SS266: How Interest Rates Impact Multifamily Valuations

SS266: How Interest Rates Impact Multifamily Valuations

Interest rates play a pivotal role in determining multifamily property valuations. In this episode, Charles discusses how interest rates and the cost of capital influence the valuation of apartment buildings.  

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Talking Points:

  • Interest rates play a major role in determining the value of multifamily properties because they directly influence both financing costs and the investor’s return expectations. Since most property purchases are financed, with many lenders offering loan-to-value ratios of 60%-80%, the cost of debt service is a major consideration for multifamily investors. Interest rates typically have an inverse relationship with multifamily valuations; for example, when interest rates increase, multifamily valuations tend to decrease. Let’s break down the key ways interest rates impact multifactor valuations.
    • 1. Impact on the Capitalization Rate (Cap Rate). So, rising interest rates and rising cap rates result in lower property values. As interest rates rise, investors require a higher rate of return (a higher cap rate) to cover the increased cost of capital and debt servicing. These higher returns are achieved with lower property values.
      • Additionally, when interest rates decrease, cap rates decrease, which increases property values. When the cost of capital is lower, investors accept lower returns, and property values increase.
      • If you want to learn more about what a cap rate is, check out episode SS76.
    • 2. Impact on the Cost of Debt. Multifamily investments are typically highly leveraged, making them extremely sensitive to changes in the cost of debt.
      • Higher interest rates increase the cost of a mortgage.
      • Reduced cash flow occurs since the cost of debt servicing has increased.
      • Reduced buying power since there are usually fewer potential buyers, which slows down the number of transactions and puts pressure on sellers to lower their prices.
    • 3. Rental Prices and Market Demand. Interest rates can indirectly affect the supply and demand for multifamily properties. 
      • Higher interest rates make it more difficult for would-be homeowners to purchase a home, which drives multifamily demand. Which might increase tenant retention, rental rates, and a property’s NOI.
      • Higher interest rates make it more expensive for developers to build new homes and apartment complexes, which decreases the new supply and thus pushes the demand for multifamily housing.
  • Interest rates don’t just affect the value of multifamily properties; they reshape investor expectations, buying power, cap rates, property cashflow, rental demand, and tenant retention.

Transcript:

Charles:
What if a single interest rate change could drop the value of an apartment complex by millions of dollars? When interest rates move, they don’t just affect loans, they reset how investors price risk, returns and value. Welcome to Strategy Saturday. I’m Charles Carillo. Today we’re talking about how interest rates impact multifamily valuations and why this matters more than most investors realize. So let’s get started. Interest rates play a major role in determining the value of multifamily properties because they directly influence both financing costs and the investor’s return expectations. Since most property purchases are financed with many lenders offering loan to value ratios of 60% to 80%, the cost of debt service is a major consideration for multifamily investors. Interest rates typically have an inverse relationship with multifamily valuations. For example, when interest rates increase, multifamily valuations tend to decrease. And let’s break down the key ways interest rates impact multifamily valuations.

Charles:
Number one is the impact on the capitalization rate, the cap rate. So rising interest rates and rising cap rates result in lower property values. As interest rates rise, investors require a higher rate of return, a higher cap rate to cover the increased cost of capital and debt service. These higher returns are achieved with lower property values. Additionally, when interest rates decrease, cap rates decrease, which increases property values when the cost to capital is lower. Investors accept lower returns and property values increase. Now, if you wanna learn more about what a cap rate is, you can check out episode SS 76. That’s SS 76. Number two is the impact on the cost of debt. Multi-Family investments are typically highly leveraged, making them extremely sensitive to changes in the cost of debt. Higher interest rates increase the cost of a mortgage, reduce cash flow occurs since the cost of debt servicing has increased reduced buying power since they are usually fewer potential buyers, which slows down the number of transactions and puts pressures on sellers to lower their prices.

Charles:
Number three is rental prices and market demand. Interest rates can indirectly affect the supply and demand for multifamily properties. Higher interest rates make it more difficult for the would be homeowners to purchase a home, which drives multifamily demand, which might increase tenant retention, rental rates, and properties. And a y higher interest rates make it more expensive for developers to build new homes and apartment complexes, which decreases the new supply and thus pushes the demand for multi-family housing. Interest rates don’t just affect the value of multi-family properties. They reshape investor expectations, buying power cap rates, property cash flow, rental demand, and tenant retention. I hope you enjoyed. Please remember to rate, review, subscribe, submit comments and potential show topics at globalinvestorspodcast.com. If you’re interested in actively investing in real estate, please check out our courses and mentoring programs at syndicationsuperstars.com. That is syndicationsuperstars.com. Look forward to two more episodes next week. See you then.

 

Links Mentioned In The Episode:

  • SS76: What is a Cap Rate and What is a Reversion Cap Rate?

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