Investment Real Estate Update
What a whirlwind 2022 was for real estate in Central Oregon and across the nation. We start the new year with pesky rising inflation, rising interest rates, a slowing macroeconomy and continued shortages in nearly all types of housing. Rents seem to be holding steady with only minor seasonal decreases and vacancy rates remain low. We continue to see an influx of cash (though slowing) from both out of state investors relocating here and people moving out of the stock market and into real estate.
When interest rates go up, real estate investors should expect lower returns unless purchase cap rates increase accordingly. Remember Cap Rates are a measurement of an investments return and
provides a standard measure by which to compare properties / investments.
Cap Rate= NOI / Purchase Price =Yield of a property over 1 year
NOI (Net Operating Income) = Gross income – Operating expenses
Navigating the ‘Negative Leverage’ in Multifamily Real Estate
What we are currently seeing is an anomaly where interest rates (Blue line) have exceeded cap rates (Green line) which should never happen in a healthy market. In this case the debt a leveraged buyer uses to purchase a property puts downward pressure on the return. The borrowed money costs more than the return (hence the term “negative leverage”). Lenders then require a higher loan to value (LTV) to achieve their required minimum debt service coverage ratio (DSCR) further diluting the buyer’s cash on cash return. This obviously is a problem for buyers wanting to finance a cash flowing investment but also for sellers wanting to sell for a top of the market price.
So, what is going to happen? I don’t have a crystal ball that predicts interest rates but most experts in that market predict that overall higher rates are here to stay for a while. This WILL eventually cause real estate values to decrease and cap rates to increase.
Multifamily property owners considering selling should consider maximizing their NOI now by getting their rents up to market rates and expenses under control prior to selling.