FINANCIAL HOUSING MARKET
RYAN FLOYD & JASON KOCH | GREYSTONE UNIQUE APARTMENT GROUP
Rising Interest Deflates Hope for Higher Values
T
he 10-year Treasury rate ascended
more than 70 basis points in the two
months following this year’s
presidential election. The Federal
Reserve has stated its intent to increase interest
rates throughout 2017.
Freddie Mac and Fannie Mae loan programs
were created by Congress to perform an important
role in the nation’s housing finance system – to
provide liquidity, stability and affordability to the
mortgage market. They provide liquidity (ready
access to funds on reasonable terms) to the thou-
sands of banks, savings and loans, and mortgage
companies that make loans to finance housing.
These two loan programs have had the biggest
jump in their interest rates, as these two loan
programs are directly connected to these long-term
metrics. Many multifamily investors were once
enam ored by new low interest rates. Now, many
multifamily investors have become desensitized
and spoiled by interest rates under 4 percent.
The days of interest rates in the low
to high teens does not seem to be im-
pending by any means, however, the
chances of interest rates being higher
in 5 years from now seems much more
feasible given the historical trends of
interest rates. In the mid-2000’s we
were in an interest rate environment
that cost the investor typically around
the mid 5% to low 6%. These rates,
although historically low for the time, seem to be
the direction that the Feds are wanting to incre-
mentally achieve again.
Multifamily assets have started to and will
continue to be affected by rising interest rates.
The question that remains in the minds of many
multifamily investors is, when and by how much?
We have seen, especially in the newer multifam-
ily product, values dropping as low as 8 to 12
percent just in the last 90 days alone. Investors
that are considering buying a 4.25 to 4.75 percent
cap rate with debt levels above 4 percent. With
the threat of increasing interest rates the effect is
to either retract their plans to purchase or at the
very least rethink their investment strategy.
Larger, more institutional capital with “patient
money”, could afford to chase smaller margin
deals that only yielded 3 percent returns. Those
returns continue to shrink and several institu-
www.aamdhq.org
tional capital firms are now contemplating a hold-
ing pattern. Even if the holding period becomes
a “wait and see” attitude to keep capital on the
sidelines until there is more certainty, clarity or
direction with the new administration to achieve
some degree of positive leverage, cap rates, must
at some point fundamentally retreat backwards.
This could equate closer to 5 percent cap rate,
depending on the product and proximity to the
core and Trans Oriented Development areas
for newer built product. To put that into
perspective, this equates to about a
10 to 12 percent decrease in mul-
tifamily asset value!
Recently built apartment
buildings are realizing less and
less rent growth as more
competition comes to
the multifamily
market.
Although demand seems to be steady, concessions
are currently occurring in many new projects and
a month (or two) may be the new norm. In the
future, this translates to investors drawing back
on what they were once willing to pay for an
apartment investment property.
The different apartment building classes will
not all experience these changes in the same way.
When it comes to class B and class C apartment
buildings, the effect may not be seen quite as
immediately or dramatically as the class A apart-
ment buildings. One could make this conclusion
because class B and class C apartment assets trade
with higher cap rates due. In the current Denver
multifamily climate, older multifamily product is
trading in the low 5 percent cap rate ranging to
high percent depending on the property’s location
and condition. For example, a B product in the
core could trade at a 5 percent cap rate or even
lower in some cases. The strategy in this example
is to buy, renovate and achieve not only rents that
are more competitive than the A product but also
the end yield is considerably higher than the A
product purchases. In terms of B and C proper-
ties, the delta in interest rate to the cap rate ratio
allows for the increase in interest rates to be ab-
sorbed without the dramatic increase to cap rates.
Value-add types of multifamily product have
also felt pressure. Pro-forma rents are becoming
more of an unsure measuring tool for stress
testing the sufficient future returns on an
older renovated property. At some point
the concessions for the A product trick-
le down to the B and C product to com-
pete with the highly amenities’ newer con-
struction product. For example, if the rent
for a 1 bed 1 bath in central Denver that was
built in 1970 pushes to $1,200 and has very
little amenities such as no parking and only
a laundry room for a perk; that property could
be competing against a 1 bed 1 bath new
construction that has parking, a dog wash, a
lazy river and a balcony for $1,700 with two
months free rent yielding the tenant a net
savings. That scenario transpires into the B
Class building lowering rent, etc. This has
happened in our market and we know his-
tory repeats itself.
To conclude, B class and C class multi-
family asset types will have a stronger outlook
moving forward than the class A product in terms
rent growth. Developers are simply unable to
build what would rival B and C class product due
to available and affordable land, not to mention
the development’s hard and soft costs.
In the past, interest rates have allowed values to
continue to climb upwards at a staggering rate. This
will continue to be a main point of discussion that
forgoes 2017 along with how values can be softened.
Ryan Floyd & Jason Koch are both Managing
Directors for Greystone Unique Apartment
Group in Denver, Colorado. Greystone Unique
Apartment Group is a specialized team dedi-
cated to multifamily investment sales and lend-
ing by providing solutions that connects buyers
to sellers while offering financing options.
www.greystoneuag.com
APRIL 2017 • TRENDS | 39