Multifamily Investors Adjusting for Lower Profit Margins This Year

As higher interest rates put upward pressure on borrowing rates and cap rates, earnings will be impacted. With rates now set to rise, however, an urgency has set in and investors are feeling a bit cautious. Appreciation and multiples have been so strong for so long that a modest reduction has been inevitable.

Higher inflation, rising interest rates and supply chain disruption headwinds that threaten to slow other market sectors are prompting some investors to adjust expectations for multifamily.

The prospect of inflation and the mark-to-market capabilities of the sector suggest rents will continue to rise as higher wages provide workers with additional spending power. 

Given the constrained supply and strong demand, ground-up construction is expected to increase in 2022. Many investors who have focused on value-add assets see continued opportunities and the need to adjust the approach. Today, elements of a value-add program likely include enhancing residents’ experience and comprehensive unit interior upgrades.

Cap rates, unfortunately, are not likely to change much because the available product is still limited—a fact that has already been driving cap rate compression down. These factors mean many investors will have to settle for a lower levered return.

Ultimately, the Fed’s expected rate bumps will leave us with an interest rate environment we were previously accustomed to, and the industry will simply need to adjust. 

The Pulse of the Market

Most areas saw a little bit of a slow-down in closed sales last week. Inventory levels increased, but only slightly. Orange County, Long Beach and LA County inventory levels were almost unchanged. San Diego, Riverside and San Bernardino County saw the biggest increases in inventory. The average days on market continue to fall around 30-45 days and about 50% of listings are still selling at or above list price. San Diego County is seeing the strongest demand, shortest time on the market, and most listings selling over the asking price.

What to Expect:
Until we see the second and third interest rate increases throughout the year, I don’t see a lot of change in weekly inventory levels or the amount of weekly closed sales. There’s still a lot of demand from investors. It should be business as usual for the next couple of months. Although there are some hints of a bit of a slow-down, it remains to be seen if these hints are just a whisper or an indicator of things to come.