Amid High Inflation, Multifamily Real Estate Investment Demand Remains Strong

By The ArborCrowd Team
May 18, 2022

The U.S. inflation rate increased to a near four-decade high of 8.3% in April, considerably higher than the Federal Reserve’s typical 2% target, according to the latest data released by the U.S. Bureau of Labor Statistics.

Inflation, which is defined as the rise of prices for goods and services, started increasing rapidly since last year and has remained high in early 2022 due to multiple reasons, including:

  • Supply chain disruptions caused by the COVID-19 pandemic, limiting the availability of products and services
  • Pent up demand from consumers as a result of the pandemic
  • Government stimulus relief packages during the pandemic, which increased household savings

Additionally, Russia’s invasion of Ukraine and new lockdowns amid the re-emergence of COVID-19 outbreaks in China are further disrupting global supply chains and amplifying inflation. While the high inflationary environment is impacting the commercial real estate industry, demand remains strong for properties, especially multifamily investments.

How Inflation is Affecting Multifamily Real Estate Investments?

As with all businesses, rising inflation is increasing expenses for multifamily real estate owners, including materials and labor costs.

To combat high inflation, the Fed began raising its federal fund rates in March for the first time since 2018 to a target range between 0.25% and 0.50%. The Fed then raised rates a half percentage point on May 5 to a target range between 0.75% and 1.00%.

This has resulted in rising mortgage rates, which is increasing financing costs for real estate investors. Nevertheless, demand for real estate as an investment is still high. This is because real estate is often seen as a hedge against inflation since property owners can increase rents in an attempt to keep up with, or even outpace, inflation. Compared to holding cash assets or fixed income products that may not appreciate at all or as quickly as the inflation rate, it’s evident why real estate is popular among investors in inflationary periods.

Multifamily, in particular, can be an effective inflation hedge because people always need a place to live and rental units typically have shorter lease terms than other commercial property types — meaning owners can adjust rent rates and respond to inflationary pressures faster.

Effective asking rents for new leases increased 15.2% year-over-year in March 2022 for multifamily units due to the high demand, which is a byproduct of a housing shortage and record for-sale homes prices.

Many multifamily properties also have long-term, fixed-rate loans, limiting the impact of rising mortgage rates resulting from rising inflation.

With higher interest rates also increasing borrowing costs for home buyers, rental units are expected to become even more attractive for average consumers, further driving up rental demand. The 30-year fixed rate mortgage averaged 5.30% in the week ending May 12 (the highest in 13 years), up from 3.1% at the end of 2021.

Multifamily Real Estate Demand Could Keep Cap Rates Low Despite High Inflation

A modestly rising inflation rate, such as the Fed’s typical 2% target, could be a positive sign for an economy as it indicates steady growth. However, when inflation goes unchecked, as it appears to currently be, it could lead to undesired outcomes for an economy.

For commercial real estate, high inflation, or more particularly, the Fed’s response to high inflation, can have other impacts besides higher borrowing costs. It could potentially affect property values and capitalization rates (often referred to as “cap rates”).

If the Fed continues to raise rates to counter inflation, Treasury bond yields will continue to increase. As bond yields increase, they may seem more appealing than real estate to investors because of the perceived lower risk.

This typically results in downward pressure on real estate values and higher cap rates as investors demand more return for the added risk relative to the safer fixed-income investments. Investors could look to adjust their entry basis in real estate (i.e., their purchase price) to account for the higher cost of debt service in an effort to maintain strong returns.

However, the relationship between bond yields and cap rates isn’t a direct correlation in the multifamily industry because of strong demand and a low supply of housing.

As a result of high tenant demand for multifamily assets, including single-family rental and build-to-rent units, investors may accept lower yields and allocate more capital into multifamily investments away from more volatile investments, which could act as a counter to widening cap rates. Additionally, microeconomic factors may allow specific multifamily markets with superior fundamentals to outperform others.

Multifamily real estate can be a hedge against inflation. With that said, in order to successfully navigate a challenging investment environment during a period of heightened inflation, it’s more important than ever to partner with a seasoned real estate-first platform that has experience identifying strong properties and markets poised to excel.

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