Despite Belt-Tightening, Fed’s Rate-Raising Medicine Is Starting to Work

Berdon Accountants and Advisors LLP, in partnership with Commerical Observer, commissioned a market sentiment survey in August 2022 to garner multifamily investor views on the state of the market. Jonathan Scalzitti, partner in Berdon’s Audit Department, discussed the economy, inflation and the white paper survey’s findings with Andrew Miller and Gavin Evans, founders and co-heads of investments at Skylight Real Estate Partners.

Scalzitti started off by noting that the Federal Reserve recently increased rates half a percent to its highest level in 15 years.

“The Fed seems hyper-focused on curbing inflation, and hopefully have not flipped the scales on us into a recession,” Scalzitti said. “Along with the increased interest rates, inflation remains at a 40-year high. And with the combination of these two, it seems like many of us could be tightening our belts in 2023 and beyond.”

But that’s not to say the panelists saw no cause for optimism.

“I think it’s pretty obvious that the Fed’s medicine is starting to work,” Evans said. “We think there will be a belt-tightening for most of next year. But I think we’re already starting to feel some [positive] signs. Obviously, there’s been a number of layoffs that have been either announced or implemented, and that will make its way through the system. I’m not sure how long it will take to find the bottom. But things will be tricky and difficult for the first half of this year.”

Scalzitti noted that, in the August white paper survey commissioned by Berdon and Commercial Observer, respondents anticipated a sharp upward trend in the cost of debt capital. Evans noted that when the market is “finding its bottom” as it is now, transaction volume goes “off the cliff.”

“After 2007, you saw transaction volumes in our markets, including multifamily, go down something like 40 or 50 percent for each of two years, so it sort of went down to down 90 percent over two years. That’s because sellers are not so quick to let go.”

He also said that it helps to think about real estate as a leveraged asset class.

“When people think values are down 15, 20 percent right now, and let’s say a property was 65 or 70 percent leveraged, the equity loss relative to a year or two years ago is more than half,” Evans said. “So people are loathe to let go and cut bait, particularly if they have good financing that was originated long ago.”

Bringing the discussion deeper into multifamily, Scalzitti then asked his guests their take on the top headwinds confronting multifamily investors heading into 2023.

Miller cited that fact that debt is outpacing cap rates.

“As Gavin said, it’s a leverage business,” Miller said. “From where we sit, there’s a massive disconnect between the buyers and sellers right now. The other big headwind is that when all of this is happening, the Fed is raising rates to cut inflation, which is grounding rental growth. So the 10 percent rental growth projections that people were making in the Southeast are not there anymore. That’s precisely why these rate hikes are happening. Our rents are actually holding pretty nicely. We’re not seeing rents come down, but we’re not really seeing rents grow.”