When evaluating whether to invest in multifamily real estate, it’s important to take current interest rates into account. The impact of interest rates can be reflected in the rate of return for a property and property values. Investors may also use interest rates to inform their overall investment strategy. Taking a moment to better understand how rates work and how they impact multifamily real estate investments can help you better diversify your portfolio.
Interest rates essentially dictate the cost of borrowing money, so real estate investments that require financing can be impacted by changes in current rates. As the cost of borrowing increases, investment returns will be lower. During times of lower interest, returns may be higher because of the reduced cost of borrowing money. This is reflected in the NOI (Net Operating Income) of an investment. Simply put, borrowing money to invest in multifamily real estate can result in better investment returns when interest rates remain low.
When the potential for cash flow in a property decreases, the overall value of the property itself can also decrease. When interest rates are high, property valuations may be lower. Lower valuations can make it more difficult to sell a property, leaving investors holding onto an asset for potentially longer than planned. As interest rates fall, a property’s valuation can go up. Investors use lower interest rates as an indicator that it might be time to sell an asset for more profit.
Fixed Vs. Variable Interest Rates
When financing a multifamily real estate asset, investors have two options. They can opt for a fixed interest rate, which provides stability over the life of the investment. However, they can also choose a variable interest rate. Fixed rates are often less risky, but variable interest rates can prove to be smart in some situations.
A fixed rate means the same interest rate is paid throughout the life of the real estate loan, but the cost of borrowing may be higher. With a variable rate, financing is provided at a lower rate that is subject to change. Financing a property when interest rates can be smart for a short-term loan, as there is less risk of the cost increasing.
The concept of a yield spread is a bit complex, but it essentially refers to the difference between the cap rate of a property and the interest rate on it. You may also hear this metric referred to as the cap rate spread or the yield cap rate spread. The cap rate is the expected rate of return, while the interest rate refers to the cost of borrowing money for the investment asset. A higher spread indicates the multifamily property is generating a higher rate of return. Of course, this is a simplification of the equation, as it is typically measured next to the current interest rate of the federal 10-year treasury note. The most important thing to understand about cap rates and yield spread in relation to interest rates is that lower interest rates typically result in lower spread, while higher interest rates may lead to higher spreads.
The impact of inflation on interest rates and multifamily real estate investing is particularly interesting. Higher interest rates can make it more expensive to borrow money for investing, but they can also make it more difficult for first-time homebuyers to borrow as well. In the current economic climate, a shortage of available houses for sale combined with higher interest rates may lead to more people deciding to rent instead of making a home purchase. This may actually be a benefit for multifamily real estate investing.
However, it’s important to consider other factors. Inflation can lead to an increase in the cost of construction materials, which provides a challenge to builders of new multifamily housing complexes. Lower supply drives up the prices of purchasing property, leading to potentially lower returns for investors.
How Interest Rates Impact Your Multifamily Investment Strategy
It’s impossible to judge the multifamily real estate market solely based on current interest rates. Many other factors need to be taken into account when choosing an investment property and when deciding to sell an asset. Lower interest rates can result in lower costs of borrowing and greater borrowing power, while higher rates may mean higher rents and greater returns. It’s important to evaluate each situation on its own merits by taking your financial goals and risk tolerance into account. As always, be sure to consult with your financial advisor before making any money moves.
DiversyFund offers REITs and single-asset multifamily real estate investment options for both accredited and non-accredited investors, and we carefully evaluate each property, as well as interest rates, market volatility, and other factors, all so you don’t have to.