Is Multifamily in Trouble? Examining Market Dynamics and Investment Considerations

Is Multifamily in Trouble? Examining Market Dynamics and Investment Considerations

In the fast-paced world of real estate investing, it’s crucial to stay informed about the latest trends and market dynamics.

There are various factors impacting the multifamily industry, including shifting market dynamics, regulatory changes, Fed rate hikes, insurance increases, and economic uncertainties.

We want to shed some light on what we believe to be the biggest culprit behind the challenges faced by multifamily investors today.

The Impact of Variable Interest Rates

The main issue affecting multifamily and other real estate investment classes is variable interest rates. This issue is not exclusive to multifamily investments but extends to other sectors such as single-family properties, industrial development, and self-storage. The volatility caused by variable rates presents challenges for investors across the board.

Let me take a step back and explain what a Variable Rate even is. When you get a loan for a property, your payment typically includes two portions: Your Principal (the amount you borrowed) and the Interest (the cost of borrowing money). You will either get a fixed interest rate loan or a variable loan. There are pros and cons to each. The Variable Interest Rates move up and down over time, while Fixed Rates stay the same. As the interest rate changes on a variable rate loan, your monthly debt payment will change due to an increase or decrease in the new interest rate.

Advantages of Fixed-Rate Debt

While variable rates may be causing some turbulence, fixed-rate debt can be advantageous in certain cases. However, it’s important to note that fixed-rate debt often comes with significant prepayment penalties, which can reduce investor returns. In addition, fixed rate loan options typically do not provide the loan proceeds to rehab a multifamily property. To put this in perspective, if we had fixed debt on some of the deals we sold in the past instead of a variable rate loans, it would have resulted in over $50 million in additional prepayment penalties. This number is staggering. So, while anyone can look to the past and say we would have, should have, could have, etc…you have to make the best decisions based on the information you have at the time along with prior experiences and lessons learned.

Comparing Single Family and Multifamily Investments

Let me draw attention to the differences between single-family and multifamily investments. I want to note that multifamily properties typically have non-recourse debt, meaning investors are not personally liable in the event of default. In contrast, single-family properties with smaller units (4 units and below) often involve recourse debt, where the lender can pursue both the property and the investor personally to cover any losses. While both single-family and multifamily have historically experienced challenges, multifamily has shown greater resilience on average; with rental drops not as severe as those seen in single-family properties.

Advantages of Multifamily Investments

There are several advantages of multifamily investments. Multifamily loans often allow for loan assumption, which enables buyers to acquire properties at lower rates compared to current rates being offered.  Additionally, multifamily investments offer significant depreciation benefits, with potential appreciations that can be allocated to investors. Furthermore, the concept of cap rates, which determines property valuation (what a property is worth) based on revenue and expenses, is unique to multifamily and can contribute to increased property values. For example, if a market has a 5% cap rate, every dollar you can increase revenue or decrease expenses will result in $20 of value.

Making Informed Investment Decisions

I want to emphasize the importance of using the information available to make better investment decisions going forward. While it may be tempting to dwell on past choices, I encourage investors to learn from previous experiences and adapt their strategies accordingly. Despite the current challenges, we are still very Bullish on multifamily investments as a long-term strategy due to the exponential value growth potential, non-recourse debt options, depreciation benefits, and the business-like treatment of properties with five units and above.

By using the information available and adapting investment strategies, investors can navigate the current landscape and make informed decisions to secure their family’s financial future.