As featured in the WMRE 2023 Outlook
We see opportunities to purchase multifamily at a discount in 2023. RealSource evaluates and concentrates on housing conditions in its top 20 target MSAs to acquire multifamily assets and is optimistic there are still accretive opportunities in the marketplace. Banks still maintain significant cash reserves to lend while real estate investment funds have record levels of capital to deploy.
Many investors may be waiting for interest rates to be near a peak and then move quickly once the Fed signals an easing in monetary policy. If federal monetary policies spark a rush of capital chasing after a limited number of multifamily deals, it may not be possible to buy multifamily assets at 10 percent to 20 percent below early 2022 prices by the fourth quarter.
Although the Fed funds rate increase has put pressure on both longer-term interest rates and commercial mortgage rates, critical geopolitical challenges could push capital flows into the U.S. Notably, the U.S. 10-year Treasury Note is now down two consecutive years. In the last 250 years, it has never recorded three down years sequentially. Last November, the Mortgage Bankers Association released a forecast that projected that 30-year mortgage rates will retreat to 5.2 percent in 2023, with unemployment normalizing from 3.5 percent to 5.5 percent.
Location matters
Most in the commercial lending industry expect performance to be dampened by elevated interest rates and low macro-level rent growth. However, our econometric model forecasts stronger rent growth in select, affordable metros. Prudent investment and deal structure in growing locations will be well-positioned to surmount capital market volatility.
Location is a key indicator of performance and new real estate construction. A housing shortage still exists on a macroeconomic level, but nearly half of new apartment construction is occurring in a handful of metros. After a pandemic-led boom in household formation, limited housing supply is still pushing record-level rent growth.
Surprisingly, many high-growth metros still have rent-to-income ratios below 25 percent. These levels leave room for astute managers to continue increasing rents in select locations. Greater borrowing costs have suppressed newly planned single-family and multifamily construction. This dynamic continues to create demand in occupied apartments. As interest rates increase, so do replacement costs, establishing more headwinds for new supply.
Defensive strategies to consider
Acquiring value-add multifamily assets below replacement cost is a defensive strategy. Affordable class-B assets that are structured with fixed-rate debt can continue to provide both stability and stronger rent growth. By executing this strategy, our econometric model can lead us to the right markets at the right time. We target properties with a cost basis well below local replacement cost. This acquisition strategy seeks accretive, cash-flowing assets with interior value-add upside potential. Tangible assets have the potential to continue to appreciate- possibly even more so with persistently higher levels of inflation. Commercial real estate loans with a lower loan-to-value ratio (near 55 percent) reduce risk and can potentially be a valuable addition to portfolios when matched with proven sponsors. Our research indicates multifamily prices in 2024, and beyond, may be higher in select metros with durable, long-term fundamentals. Early 2023 may be an ideal time to buy in certain cities and states with a track record of population growth, relative affordability, and favorable business and tax policies.