The Multifamily Market: An Update

The current multifamily market has created one of the most unique environments we’ve seen over the past 15 years, and we’re bullish on the opportunities it’s likely to produce. Interest rates are at a 17-year high, transaction volume is at a 13-year low, and more than $4 billion in multifamily loans will mature over the next five years.

Additionally, the market has seen significant expense increases in insurance, taxes, and payroll—among others—while rental growth rates have slowed noticeably over the past several years. Just looking at the market mathematically, one would think that prices would decrease relative to the increased expense burden in a low-rent-growth environment and that we’d be in a strong buyer’s market. Yet quality opportunities are still few and far between.

Here are some numbers for perspective: Last year, Worcester Investments underwrote more than 300 properties and closed on two. We’ve purchased more than 6,000 units since our inception in 2006 and operate a current portfolio of more than 3,500 units. While we invest in other assets, purchasing and operating Kansas City and Midwest multifamily is our primary focus. It’s what we live and breathe. Yet we’re about halfway through the year and we just went under contract for our first potential acquisition in 2024. Since the spike in interest rates and expenses, most sellers have so far been unwilling to adjust pricing to levels that make sense for most buyers.

A significant driver of this stubborn multifamily pricing phenomenon is the belief that interest rates will decrease “soon.” With rare exceptions, those selling today do so because of exposure to floating rates or imminently ballooning loans. Those who secured very low-interest-rate financing pre-and post-COVID, either via purchases or refinances using agency debt (Fannie, Freddie, HUD), likely locked their rates for 10 or more years. Agency loans typically offer the best terms (lower interest rates and longer fixed durations) for qualified borrowers, so many multifamily buyers, including us, took advantage of this environment to lock in low interest rates.

While agency loans are assumable, they are subject to yield maintenance fees—high prepayment penalties. Because the loan amount is fixed, new buyers who assume existing loans will likely have to contribute a large equity down payment or take on a supplemental loan at a much higher interest rate, making assumable-finance purchasing somewhat restrictive.

Furthermore, because many prospective buyers believe interest rates will decrease soon due to inflation reduction and Fed guidance, they do not want to pay the premium/low-cap-rate pricing that a buyer with an existing low-interest loan expects if selling in a high-interest-rate environment with years left on their low-interest loan.

As a result, most owners who are not subject to interest-rate pressure are choosing to hold. We are a prime example, owning 25 properties/small portfolios, most of which are locked into long-term agency loans originated between 2018 and 2022. We are holding these properties with no intention of selling in the near future.

Despite these challenges, we remain optimistic as multifamily buyers. Many owners did not secure long-term low-interest loans when available and are now facing the prospect of significant rate increases. Regardless of recent rate variability, the mortgage payment is often the largest expense for a multifamily asset. When rates double or triple, as often happens during interest-rate turnovers today, it massively impacts the yield of the multifamily investment and the property’s intrinsic value.

About $61.8 billion in multifamily loans are expected to mature in 2024, $84.3 billion in 2025, and $89.3 billion in 2026. As more loans balloon, more owners will be forced to sell, increasing the number of sellers and creating a better supply/demand balance that should compress pricing and increase cap rates to levels more aligned with current interest rates. 

Lastly, inflation has remained stubborn, keeping rates relatively high. Many owners and lenders have extended loans in hopes of rate decreases, and they are feeling increased pressure and less hope that rates will drop aggressively enough to help them avoid underwater fire-sale scenarios.

While many buyers with impending loan balloons feel the pressure, pricing has mostly remained higher (with yields lower) than the current interest-rate environment justifies for most sophisticated buyers. However, we are hopeful that a correction is imminent and that an increased number of properties will hit the market at price points that meet our yield standards.