At its seventh meeting of the year, the Federal Open Market Committee (FOMC) voted unanimously to approve another .75% increase, the fourth consecutive .75% rate hike this year bringing the benchmark federal funds rate range to 3.75%-4.00%. The FOMC reiterated its commitment to return inflation to 2%, which is far below the 8.2% CPI rate recorded in September, and anticipates that additional increases will be necessary to achieve its goal. Policymakers also pledged to continue reducing the Fed’s holdings of Treasury and agency debt and mortgage-backed securities on its balance sheet.

“Financial conditions have tightened significantly in response to our policy actions, and we are seeing the effects on demand in the most interest-rate-sensitive sectors of the economy, such as housing,” said Jerome Powell,Chair of the Federal Reserve. “It will take time, however, for the full effects of monetary restraint to be realized, especially on inflation. That’s why we say in our statement that in determining the pace of future increases in the target range, we will take into account the cumulative tightening of monetary policy and the lags with which monetary policy affects economic activity and inflation.”

In the press briefing following his formal statement, Powell said he doesn’t think the Fed has overtightened, noting that inflation is still well above the federal funds rate.

Capital Readily Available

Matthew Buttram, Director of Capital Services at Ariel Property Advisors, said rate hikes are starting to impact activity in the commercial real estate market but, unlike the Financial Crisis of 2008-09, which was a liquidity crisis, capital remains readily available to borrowers, only at higher interest rates.

“We have not encountered a situation where we haven’t had an abundance of competitive financing options across all asset classes,” Buttram said. “However, the underwriting is tighter and it’s taking lenders longer to screen deals, perform due diligence, make decisions and close loans

Market Seeing Price Adjustments

Buttram said the market is slowly adjusting to the higher rate environment with buyers and sellers throughout the country spending more time negotiating prices to achieve specific return metrics.

“We’ve been screening more deals for clients shopping for softer asset pricing,” he said. “The feasibility of an acquisition, and subsequent trade price, is increasingly dependent upon the cost of capital. That being said, debt is still more affordable than equity in most cases.”

Lenders Offering New Options

The lending landscape is adapting to the volatility by offering options that will potentially mitigate the effects of rising rates. These include more aggressive interest only options and longer amortization terms in some cases. Additionally there are lenders that allow clients to lock their interest rate at term sheet and lower or eliminate the prepayment penalty, knowing that clients will look to refinance early when rates fall.

“We have seen some multifamily lenders in our network quote 35 year amortization terms, instead of the 30 or 25 years that were typical only a few months ago,” Buttram said. “This longer term allows for stronger upfront returns and enhances the feasibility of an otherwise coverage-constrained transaction. More recently, there’s been interest shown in utilizing interest rate buy-downs, where a borrower pays a fee at closing for a lower interest rate, to counteract the effect of rising rates at the transactional level.”

Smaller non-bank and alternative lenders also are gaining market share by actively lending in the bridge, rehab, and construction space, though they continue to be priced relatively higher than rates quoted for stabilized assets.

“Within the rehab and construction space, C-Pace financing continues to gain steam as it allows an investor to finance additional expenditures at extremely competitive rates, potentially upwards of 200 basis points cheaper than conventional financing, aiming for higher sponsor returns,” Buttram said. “Our team has developed close relationships within the evolving and regionally regulated C-Pace network that we are leveraging on behalf of clients.”

Looking Forward

Though there is uncertainty and headwinds in the markets, residential rental growth rates, when adjusted for inflation, remain stable and even robust in many markets. Historically high occupancy and supply constraints within the multifamily market will continue to drive demand into the medium- and long-term. Ariel’s team continues to create value for our clients by structuring optimal solutions and providing tailored capital markets insights for potential acquisitions our clients are considering