Rising Cost of Debt Plays Outsized Role in Housing Market

The rising cost of debt topped LaSalle Mid-Year Update’s list of biggest impacts on commercial real estate for the second half of 2022.

“High-leverage buyers no longer dominate bidding and set prices,” LaSalle wrote. “Home buyers may tilt to renting as home buying gets even less affordable.”

The home-buying market has been in a bit of turmoil lately, with volatile mortgage rates and fluctuating home prices during the summer stirring the pot.

Kelly Mangold, AIA LEED AP BD+C Principal RCLCO, tells GlobeSt.com that rising interest rates have cooled down the competition for homes resulting in fewer bidding wars as the combination of high mortgage rates and high home prices make the for-sale market less affordable for many.

“Because of rapidly changing conditions, many households may be taking a ‘wait-and-see’ approach and choosing to rent in the near term, though some others may be even more motivated to buy before rates rise further,” Mangold said.

“For those who have the means, this may be a good time to buy because of the lack of competition. One sector that is likely to benefit from rising mortgage rates is the single-family build-for-rent sector, which has increasingly become institutionalized over the past several years, because many people who are seeking a home may choose this as an attractive option to rent for a year or two while waiting for conditions to improve.”

Drugs, Alcohol, and Leverage

Erin Sykes, real estate advisor, chief economist, LEED AP, Nest Seekers International, reminds of a quote from Berkshire Hathaway’s Charlie Munger, “Three things ruin people; drugs, alcohol, and leverage.”

Sykes added that rising mortgage rates have increased the monthly payment on the median home by more than 55% in 2022 as the Fed attempts to cool an overheated housing market. 

“With stocks and bonds both down double-digits year to date, consumer balance sheets have taken a hit, thus even those using equity lines of credit have less bandwidth to make cash purchases,” Sykes said. “That being said, with an average 30-year mortgage hovering at 5.5% and prices beginning to fall, it still makes more sense to buy than rent in most markets.”

Jon Spelke, managing director of LFB Ventures in El Segundo, tells GlobeSt.com, “As interest rates stabilize, asset pricing will adjust to the new financing norm creating opportunity for home buyers who have been priced out of the market. 

“Given the overall supply slash demand in balance of roughly 4 million housing units, there will continue to be strong demand for both for sale and rental housing.”

Monthly Mortgage Payments up 17%

Michael Busenhart, vice president, real estate at Archer, tells GlobeSt.com that the current median price for a home in the US for Q2 2022 is $440,300. At 20% down, that translates to a $352,240 mortgage that costs $1,872/month at today’s average 30-year fixed rate of 4.91% before any taxes and insurance payments. 

“That same mortgage cost $1,581 in January 2022 when average mortgage rates were 3.56%,” Busenhart said. “That is a 17% increase in monthly mortgage payments on top of the 4% increase in median home values from Q4 2021.”

The average rental rate for a two-bedroom apartment per rent.com is currently $2,048,” he said.

“With median home prices increasing a total of 36% compared to Q2 2020 and mortgage rates increasing 17% in the past six months, this has put a lot of pressure on homebuyers to come up with increased funds for a down payment as well as a higher monthly mortgage payment,” according to Busenhart. “As a result, we expect to see more would-be home buyers stay in the rental market due to the monthly mortgage payments inclusive of insurance and taxes outpacing monthly rental rates.”

Downward Pressure on Multifamily Assets

He said that on the flip side, “we are also seeing some downward pressure on the pricing of multifamily assets. While rising rents have led to increased NOI, we are also seeing that the rising interest rates for acquisitions are leading to lower loan to values at purchase (requiring more up-front equity) and decreased property values to get to the same returns.”

One example, he shared, is a Core-Plus deal in Atlanta with an NOI of $3.08mm. In October 2021 an investor seeking an 11% IRR over 5 years at 2.7% would have been willing to pay $76.8mm. That same investor today will pay $71.1mm at a 4.83% interest rate to get the same return. That is $5.7mm loss in value over a 10-month period solely based on rising interest rates. 

“To adjust for this change in value, an owner might decide to hold on to the asset and forego a sale, and instead focus on ways to increase the NOI at the property.”