On Wednesday, May 3rd, the Federal Reserve raised the short-term interest rate to 5.1%, the highest in years.
What does this mean for commercial Real Estate, particularly the multifamily sector? First, the Fed Interest rate affects everything in the economy. Once banks need to pay more for their capital, it gets passed on to the consumer in higher interest on loans.
Conversely, banks will pay more for savings accounts and money markets. When investors consider their options for possible investments, they must start with the most stable and conservative choice. Government Bonds, Savings accounts, and Money Markets are the most traditional options. Today banks are paying over 4% on Money Markets or Savings accounts. The money is liquid, and the possibility of losing your money is next to zero, especially if you invest in Government Bonds.
When an investor compares this to Real Estate, they must seek a higher return than they can earn in the bank. Multifamily buildings are businesses with many moving parts. The rental market is subject to change, as are all the expenses. To take on the risk of possibly losing your investment, the Cap Rate (the return an investor will receive on a building before debt) must be higher than what they can receive in a bank.
Higher Cap Rates reduce the value of Real Property because it must compete against other forms of investments, in particular Bonds, Money Markets, and Savings accounts.
Secondly, as mentioned, when borrowing money costs the banks more in interest, they must pass it on to their borrowers. So, when an owner of Real Property wants to get a mortgage on their Multifamily building, they will pay more in interest, which means they must borrow less. When an investor can borrow less, he will not be willing to spend as much for the property, adding pressure to reduce the value of the property.
These are just a few factors about which entire books have been written.