Many investors evaluate these factors when deciding where to spend their money. Stability and predictability are crucial to them. But things feel much less predictable now that there have been years of low-interest rates and generally constant inflation. The Consumer Price Index increased 7.9% in February compared to the previous period in 2021, and the Fed just increased interest rates, the first of up to six such hikes this year. That is the highest yearly inflation rate since February 1982.
The possibility of a recession is enhanced by rising consumer demand, supply chain disruptions caused by COVID-19, staff shortages, and increasing energy prices. All of these elements are contributing to inflation. To contain soaring inflation, the Federal Reserve voted on March 16 to raise interest rates by a quarter percent, from 0.25% to 0.5%, with more increases likely.
What effect does everything have on the prospects for investing in multifamily real estate?
Throughout an investment’s life cycle, we keep an eye on interest rates and inflation. To reduce the risks in the current context of inflation, we are doing the following four things in particular:
- Concentrating on Multifamily
Other items are growing in value besides inflation and building prices. Rents and asset development expenses may rise together if inflation keeps going up. If expenses, such as the cost of financing, can be kept under control, multifamily property owners will have larger profit margins while rising rents increase income. Additionally, we have the flexibility to routinely modify rental costs with our multifamily housing holdings. When a long-term lease for an office building might lock in rent levels for ten years, for example, it is more challenging. Even if cap rates remain high, values will undoubtedly keep climbing since as rentals increase, so will our net operating income.
Inflation is being outpaced by returns. According to statistics from the Consumer Price Index,RealPage, and the NCREIF NPI-Apartments Index, monthly rent and earnings on multifamily investments will grow faster than the inflation rate in 2021. Approximately 360,000 brand-new apartments were delivered in 2021, however, the National Association of Realtors estimates that tenants occupied over 700,000 new apartment units, which is 50% greater than the pre-pandemic peak.
Demographics and consumer demand favor us. The greatest accessible inflation hedge, in our opinion, continues to be multifamily real estate. Multifamily investments gain far more from demographic, and wage growth trends than office or retail assets do, among other things. As more individuals have the choice to select their place of employment and residence, many are relocating to the quickly developing southern and western regions where we are investing investments. Baby boomers and those who have just had their nests empty are looking for more freedom. Millennials are delaying house purchases and raising kids later in life. And Gen Z, who are just beginning their professions, are boosting demand for rental accommodation, which is expected to increase significantly over the next decade.
Accommodation is a crucial necessity, particularly in rented housing. Numerous folks wish to purchase a property yet lack the funds to do so. This issue is made worse by inflation since rising housing expenses cause savings to lose value. In a downturn, people may reduce their spending on shopping, recreation, and travel, but a place to live remains a need.
- Debt Cost Reduction
The top-line increase resulting from cost control on multifamily constructions acts as a helpful inflation cushion. The simplest way to manage debt, which is a hefty burden, is to lower the interest rates on long-term debt. We use variable rate debt since a substantial portion of our portfolio is related to development; this debt will often not be addressed for 2 to 3 years after the project is secured and construction is finished. We are using a variety of tactics to prepare for anticipated future interest rate increases.
One of them is looking for ways to obtain appealing fixed-rate construction finance from the United States. Housing and Urban Development (HUD) (HUD). Rates are comparable to those for loans available on stabilized assets permitted under HUD’s 221(d)4 construction financing program. When compared to when conventional construction loans are converted to fixed debt, such funding, which might last four decades, would reduce the risk of greater interest rate exposure.
- The Use of Hedging Instruments
To assist us to lessen or restrict the risk associated with long-term interest rates, we are deploying hedges at both the estate and Fund levels. These are some examples:
We have synchronized our forward-dated interest rate swaps with the anticipated refinancing dates for our long-term debt. With the help of these instruments, we may successfully fix all or a fraction of the total debt for upcoming, long-term financing. We will get payments to cover the higher interest expenses if interest rates rise above the predetermined swap rate. If interest rates remain below the future set swap rate, our assets or Funds will be required to make higher payments; nonetheless, despite this risk, swaps provide better predictability of expected cash flows.
Forward interest rate swaps, In essence, are choices to engage in an interest rate exchange at a later time. We execute the option and get payments that offset the higher interest rate expenses if rates rise just above the option strike price. We do not exercise the option if rates remain below the strike price, and the premium becomes a committed expense. Although we typically prefer to employ swaps rather than swaptions to spend as much capital as feasible in real estate assets instead of hedging instruments, we can speed up swaption purchases ahead of anticipated near-term market action.
- Using Extensive Due Diligence and Underwriting
Our real estate analysts have been selecting the greatest markets for multifamily real estate investments for many years, and they are guided by our real estate professionals who reside in the areas where we make our investments. They have connections with our development partners, which gives us benefits over the competition, sometimes including early entry into the greatest off-market agreements. In addition, we usea unique model created by our data scientists. Our ability to identify patterns in variables like rent per square foot, lease renewal rates, and rent increases, and validate them. It is made possible by the block-by-block insights and predictions that are created using machine learning and millions of data points.
We have a better chance of making investments that live up to or beyond our expectations because of our meticulous underwriting. To determine what would be necessary to generate suitable risk-adjusted returns, we stress-test by simulating various scenarios utilizing various shifting data points, such as interest rates, inflation, and cap rates. To identify the prospects that represent the finest risk-adjusted investments, we also analyze the environmental, legal, physical, and financial elements of a property. To provide a buffer, we properly employ leverage and increase deal value.
We wouldn’t just sit on the sidelines and wait for something to happen; rather, we expect that any interest rate increases will happen slowly and inflation will remain under control. By making plans, developing strategies, and taking appropriate action, we approach our job like risk managers. We have regularly delivered top-decile earnings to our investors throughout the years thanks to these core principles. They eliminate as many uncertainties as possible from the process of acquiring, creating, and overseeing each property in our Funds.
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Come join us! Email me at mark@dolphinpi.us to find out more about our next real estate investment.