Understanding the Real Estate Market
There is a lot going on in the market right now. The Fed is trying to navigate inflation caused by various factors from excessive printing to global politics.
While it can be overwhelming to try and understand everything happening in the market, below are some of the driving factors that are influencing what we believe will happen over the next few months.
A couple of weeks ago, the Fed raised the overnight rate by 75 bps. This was the fifth increase this year and third 75 bps increase in a row. Earlier in the year, the Fed’s consistent push of the rates did not have a significant impact on the market. Due to this they continued to introduce higher rates.
While the Fed continues to bump interest rates, inflation does not appear to be slowing down anytime soon. The Fed announced updated rates a few weeks ago with inflation at 8.2% while core was sitting at 6.3%. It appears to be stabilizing but remains high with no signs of coming down. While excessive printing was one of the main driving forces behind inflation, the global supply side issues helped to hold it at steeper rates.
Amidst the interest rate hikes and inflation, the US economy has remained strong with unemployment at 3.7% with 5.2m job openings – illustrating that there are as many (if not more) jobs than there are people looking for work. At the same time, wage growth was 5% over the past 8 months and there is 23 trillion in savings – 5.8 trillion more than before the pandemic.
The Fed had originally planned for a “soft landing” and thought this could be achieved through a few slight bumps to the Fed funds rate. Despite their best efforts, the US economy has continued to push through these turbulences and remain strong with some minimal softening. As a result of this, the fed is now getting more aggressive with projected rate hikes of 75 bps in November and another 50 bps in December – bringing the overnight rate (SOFR) to 4.4%.
While real estate trends in early to mid-2022 appeared to not have been impacted by the heightened interest rates, as of this most recent quarter, apartment owners with variable rates began to feel the squeeze. With this most recent hike, it has introduced the concept of “negative leverage” where the going-in cap rate is less than the cost of capital. The issue becomes exacerbated as there is still a disparity between what sellers are expecting to sell for and what buyers are willing to pay.
So how do we proceed as buyers? The answer is to continue underwriting conservatively (with an emphasis on lower growth rates and higher exit caps) and plan to hold on to new acquisitions for a longer term (5+ years). This is not to say if the market conditions correct over the next couple of years you can’t sell or refinance earlier.
As always, we hope this is insightful. If you’re interested in learning how to invest or discussing some of our current investment opportunities, don’t hesitate to reach out!
Mitch and Kevin