future interest rate increase would reduce multi-unit price?

[John Tan]

I wonder if future rate increases would decrease multi-unit price?

Since multi-units are priced based on CAP rates, they will be interest rate sensitive. Ie buying a multi-unit at 10% CAP makes sense in a 3% treasury-rate environment, but what if treasury goes to 8% in the future? I assume the CAP rate of the multi-units would need to increase to keep up. So unless rent jumps to, does that mean the price of the multi-units would need to decrease?

Let's say an apartment complex costs 100K and generates 10K in cash flow, assumes now market demands 15% CAP rate, and a rent increase of 20%. Even with now 12K cash flow, the unit is worth now 80K and a drop in price of 20%? So would it be wise to wait to buy multi-units? Especially given the market for them seems pretty hot? Any intelligent and analytical response would be much appreciated!

[James Park]

@John Tran,

The answer is, "It depends". In markets where the median home price / median household income is very high, a higher interest rates will have much more of impact in housing prices compared to where the ratio is very low (lower than 3), thus the housing in the area will be less impacted. Also in terms of valuation of real estate, I look at rental parity: If it is cheaper to own than to rent : the asset is under valued whereas if it is cheaper to rent than to own : the asset is over valued.

What is much more important than the interest rate is the purchase price as you always can refinance in the future at a better rate, but cannot change the price you paid for your asset. Some of the smartest economists and hedge fund managers I know have been calling a reversal in the ten year yield for several years now. Bill Gross made a big announcement in the finanical media that it is the end of the 30+ year bond market rally couple of years ago. The 20 year treasury has rallied 27% since Jan 1st, 2014 until today.

For those of you who think it is impossible for rates to go any lower, the Japanese and European 10 year bond is less than 1%  where we are currently at 2% today.

The markets can stay irrational for some time, but fundamentals will always win out in the long run from my experience. Right now is a time I find the financial markets to be extremely irrational.