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- The Multifamily Investment Market Slump Explained
The Multifamily Investment Market Slump Explained
Rate hikes make debt financing a struggle, property appreciation exceeds NOI growth decreasing cap rates.
Cooper Thayer
October 16, 2022
News: Freddie Mac's Apartment Investment Market Index® indicates an unattractive multifamily market
The AIMI, a measure of national investment conditions of apartment properties, has experienced its largest decline in the history of the index this year.
The index, split into three variables (mortgage rates, rent growth rates, and price growth rates), has displayed a rapid increase in prices and rent growth since Q2 2020, with a major spike in mortgage rates in the second quarter of this year.
The Effect on the Investment Landscape
As commercial properties are generally valued using cap rates (NOI/Value or Price), an increase in price, holding NOI constant, will reduce the cap rate, making it less attractive to potential investors.
“Although higher rates and property prices have driven the index down, NOI growth remains strong. The drop in AIMI this quarter reflects moderating investment conditions brought about by changing trends in the broader economy."
So what happens when NOI and price both increase?
According to the Freddie Mac report, national NOI growth was 3.0% as of Q2 2022, but property prices have increased a whopping 21.8% over the same period. Despite relatively strong NOI growth increasing the numerator of the cap rate function, the rapid outpacing of NOI by price increases vastly outweighs the effect of strong NOI growth, resulting in quickly decreasing cap rates and investment attractiveness.
Adding Insult to Injury
Low cap rates do not necessarily mean bad investments, since NOI is not the bottom line. But when you throw rapidly increasing mortgage rates into the mix, it becomes near impossible to find many multifamily investments that will yield a positive cash flow in the near term.
The Freddie Mac index reported a 131 basis-point (1.31%) increase over the year of mortgage rates, which are expected to increase even further throughout the remainder of the year. See below for more on that.
News: CPI inflation numbers come in above expectations; Fed more likely to continue rate hikes
On Thursday, the Bureau of Labor Statistics (BLS) released its monthly Consumer Price Index (CPI) data, coming in at +0.4% month-over-month (adjusted) and 8.2% year-over-year (unadjusted). The economy's persistent inflation is a likely indicator that the Federal Reserve will continue its hawkish policy, increasing the federal funds rate to reign in inflation.
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