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The Impact of Rising Commercial Mortgage Rates on Multifamily Investment

Discover what the latest commercial mortgage rates trends mean so you can make informed decisions for your business investments.

April 14, 2023

Commercial mortgage rates

Commercial Mortgage Rates

Commercial mortgage rates in the United States fell to an all-time low in 2021, making loans very affordable. Many American investors jumped into investing in income property, specifically multifamily rentals. With inflation on the rise, the Federal Reserve has spurred multiple benchmark interest rate hikes, forcing mortgage rates to rise significantly in a very short period.

The average interest rate for a commercial mortgage jumped from 3.25% in January 2022 to 6% in January of 2023. The impact of rising commercial mortgage rates can be felt heavily across all sectors of the US real estate investment market.

The extreme rise has been driven by the impact of inflation. The mortgage rates for income property have a significant impact on value. As an investor, the amount of your mortgage is generally your single largest monthly expense and its rising cost weighs heavily on what you can pay for a property.

What is the Impact of Rising Commercial Mortgage Rates on Return on Investment (ROI)?

Rising mortgage rate in general leads to homeownership being less affordable which increases demand for rental apartments but any increase in income is a drop in the bucket compared to the rising cost of interest on your commercial mortgage.

From an investor’s perspective, the main question is how rising commercial mortgage rates will impact cash flow. As an investor, to understand the potential impact of rising rates on after-debt cash flow, you must understand how it affects the three main components of multifamily income property operation; rent, operating expense, and debt service.

1. Rent

As commercial mortgage rates increase, property rents should increase, which is good for investors. This is a very general premise, and each individual market will respond differently based on a multitude of other factors.

2. Operating Expense

Win a rising commercial mortgage rate environment, you will likely experience an increase in operating expenses. Rising interest rates are generally driven by the impact of inflation which means the operating costs will rise as well.

3. Debt Service

With rising interest rates, there will be a rise in the cost of debt. In the long run, with the national housing shortage expected to continue into the 2030’s we fully expect the markets to settle and investors will be fine. But in the short term, they should be careful not to over-leverage or have debt come due in a high commercial mortgage rate environment because the consequences could be dire.

What is the Current Commercial Mortgage Rate Landscape?

To understand how rising commercial mortgage rates impact your multifamily investment, you must understand the current circumstances. The Federal Reserve has increased rates from nearly 0% to 4.75% in less than 9 months.

They are still grappling with excessively high inflation at 6.4% in January of 2023 with their stated goal of reducing such to 2%. If they follow through we can expect rates to rise further with the eventual terminal rate to be close to 6%. This means that commercial mortgage rates for multifamily rentals peak at around 8%.

How to Do Higher Commercial Mortgage Rates Impact Multifamily Investment?

1. Cost of debt

The cost of debt will rise.

2. Capitalization rate

Capitalization rates move parallel with commercial mortgage rates so we can expect them to rise across all US markets which means lower income property values.

How can Investor Protect Themselves from Rising Commercial Mortgage Rates?

1. Lock in at a Longer Term

If you can obtain a rate you can stomach, make sure your term is far enough out i.e., 5 years or longer so that when your loan comes due, hopefully, we are in a better interest rate environment.

2. Invest at a Capitalization Rate that is Higher than Your Interest Rate

A multifamily income property purchased at a capitalization rate that is higher than the cost of debt is said to have positive leverage. This means the money you are borrowing is making more than its costs you to borrow it.

3. Increase Cash Reserves

You need to have cash on hand to protect yourself from the impact of rising interest rates and higher inflation on your income property’s day-to-day operational costs.

4. Diversify Your Portfolio

Diversifying your multifamily investment portfolio by investing in 2 to 3 different markets with strong underlying fundamentals. It will help you to mitigate the risk of one investment by the results of others due to an unexpected shift in market condition, like loss of employment in one market.

Commmercial Mortagage Rates: Conclusion

Rising commercial mortgage rates will lead to opportunistic buying opportunities. Certain income property investors, especially developers, will be squeezed by debt coming due, and be forced to sell their multifamily development at a discount or recapitalize which is not an easy thing to achieve. Investors with large cash reserves will win the day.

The best thing you can do is raise a lot of capital, align yourself with the right lender, and be prepared to make a transaction as easy as possible for the Seller and the associated Lenders to get the property at a good price. As most income property investors generally say, “You make your money at the buy”.

One-way investors can curtail the impact of rising mortgage rates is by partnering with a reputable and experienced property management firm. Summerfield provides exceptional services at a good value. If you own properties that are 75 units in size or greater, we would like to talk to you!

Commmercial Mortagage Rates: FAQs

Q: What is the impact of inflation on a multifamily income property?

A: It is multifaceted, it has a combination of greater demand for rentals with higher operating and debt costs. Overall, it is our view it is not good for income property value or investor bottom line.

Q: How to take advantage of market opportunities in a rising commercial mortgage rate environment?

A: Target Owners of multifamily income properties whose loans are coming due in the next 12 months.

Q: How do cap rates change with rising commercial mortgage rates?

A: If the interest rates go higher, cap rates generally rise as well.