Federal Reserve Interest Rates
The Federal Reserve is expected to leave interest rates unchanged per Dallas Fed Robert Kaplan. Robert Kaplan “called on his fellow central bankers to continue to be patient as economic events unfold before making changes to interest rates.” (CNBC) The U.S. 10-year Treasury yields have remained between 1.97% and 2.06% over the past week, which is still considered historically low. These are the lowest levels since November of 2016. Fears that rising interest rates will result in higher cap rates and declining property values seem reasonable, but there are other variables that have the potential to offset value declines. In fact, economic and employment factors may provide protection to overall property performance in a rising interest rate environment. The expansion of job growth and demand for renting over homeownership will keep the multifamily apartment outlook from slowing down.
The rising cost of homeownership will result in an increase in apartment occupancy levels. Yardi Matrix expects rents to continue to rise in 2019, at a rate of 2.8%, marking another year of consistent improvement. Greg Willett, chief economist for RealPage, a provider of property management and data services, predicts that multifamily occupancy will be around 95% for class A, and near full occupancy for class B and C apartments. There is a significant number of retirees looking to downsize, and a number of millennials that are looking to rent in urban areas where they are within walking distance to their jobs, and have access to shopping and recreation within close proximity. As interest rates rise, a number of renters that were looking to purchase homes may opt to continue to rent and decide to forego the increased cost of purchasing a home.
According to Yardi Matrix, development activity will remain strong in 2019. They expect deliveries to come in at about 300,000 units this year. High growth metros continue to drive new supply. These metros include Dallas, Miami, Seattle, Washington D.C., and New York City. According to the commercial real estate brokerage firm Marcus & Millichap, “in spite of the high level of new supply, vacancy rates are hovering around 4.5 percent nationally. Vacancy rates in primary markets are currently the lowest at 4.1%. Secondary markets are at 4.5% and tertiary markets are at 5.2%.” Dallas is expected to complete the most units in 2019 at 22,410, followed by Miami at 16,320, and Seattle at 12,450. According to Freddie Mac Multifamily, the vacancy rates have performed better than forecasted, which put the market in a good position to absorb the high levels of new supply.
Rent growth is expected to be moderate in 2019, but above historical averages. Yardi Matrix expects rent increases in 2019 to range from 2.5% to 3% nationally. They attribute this to the number of young adult households continuing to rise, with families remaining as renters longer than they did in the past, along with retirees who are selling homes with high property taxes and turning into renters. The highest 2019 rent increase percentages expected are 6.5% for Sacramento, 5.8% for Tacoma, and 4.6% for Salt Lake City. A majority of Eastern Metros will top out in the 1.5% to 2% range.
Multifamily Cap Rates
Cap rates and Treasury rates are correlated, and in most instances, a rise in interest rates causes a rise in cap rates. Freddie Mac Multifamily expects cap rates to respond to higher interest rates by slowly increasing, and stated that “multifamily property prices increased 10.7% annually as of the third quarter of 2018. Despite moderating fundamentals, apartment investments continue to provide stable and safe returns for investors.”
For 2019, current interest and cap rates are still historically low, and occupancy levels are at an average of approximately 95%. Since apartment values have increased significantly over the past several years, now is a great time to use the equity that has built up to reduce your interest rate, cash out, and or do the necessary capital improvements that your project may require. This will reduce the overall expenses and increase the value of the asset.