Soaring interest rates stall apartment transactions

This article is the first in a series exploring the impact of rising interest rates on the U.S. multifamily housing market.

Earlier this year, apartment owner CGI+ planned to take advantage of the then-astronomically high property prices to sell three of its four properties in Southern California.

"We really wanted to seize the opportunity of the seller's market at that time," said Aaron Cohen, COO of the Woodland Hills, California-based company. However, by April, CGI+ had pulled the listings for two of those assets; in May, the company decided not to sell another one. This rapid shift stemmed from a core issue: rising interest rates.

Cohen noted that higher borrowing costs have thrown cold water on the once-hot apartment sales market. Buyers' offers failed to meet CGI+'s expectations, or buyers demanded "retrades" during the transaction process, meaning they asked for price reductions after the purchase process had advanced.

"We pulled the deals because we wanted to sell at the ultra-high prices we saw in the market," Cohen said. "But due to rising interest rates, buyers came back to us trying to renegotiate. We said, 'Listen, we don't need to sell these assets; they are performing well.'"

Cohen is not alone. Others in the industry have also observed that rising interest rates and fluctuating U.S. Treasury yields are killing deals. As financing costs rise, buyers seek discounts, while sellers are reluctant to lower prices.

Nevertheless, overall data still shows a healthy market. According to data shared with Multifamily Dive by MSCI Real Assets, a company providing tools and services to the global investment community, the multifamily sector recorded $21.5 billion in sales in May, up 22% year-over-year, setting a record high for that month. However, MSCI noted that the pace of growth in April and May had slowed compared to the first quarter of this year.

Sticker Shock

At the beginning of this year, the 10-year U.S. Treasury yield, one of the benchmarks for apartment loan interest rates, was around 1.6%. By March, as the war in Ukraine intensified and inflation climbed to multi-decade highs, the yield approached 3%. In mid-June, it briefly exceeded 3.48%, the highest level since 2011.

As interest rates and Treasury yields rise, borrowers face higher costs, often after they have already signed contracts.

"Rising interest rates have changed the calculation," said Otto Ozen, executive vice president at The Mogharebi Group, a brokerage based in Costa Mesa, California. "When lenders give you less money, it affects the amount of equity you have to put in and the returns you expect."

According to Patrick McGlohn, senior managing director at Berkadia's Washington, D.C. metro office, the surge in Treasury yields in early June not only pushed up fixed-rate borrowing costs but also affected floating-rate debt. "It has impacted the amount of loans for all types of loans and the borrowing costs for fixed-rate loans," he said.

When borrowing costs rise, buyers can go back to sellers and ask for price reductions. And that is exactly what has often happened over the past few months. "Buyers of some ultra-large institutional properties are either canceling escrow or retrading and asking for discounts," Ozen said.

There is debate about how much retrading is actually occurring in the market. Cohen estimates that 25% to 30% of the deals he has seen have fallen out of contract, while Kyle Draeger, senior managing director of multifamily debt and structured finance at Houston-based CBRE Capital Markets, says such cases are more limited. "Buyers don't want to be seen as serial retraders," he said.

Sellers Face a Choice

When buyers ask for discounts, sellers face a choice: either walk away from the deal or accept a lower price. But as interest rates continue to rise, owners may face the shadow that if they hold on for a few more months, prices could be even lower.

"Sellers won't be able to get similar prices if they put the property back on the market," said George Goyal, founding partner at Three Pillars Capital Group, a Houston-based firm focused on Class B and C multifamily communities.

Some owners, like CGI+, chose to pull assets off the market rather than accept lower prices. "They realized they didn't have the right buyer pool, or the buyer pool wasn't large enough, so they ended up holding the assets until another selling opportunity arises," Cohen said.

If owners are determined to sell or are forced to sell, they will need to reassess their expectations for value. "Sellers now have to come down from their high expectations on pricing," Goyal said.

Traditionally, during periods of market turmoil, sellers adjust their price expectations, even if it takes a few months. "Typically, sellers' expectations come down because the buyer's cost of debt has risen too much," Draeger said.

Bidders Disappear

As apartment properties become harder to underwrite, buyers are becoming more cautious. Cohen estimates that the number of interested bidders in many deals has decreased by 50% to 75%.

CGI+ is one of those buyers that has pulled back. "We are being strict and hitting the brakes on purchasing deals right now unless we find a deal that truly works financially," Cohen said. "Most companies are like us; the buyer pool has indeed shrunk significantly compared to before."

Swapnil Agarwal, CEO and founder of Houston-based Nitya Capital, has adopted a similar strategy. In 2021, Nitya completed nearly $2 billion in total transaction volume, but now, he plans to pause acquisitions and observe how the market reacts to rising interest rates.

"We are working to close the last three residential assets we have under contract," Agarwal said. "Now we will pause acquisitions for the rest of the year."

Meanwhile, buyers who are still purchasing are underwriting conservatively. "We are assuming interest rates will be between 4% and 5%," said Joe Lubeck, CEO of American Landmark, a Tampa-based apartment owner and management company. "So we will continue to pursue fixed-rate loans with the longest terms possible."

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