Interest Rates Just Don't Matter in Multi-Family

[Robert C.]

I thought I'd start a discussion about rising interest rates, because quite honestly I'm not hearing that much about it, and I'm wondering why. From what I'm observing, it's like the elephant that's NOT in the room, even though I'm POSITIVE every investor is privately obsessing over the rates as they put together their pro formas. 

I saw @Ben Leybovich put together a blog post back in February and the rates have only gone up since then, +1.25%-1.5% since last year. And I believe @Sam Grooms, made a mention in their trending success story (98-units Closed).

Here's the pickle... The MF interest rates have clearly gone up and are expected to continue that trajectory. However, at least in my neck of the woods, there's been no change in the cap rate expectations, and in some areas investors are paying even more. What gives?? What are you all seeing in multi-family? 

Here are some of the theories I'll throw out there to start the discussion:

1.) The market just hasn't caught up... I felt more strongly about this explanation earlier in the year, but it's been a while, and the Fed has clearly indicated where it's headed.

2.) People are getting stuck in 1031 land, and they have to compete for still limited supply.

3.) The short term trend in the achievable rates are slightly downward these past few weeks, and people are waiting to see what happens.

4.) Investors think we're headed for a crash, and the only lever the Fed has is to lower interest rates again. 

5.) Everything is going to keep going up - values and rents! (I don't really see how this is possible in the bay area for now, and the rents have already stalled).

Clearly, there is movement in the single family arena, which makes sense, so I'm talking explicitly about MF. I would love to hear some feedback. Are you seeing the same thing in your markets? What do you predict?

[Bill F.]

@Robert C. will RE being very localized it is a tall order to come up with a story that fits all MF throughout the country and without being a macro-economist everything we say is just a guess. 

The simplest explanation is that the market still has lots of over exuberance and people simply don't care about rates. Why let a little thing like borrowing costs get in the way of a good time?

As a tool of monetary policy, are not meant to slam the breaks on an economy, but merely slow it down by making deals at the margin less attractive, mean that you shouldn't expect a systemic change quickly. Also, lending rates haven't been going up in a lock step 25 basis point per quarter. Look at the FF Rate and 10yr spread.

Finally, its important to remember that interest rates are driven by the market and not directly by the Fed Fund Rate. The US being pretty much the only economy that is safe and large enough to absorb massive amounts of capital, so foreign cash, from China, Russia, Brazil, South Africa... floods into the US and invests in both the bond, equities, and RE market; driving prices up and yield down. Again looking at the Fed Funds Rate, 10 yr  Treasury, and their spread helps illustrate this point. Another way to look at Cap Rate is as a signal of perceived market risk of the underlying asset. The US s less risky than other markets. Welcome to a global economy, your iPhones cost less, but yields/returns suffer.

Another idea is that since the fed is so transparent with their planned rate hikes, the market already takes them into account before they happen... 

 Or it could be something else entirely... who knows. I just add 75 basis points points per year to my refi projections when I model. I don't know what "new normal" rates look like, but they will most likely be higher than current ones. If the deal pencils at 9% it will work at 8%.