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Sector Highlight: Multifamily

Investment capital once again poured into the multifamily sector in Q3/Q4 as multifamily transaction activity topped the four major real estate sectors. Investors still see rent growth remaining above the long-term average despite the moderation in rents experienced so far in 2022. Furthermore, sales activity in Q3 stood well above pre-pandemic levels. Dallas-Fort Worth and New York took the two top spots in transaction volume over the past 90 days, but Houston and Phoenix both were not far behind as investors’ interest in Sunbelt locations remained strong.


Higher Cost of Capital

Inflation has hit a 40-year-high and the Fed has responded aggressively with four interest rate hikes with the latest two being the largest hikes in three decades. As a result, lending has taken some hits and lenders have responded by avoiding riskier loan types. The rise in long-term interest rates has changed the composition of the acquisition pool as high-leverage buyers are unable to operate with the elevated cost of debt.


This has opened the door to more traditional institutional capital sources and well-capitalized private buyers that focus on lower leverage to purchase properties. Thus, there was no vacuum of capital in the multifamily sector towards the end of the year. However, the combination of rising interest rates, more expensive debt, and lower pro-forma rents lead to Class A building’s cap rates rising during the summer.


With the 10-year treasury rate rising upward pressure on cap rates will most likely continue in the short term. Some investors have already moved to the sidelines as they await further signaling on the direction of economic growth and the Federal Reserve’s inflation-fighting. We could see a pause in transaction activity during the fourth quarter as the market awaits more clarity.


Is CRE Debt Proving Resilient?

Amid the market turmoil, commercial real estate debt has seen a significantly smaller drawdown. The Giliberto-Levy Commercial Mortgage Performance Index, which tracks the performance of fixed-rate, seven to ten-year commercial mortgages held on institutional lenders’ balance sheets, returned -4.41% through Q1 2022, as it benefited from a still solid backdrop for commercial investments.


CRE debt has performed well during historical periods of economic softness or recession. 


The chart below illustrates commercial real estate performance through the global financial crisis and looks at its performance through the global financial crisis (GFC). As it shows, the S&P 500 declined nearly 50 percent in late 2007 while commercial real estate property prices fell more than 30 percent. Commercial real estate debt fared significantly better with a modest drawdown during the Global Financial Crisis.


Part of the disconnect in financing market challenges, pricing, and deal activity is explained by what was sold in Q2 2022. While deal volume in total was up 17 percent, the number of traded properties was down 22 percent. This combination suggests that deal activity was weighted toward larger deals more suitable for institutional buyers. These investors typically have deeper pockets, more equity to deploy, and less sensitivity to near-term changes in debt costs.


Looking to the Future

Multifamily and industrial properties still dominate investments and account for 61 percent of all transactions made in the first half of 2019. Lending institutions are adopting a more conservative stance on these two asset classes; these assets are now seen as low risk given strong demand, low vacancy rates, and rent growth in many markets.

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