Rising interest rates and what’s next for multi-family loans

Multi-family investors are bracing for an uptick in mortgage rates and other forms of real estate financing as the Federal Reserve hikes interest rates in 2022. To fight inflation, the Fed plans three 25-point hikes basis each. And in December, the Fed announced that it would end its bond-buying program by March.


But the consensus among mortgage bankers and economists is that increases in the cost of capital will be modest and will not dampen the availability of financing or the surge in investment. Multifamily loan volume will grow 3% to $421 billion this year as the economy continues to rebound, the Mortgage Bankers Association projects.

“The change in interest rates should not reduce the demand for multi-family housing this year. Much of the demand is being driven by property values ​​and fundamentals, both of which are extremely strong right now,” said Jamie Woodwell, vice president of commercial real estate research at MBA. Strong property income and a low vacancy rate are combining to drive up valuations, he added.

Another key factor is the national housing shortage. Construction is up 5% this year to almost 500,000 units, reports Robert Dietz, chief economist at the National Association of Home Builders. “Demand is especially strong in growing southern cities such as Austin, Nashville and Phoenix, as city dwellers in high-cost markets move to less densely populated areas,” he noted.

All things considered, multi-family rent growth is unlikely to repeat the performance of 2021, when rents rose 13.5% year-over-year through November, according to Matrix Yardi. Still, lenders will be signing deals against the backdrop of a strong, if less sensational, market potential. For 2022, CBRE forecasts rent increases of 6.5% and continued low vacancy in urban and suburban markets.

Training effect

August 2021. Source: Mortgage Bankers Association

Mortgage bankers are now weighing the impact of Fed actions in the months ahead. Forecasts vary as to whether the average 30-year fixed rate mortgage will rise (currently at 3.05%) in 2022. Some bankers are predicting a 25-30 basis point hike. Fannie Mae, for example, expects the average 30-year fixed rate to reach 3.3% by the end of the year. On the other hand, MBA foresees a 4% increase.

But student and senior housing, in particular, could see a bigger upside if the Omicron variant blocks the recovery in those sectors. Any foreclosure could harm the short-term prospects of these sectors, observers say. Affordable housing, very attractive to banks and public companies, should benefit from the most aggressive rates this year.

This is largely because Freddie Mac and Fannie Mae are on a mission to help alleviate the housing shortage and are incentivized to offer the best terms on these deals. Each agency has raised its 2022 cap for multi-family loans to $78 billion. Banks also get community reinvestment credit for organizing packages.

A $107 million Fannie Mae credit facility arranged by PGIM Real Estate last fall for a national affordable housing operator illustrates the trend. The agreement has funded nine properties that will provide more than 1,200 affordable units in Colorado, New Mexico and Texas.

It was structured as a 30-year fixed rate loan which the operator intends to use to repay existing debt and provide capital for expansion. The PGIM Real Estate client hopes to increase the credit facility by $100 million over the next three to five years to pay for real estate acquisitions.

Fixed or Floating?

While mortgage rates are not expected to skyrocket this year, there will be a ripple effect in the housing finance market.

“The general expectation is that interest rate increases will more directly affect short-term borrowing and variable rate financing and have less of an effect on the cost of longer-term fixed rate mortgages,” said MBA’s Woodwell.

Floating-rate financing will likely rise to 75 basis points above the federal funds rate, predicts Michael McRoberts, president of agency lending at PGIM Real Estate. “This will cause investors to migrate to fixed rate financing in 2022,” he said. As a result, investors will need to weigh the prepayment flexibility of a floating rate structure against the cost, he adds.

Choosing between fixed-rate and variable-rate loans depends on the borrower’s investment strategy and circumstances, says Gregg Gerken, executive vice president and head of commercial real estate at TD Bank.

“If an investor is planning to sell the asset in the short term, they can opt for a floating rate loan and put a cap on it as an interest rate hedge to take advantage of current low rates with some upside protection for the future,” he said. It’s a good approach for a buyer who expects a three-to-five-year hold on a property that’s not yet fully leased, Gerken added.

Additionally, there are several trade-offs to consider. “It all depends on the type of asset you are financing and your investment plans,” observed Jeff Wilcox, director at Portico. “If you’re a generational holder, a fixed rate product with rate certainty might make sense.”

One trend that could emerge, experts say, is that more investors will opt for shorter five- to seven-year fixed-rate acquisition loans, rather than three-year variable-rate bridge loans.

Cap Rate Trends

Another concern is whether rising interest rates will affect cap rates, and if so, to what extent. “We don’t think rising interest rates will have an impact,” said Matt Vance, head of multifamily research for the Americas at CBRE, noting that cap rates and bond yields don’t necessarily move in line. tandem.

“Given the amount of capital targeting this real estate sector, there is enough spread between the cap rate and the bond yield to allow for continued modest compression in cap rates as we have seen in 2021,” when rates have down about 10 basis points.

An encouraging sign is that rising interest rates are unlikely to have a material impact on the loan-to-value ratio or interest-only provisions. “Over the past 18 months, many non-bank lenders have lent on LTV because rental rates are rising so rapidly and the overall debt service ratio is improving,” Gerken noted.

As an example of interest-only trends, PGIM cites a $44.5 million loan for a property in Georgia. With a spread of 258 basis points to SOFR, the 10-year Freddie Mac financing starts with five years of interest only. “We were able to get a good split because this is a 100% mission” for the GSE, noted Lee McNeer, executive director of creative agencies at PGIM Real Estate.

Read the February 2022 issue of MHN.

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