Buying assets in a rising interest rate environment
As interest rates are creeping up and if you are borrowing at 5% interest, how do you make money purchasing a 4/5 cap property? Is it by hoping that rent growth increases and cap rates start to rise? Essentially the market decreasing purchase prices of these assets?
What is your or your company’s strategy of buying property in this type of environment to hedge yourselves? Waiting for the next downturn?
Buying a 4 cap in New York City and borrowing at 5% interest seems like you are relying too much on appreciation... we’ve seen what happened with that.
I think enough capital is out there to sustain low cap rates. Secondly, interest rates rise to curb inflation. So if interest rates are rising it's because rent growth/appreciation is also increasing which should act as some sort of hedge.
you dont buy stabilized 4 caps, or have some plan on how to make it better. doubt new floors will do this
with 10 years at 3%, do you think the higher risk of real estate is worth a 100bps spread (assuming a 4 cap?
completely dependent on your goals. As an opportunistic investment seeking returns that are beating the market, obviously no. If you're a russian billionaire on the run and looking to save your cash, maybe.
delete
I mean the easy answer is that you have some kind of value-add strategy which will turn the 4 cap into a 6 cap and you take advantage of the spread.
The other answer would be that you're a fund with a ton of loose cash and it makes more sense t deploy in a low-leverage situation just to put capital out the door.
Interest rates are creeping up and cap rates haven't quite adjusted yet. Every seller out there says "all my friends sold their multifamily deal on a 4.25, so can I!" and people are paying up for it because that's all that's out there.
Give it 6, 9, 12 months for pricing expectations to correct before dipping your toes back in.
Agreed. Cap rates don't move in exact harmony with interest rates, but over the long term they must trend together; it's a mathematical certainty caused by the law of supply and demand. If the cap rate doesn't work then you don't buy--once enough buyers realize that the sales prices are too high to reflect the risk then prices will start to reflect the buyer sentiment.
I'd be curious to hear how people are approaching debt in this environment, are you using more fixed to try and lock in now or taking advantage of the spreads on the floating? Probably depends a little on the asset specific strategy but would still be curious. Also does rising rate environment make CMBS more attractive?
I think everyone is missing the point entirely - coming from an econ background I don't see interests rates having a real effect other than the following. Cap rates have bottomed out - anyone in the industry has known this for a while. Global capital allocation demand is high, this won't subside if you're in a major/growing market. Asset managers will only pay attention to this in terms of cash out refi's, most of which hedges downside risk on the fund level so they don't give a shit.
Valuations are just multiples of NOI, so therefore there is still a ton of money to be made in depreciation and reductions in OpEx, let alone rental rate increases and the new tax write offs of CapEx. Combine all of that and then remember that markets are regional so there will always be opportunity as long as the demand keeps pace.
Interest rates always impact real estate. They are a part of a basket of things that absolutely do impact real estate values and/or real estate strategies.
Global demand for real estate remains high, yes, but rising U.S. interest rates will weaken the buying power of foreigner investors (assuming the USD rises in relation to the investor's domestic currency), which means they will likely be willing to pay less. Of course, nothing happens in a vacuum and markets are local, but over time the law of supply and demand is immutable and prices must reflect the underlying economics; when they don't it's called an asset bubble.
Nothing you've said is refutable and I obviously agree. I guess my tone was exaggeratory, but I don't think there is as much need for worry as there is hype. I used to be the king of that nonsense and have sense realized to deal with what is, and not what might be. This has served me in a far greater manner in this industry.
Find a way to buy at a discount to replacement cost. Have to stay disciplined in a market like this
you have a valid point. As interest rates rise and cost of debt increases, you're going to see downward pressure on market demand for properties that can trade at a 4/5 cap (assuming that a 4 cap is going to be class A or in a primary market). Generally speaking, institutional partners go into alternatives (RE) to diversify from equities, which is typically the primary driver for achieving the required rate of return of said institutional investors. That said, assets that trade at a 4/5 cap are going to provide some cushion during the downturn for these large institutional investors, but not necessarily be the primary driver of returns.
From personal experience, the only class A properties I see getting absolutely massive returns are industrial properties. And half the time it's unsolicited offers where our levered returns hit +20%. kind of nutty.
if you have any other questions, feel free to pm.
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