Martha and the Vandellas probably were not singing about financial markets in their 1965 hit “Nowhere to run … nowhere to hide,” but the song describes the feeling in the market for just about everyone. The possible exceptions are apartment and industrial property real estate investors.
The nagging truth overriding the market is that inflation is going to be stickier than most predicted and that is making the Federal Reserve antsy. The Fed has effectively flattened the yield curve so that the difference between short-term and long-term rates is almost nonexistent. But both are well off their historic lows.
Yields on 10-year Treasuries, which are a benchmark for long-term commercial mortgage rates, are up to their highest level in over 11 years and 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 5% to 5.50% range for lower leverage loans and floating rate loans are not much different, pricing in the 200 to 250 over SOFR range.
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So, while the Fed has maintained their pirate mentality that “the beatings will continue until morale improves,” borrowers are struggling to make sense of the new normal. Unfortunately, the new normal is higher inflation for a while and that means higher rates.
According to a recent Newmark Multifamily report, apartment rents across the country grew 13.5% in the trailing 12 months that ended in June 2022. That is well above inflation, which was running at 9.1% in the 12 months ended in June and, more recently, 8.3% in the 12 months ended in August. The question for apartment investors, however, is how much higher can interest rates move while cap rates remain so low.
The same Newmark research indicated that cap rates have compressed for multifamily product in the first half of the year and increased in only several major markets. That trend of compressing cap rates will be difficult to hold as interest rates march higher.
Lenders across the board are reporting that overall credit is tightening, but they are still on the hunt for good multifamily and industrial property backed loans. Office projects are giving many lenders pause as they still cannot understand the office occupying environment two and five years into the future. Retail properties have also been facing more difficult underwriting due to recent negative news from several large retailers and movie theater chains.
Here in Richmond, the story is much the same as around the country. With costs rising, it is more difficult to pencil out new construction, which will keep new supply from growing too rapidly. That constraint, however, is the same thing that is keeping rental rates growing for both apartment and industrial properties. According to Apartment List’s September Rent Report, rents in Richmond are up 9.6% year over year, which trails the national average growth of 10%, but is well ahead of Virginia Beach, which had only 5% rental growth in the past 12 months.
John B. Levy & Co. partner and investment banker Andrew Little can be reached at alittle@ jblevyco.com.