Return rates on apartment buildings are on the decline as interest rates rise, leading landlords to wonder how much more they can increase rents to offset the loss.
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Negative leverage, or a phenomenon where return rates fall below the interest rate on a mortgage, is rearing its ugly head 14 years after the housing market crash of 2008, when defaults on apartment-building debt reached crisis levels.
While most experts do not predict a repeat of what occurred in the late aughts, owners who paid steep prices for apartment buildings could be at risk as the prospect of raising rents on cash-strapped tenants becomes less tenable, according to a report by The Wall Street Journal.
Multifamily has been viewed by CRE investors as a hedge against inflation due to the ability to adjust rents alongside rising interest rates. But as rental rates reach historic heights, landlords have less wiggle room. According to Realtor.com, the median asking rent rose to $1,827 in April, the highest rent on record and up 17% year-over-year.
The pandemic sent a rush of investors into the multifamily market, causing buildings to sell for much higher than what they were actually worth. This phenomenon led some to conclude that the U.S. housing market is in bubble territory, but whether or not values will decline enough to cause a pop is still up for debate.
Values of buildings could drop if interest rates rise faster than rents, which is why an increase in rental income is critical, per the WSJ. But cap rates of multifamily buildings have been on the decline since 2015, according to CBRE, which makes rising interest rates even more threatening to owners.
“There’s no question you’re going to have rent growth; the question is whether it will outpace interest rates,” David Brickman, CEO of NewPoint Real Estate Capital and former head of Freddie Mac, told the WSJ.
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