The State of the Multifamily Market and a Look Ahead to 2023
The Macro Environment
As 2021 drew to a close, concerns about rising inflation and an overpriced housing market began working their way into conversations. The Federal Reserve and many industry experts assured anyone who would listen that inflation was transient – a pandemic-related phenomenon resulting from disrupted supply chains and the unwinding of pent-up consumer demand. A sense of FOMO and ultralow mortgage rates kept the market superheated even though housing inventory was at historic lows and home prices were at historic highs.
When the Federal Reserve raised the Funds rate by a quarter-point in March of 2022, it was little more than a speed bump. A 50-basis points (bps) rate increase in May, persistent inflation, and slowing rising mortgage rates began to get some attention – the housing market started to slow a little.
June saw the start of four consecutive 75-bps increases in the Federal Funds rate – effectively pumping the breaks on a locomotive. Still, inflation has remained stubbornly high, and the job market has remained resilient. On a positive note, there are several indicators that we have passed the peak inflation – including October’s CPI coming in lower than expected at 7.7%.
After the November meeting of the Federal Reserve Committee, members signaled that additional rate increases could be expected. Still, future hikes might not be as high as in recent months. Additionally, the Fed indicated that rates would likely climb more than initially anticipated and should remain at higher levels for an extended period.
There are other macro factors at play in the markets – rising energy and food costs, geopolitical instability, supply chain disruptions, and a crypto meltdown, to name a few. These and other factors will continue to influence the economy and the commercial real estate industry well into 2023.
The State of the Multifamily Market
2022 picked up where 2021 left off – with a flurry of activity across commercial real estate. According to Real Capital Analytics, sales volume for multifamily properties exceeded $150B in the first two quarters of 2022, and cap rates averaged 4.3% – two-tenths of a percent lower than in 2021.
Multifamily sales volume continued strong into the third quarter but has fallen off the record-setting pace, which marked the first half of the year. Through the end of the third quarter, sales volume was $240B, setting up a year-end volume of just over $300B.
Multifamily cap rates have remained low throughout 2022, closing out the third quarter at 4.6% – still well below historical averages of 5.3% – 6.2% depending on the asset class. Rent growth has continued strong – remaining above 10% through the third quarter, but it has moderated and is expected to drop below 6% in 2023.
The 10-year treasury is one of the most influential factors for determining mortgage rates in the multifamily space. The 10-yr started 2022 at 1.63%, peaked in October at 4.25%, and has floated in the upper 3% to low 4% range since mid-September. In response, multifamily mortgage rates that started the year in the low to mid-3% range are now in the low- to mid-6% range.
According to Moody’s, the number of negative leverage loans (a loan with an interest rate higher than the cap rate) ticked up in Q2 of 2022 before spiking to over 30% of CMBS loans by volume in Q3. Since interest rates have jumped faster than markets can respond, the number of negative leverage loans will likely remain high into 2023.
In addition to an increase in negative leverage loans, CoStar is reporting the occurrence of repricing or “retrades” has risen since the start of the year. The initial response to rate hikes saw some buyers asking for a 3% to 5% reduction in sales price. As rates have continued to increase, some buyers are asking for price reductions of approximately 10% to 15%. Current market conditions still favor sellers, so not all repricing attempts have worked out for the buyers.
Almost all commercial real estate investors have to adjust to the new market conditions. For the time being, sellers still have the advantage thanks to double-digit rent growth and historically low vacancy rates.
The Outlook for 2023
Markets will continue to shift in 2023 in response to macroeconomic conditions. The Federal Funds rate is expected to reach 4.75% to 5% early next year and will likely remain close to that level for some time. Supply chain issues, capital markets, and geopolitical instability will continue to influence market conditions. Further, most experts agree that there is a significant chance of a recession in 2023.
Initially, interest rates will likely continue to climb at the start of the year. However, if the Fed slows or stops raising rates, we will probably see mortgage rates stabilize and then begin to drop. It is doubtful that rates will be in the 3% range any time soon, but a return to 5% could be possible by as early as Q2 of 2023.
Trading volume will likely remain low, with many buyers staying on the sidelines until lending conditions are more favorable. There will continue to be investors with capital to place or that are well-positioned to obtain favorable lending terms making it unlikely that there will be a complete halt to trading.
Inventory will likely decline as investors planning to exit properties in 2023 find it more advantageous to hold on to their assets. Not all owners will decide to keep their properties – some will not be positioned to hold, while others may simply want to liquidate an asset they no longer want or need in their portfolio. These sellers may find that even if they can’t capture the historically high prices of 2021 and 2022, sticky cap rates, limited inventory, and above-average rent growth will keep prices higher than expected.
Now for the elephant in the room – a recession. There is still a high probability of a recession in 2023. While it may seem counterintuitive – the chance of a downturn helps the multifamily market. Historically real estate, especially multifamily properties, has fared better than other asset classes during a recession. Investors looking to move their money out of stocks and bonds may consider real estate a safe haven investment.
How We Can Help
Sweetwater Capital is well-positioned to evaluate and respond to changing market conditions, and we are committed to providing a tailored approach for each client. It is vital to have a team of skilled professionals to help you in our dynamically changing markets. Sweetwater Capital has experts in Commercial Mortgage Brokerage, Investment Sales, and Commercial Property Management. Let us help you capitalize on current opportunities and position your assets to take advantage of the shifting markets.