Martha and the Vandellas probably weren’t singing about financial markets in their 1965 hit “Nowhere to run…nowhere to hide,” but the song describes the sentiment in the market for just about everyone. Possible exceptions are real estate investors of apartments and industrial properties.
The nagging truth dominating the market is that inflation is going to be stickier than most forecasts and that is making the Federal Reserve nervous. The Fed has effectively flattened the yield curve so that the difference between short-term and long-term rates is almost non-existent. But both are well off their all-time lows.
Yields on 10-year Treasury bills, which are a benchmark for long-term commercial mortgage rates, have risen to their highest level in more than 11 years and are pushing commercial mortgage rates higher with them.
According to the John B. Levy & Company Commercial Mortgage Survey, 5- and 10-year fixed rates are in the range of 5% to 5.50% for low-leverage loans and mortgage loans. variable rate are not much different, with prices ranging between 200 and 250 compared to SOFR. interval.
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So while the Fed has maintained its pirate mentality that “the beatings will continue until morale improves,” borrowers are struggling to make sense of the new normal. Unfortunately, the new norm is higher inflation for a while, which means higher rates.
According to a recent Newmark Multifamily report, apartment rents across the country rose 13.5% in the past 12 months ending June 2022. That’s well above inflation, which was 9.1% in the 12 months ending in June and, more recently, 8.3% in the 12 months ending in August. The question for apartment investors, however, is to what extent interest rates can rise while cap rates remain so low.
The same Newmark research indicated that cap rates were compressed for multifamily products in the first half of the year and only increased in several major markets. This trend of cap rate compression will be difficult to sustain as interest rates rise.
Lenders at all levels are reporting that overall credit is tightening, but they are still on the lookout for good loans backed by multifamily and industrial properties. Office projects give many lenders pause because they still cannot understand the office occupancy environment two and five years from now. Commercial properties have also faced tougher underwriting due to recent negative news from several major retailers and movie theater chains.
Here in Richmond, the story is much the same as across the country. With rising costs, it is more difficult to consider new construction, which will prevent new supply from growing too quickly. This constraint, however, is the same thing that is keeping rental rates up for apartments and industrial properties. According to Apartment List’s September rent report, rents in Richmond rose 9.6% year over year, which is below the national average growth of 10%, but is well above in Virginia Beach, which has seen only 5% rental growth over the past 12 months.
John B. Levy & Co. partner and investment banker Andrew Little can be reached at [email protected]