait for more stable conditions, explore alternative investments until the market outlook becomes clearer.