The Federal Reserve has become the boogeyman for multifamily syndicators across the nation.
Established in 1913, The Federal Reserve was a response to the massive 1907 panic that sparked multiple bank runs, which led to widespread chaos in the banking sector. Congress created The Federal Reserve to handle the banking crisis, and they’ve been using monetary policy to influence the economy ever since. They do a wide range of things, from attempting to control inflation to promoting employment.
In order to accomplish their goals, the Fed has a tool belt of tactics. They are able to manipulate the money supply in the economy by selling and purchasing open market securities.
The Fed Acts, Multifamily Reacts…
The actions taken by The Fed obviously has an impact on the multifamily industry. As mentioned earlier, The Fed uses the discount rate, reserve requirements, and the purchase and sale of open market securities to manipulate interest rates and credit markets. These factors also influence the multifamily industry and a multifamily investor’s financing options.
So, let’s start with short-term interest rates. The Fed is able to influence short-term interest rates by setting a federal funds rate target range. The federal funds rate is the interest rate charged by banks when they lend another bank money overnight. By increasing the federal funds rate, banks have to spend more money when they borrow money. As a result of this, consumers have to pay more to borrow money from banks so that the bank can make up for this increase in costs. Consumers, which include multifamily investors and developers, experience higher interest rates on loans, such as mortgages.
As mortgage rates increase, less consumers are able to afford single family homes. This causes homeownership rates to decline. These people still need a place to live, which drives up demand for rental units. That’s good news for multifamily investors like us. But multifamily investors aren’t immune to the downsides of higher interest rates. Multifamily investors also experience higher costs of taking out a loan to purchase a multifamily property. This is why investors must take higher interest rates into account when they underwrite a deal.
Lower interest rates are favorable for investors. Interest rates decrease when The Fed decreases the federal funds rate, which lowers the costs of borrowing between banks.
But The Fed has other tools at their disposal that allows them to influence the multifamily industry and the economy at large. Their ability to manipulate credit in the economy by selling and buying securities allows them to change how much credit is available. These securities also include mortgage-backed securities. The level of mortgage-backed securities in the economy impacts a multifamily investor’s access to favorable debt on their properties. Many investors use 50-70% or more of leverage to buy these properties, so any change to their debt will heavily influence their ability to make purchases.
The impact the Fed’s actions have on the economy at large also has an impact on the multifamily industry. The Fed’s actions to combat inflation may lead to weakening the economy, which results in lower unemployment and an increase in wages. This could lead to a decline in demand for multifamily housing, as less people can afford the rent.
The Fed’s ability to cause lower mortgage rates could also result in a higher pool of qualified single-family home buyers, which would decrease demand for multifamily units.
The Fed isn’t the only economic force that impacts the multifamily market. As you might have learned in Econ 101, supply and demand, government policies, and current events like wars and pandemics can also impact the industry.
Now that we’ve addressed the many levers The Fed can pull to influence the economy, which impact the multifamily industry, let’s dive into some ways multifamily investors can mitigate their effects.
1. Hiking Mountains Are Good, Interest Rates…Not So Much
As we’ve seen since 2022, The Fed’s actions can lead to higher interest rates. Savvy multifamily investors keep a pulse on The Fed’s actions, and make sure to stay updated on what they’re doing and saying! Looking at patterns to determine the direction of The Fed’s actions based on recent decisions can help you make educated projections to underwrite conservatively.
2. Money Might Grow On Trees?
Quantitative Easing is the strategy used by The Fed to influence credit in the economy. As mentioned above, The Fed can buy and sell securities. When they buy securities, they are injecting money into the economy, thus increasing the money supply. This makes it cheaper to borrow money for banks and increases bank reserves, which gives banks more liquidity, and results in a decline in interest rates. Quantitative tightening is the opposite.
Understanding what The Fed is doing can help investors make the right decision on whether or not to proceed with a deal, especially when it comes to the kind of debt they’ll be able to secure to purchase a property.
The Fed plays a major role in the economy and in how multifamily investors navigate it, whether we like it or not. So, it’s important to understand The Fed’s decisions, their philosophies, and their current perspective on how the economy is doing.
Understanding The Fed is key to mitigating risk and continuing to thrive in an evolving multifamily investment environment.