SoCal Multifamily Sales Pulse - April 3, 2022 - April 9, 2022

• 11 April 2022
• Mike Lembeck

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Here's What's Happening In The Market, Here’s What This Means For You

What Rising Interest Rates Mean for Apartment Cap Rates

Many in the investment community worry that increasing interest rates in the coming year might have an adverse effect on their apartment property values.

With both inflation and interest rates rising, following the first Federal Reserve rate hike in three years, many multifamily investors are fearful about the impact these duel forces will have on apartment cap rates, which have trended downward over the last twenty years.

In Q4 2021 apartment cap rates reached a low of 4.7%, down 30 basis points since the prior year, according to apartment transaction data tracked by Real Capital Analytics. 

Interest rate hikes that are too aggressive could put a damper on economic growth prospects, which would have an adverse impact on property values and upward effect on cap rates. Cap rates could also potentially face upward pressure in markets with diminished rent growth projections, as seen in the San Francisco and New York City markets over the past five years.

Still, apartment cap rates are fundamentally a real rate of return that should only be affected by changes to the real rate of interest. Apartments, given the short-term nature of their leases, are uniquely positioned to simply re-price their rents during inflationary periods in order to offset higher nominal interest rates. Even though the 10-year Treasury has already inched upward, the apartment market continues to benefit from historically high occupancy rates and rent growth, causing cap rates to further decrease.

If higher borrowing costs are offset by higher growth rates in rent and NOI, cap rates should remain unchanged. In other words, cap rates can be thought of more as a real rate of return, which are only affected by changes to the real interest rate.

The Pulse of the Market

Sales are still brisk and inventory levels have remained about the same. It seems that as soon as inventory hits the market and the total listings increase, they are absorbed by the market just as quickly. There’s been no sizeable increase in inventory this year. Will it happen and when is tough to say. Southern California multifamily is a solid investment and if you currently own property there are not a lot of better investments right now.

WHAT TO EXPECT
In the short term, I don’t expect much change from current conditions. We’ll see some investors drop out of the market as interest rates increase, but as mentioned in this week’s What’s Happening in the Market, cap rates aren’t anticipated to change much as long as rents continue to increase.

Give me a call if you’d like an analysis done on your property to determine your equity position for a potential sale or exchange. If you’re concerned about the availability of an upleg property when doing a 1031 exchange, we have access to a lot of inventory using the Delaware Statutory Trust to help satisfy the need for an exchange.

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