Paul Russo sums it up succinctly: “Higher interest rates are killing deals.”
And who could argue? Russo, senior director of multifamily investment sales with West Bloomfield, Michigan-based Encore Real Estate Investment Services, said that higher interest rates have put most multifamily sales in his market on hold.
The big problem? There is still a disconnect between sellers and buyers when it comes to pricing, with buyers wanting lower sales prices to make up for the higher rates attached to loans today.
“The high rates are scaring a lot of buyers out of the buying pool,” Russo said. “They are sitting on the sidelines waiting for a rate drop.”
And relief? It’s not coming anytime soon, as Russo says that the days of interest rates in the 3% range are long gone.
Paul Russo, senior director of multifamily investment sales with Encore Real Estate Investment Sales.
A rise in seller financing?
Russo did say that he is seeing an increase in sellers offering to finance multifamily deals today. There’s a problem, though: Even sellers are charging interest rates at or slightly above 8%. That makes seller financing not much different from what buyers could get from regional or national lenders, Russo said.
“Everybody thinks that a seller will finance the deal for them at 6% or 5.5%,” Russo said. “That is not the case. Sellers know where interest rates are at. They are adjusting their seller financing rates in accordance with where interest rates are in today’s market.”
Russo points to a potential multifamily sale he worked on in Lansing, Michigan. The owner was entertaining seller financing offers. But he also wants to charge an interest rate near 8% and won’t budge.
Because of this, he’s held onto his multifamily asset.
“He doesn’t need to sell. He wants to sell and retire,” Russo said. “But he doesn’t want to give away the properties. And he doesn’t want to provide an interest rate of 5% or 6% when the going interest rates are higher. He’s willing to wait it out. For the buyer, though, it no longer makes sense to continue to seek seller financing. The buyer can get money from a traditional lender at that interest rate.”
Thanks to higher rates, when multifamily properties do sell, they do so after sitting on the market for longer. Russo said that in 2021 and early 2022, many apartment properties sold within three months. Now Encore needs six months at a minimum to sell most multifamily properties, he said.
“The buyer pool has shrunk because of higher rates,” Russo said. “Because of that, deals are sitting on the market longer.”
The financing struggle
Russo said that many buyers are also struggling to find banks willing to lend in today’s economic environment.
He cited one local bank in Michigan that stopped commercial real estate lending completely in 2022. That bank reentered the market this year, he said, but the criteria that the lender expects borrowers to meet are so strict – more money down, focusing mostly on avoiding risk – that it’s still nearly impossible for potential buyers to pry commercial real estate financing from it.
“Some banks do not want to put new debt on their books right now,” Russo said. “They don’t want to refinance deals, either. Again, they want debt off their books.”
Those deals that do make it across the finish line? Russo said that many of them are lower-priced transactions, in the $1 million to $2 million range. And while deals in the $5 million to $10 million range are getting done, Russo says that they are staying on the market longer, waiting for institutional buyers that have more cash available to make these transactions work.
Leasing activity remains strong
In better news, leasing activity remains strong in the multifamily sector in Michigan, Russo said.
Part of this is because of the challenges buyers are facing in the single-family housing market. Housing prices are high. So are mortgage interest rates. These financial hurdles are keeping many would-be homebuyers out of the housing market.
“First-time homebuyers are getting a straight-up shock value when they look at homes,” Russo said. “The housing market is still overpriced, in my opinion. Then buyers are getting slapped with the interest rates. Younger buyers are also dealing with student-loan debt. They can’t afford a housing payment. They can’t afford a mortgage payment that is $2,000 a month or higher. Because of that, they have to find somewhere to rent.”
Because of the housing market challenges, the demand for apartment units throughout Michigan remains high.
Russo said that demand for apartment units is even higher today than it was in 2021. This makes sense if you look at interest rates. In 2021, homebuyers could qualify for a mortgage loan at an interest rate of 3.5%. There was more incentive to buy because mortgage dollars came cheaper.
Those days are gone. And as Russo says, those 3.5% mortgage interest rates – or lower – probably aren’t coming back.
“I think the correction in interest rates has happened,” Russo said. “I didn’t think we’d see rates near 8%. But I think things are going to normalize. I think rates will eventually come down. I don’t have a crystal ball, but I do think we will see some improvement. I just don’t think we’ll see rates as low as they were in 2021 again.”
Russo says that creativity is the key for getting deals done today. For instance, multifamily owners might have carports on their property. They might consider charging renters for using them each month, a way to create a new income stream during challenging economic times.
“The only way to get deals done today is to think outside the box,” Russo said. “That’s how you get deals across the finish line today.”
And those owners who are willing to get creative? They can still survive in today’s multifamily market, Russo said. That’s because the multifamily sector, despite the challenges it faces, remains one of the strongest commercial asset classes.
“I still think that multifamily is one of the best places for investors to park their money right now,” Russo said. “At the end of the day, there always needs to be housing for someone. That is why I think that apartments are almost bulletproof for investors.”