Elevated Interest Rates Pose Long-Term Risk to Apartments

A prolonged period of elevated interest rates –– compounded by rising operational costs –– continues to impact rental housing providers nationwide. Beyond myriad effects on day-to-day industry operations, rising rates also pose a long-term risk to the future of apartment availability and affordability.

At its recent meeting in March, the Federal Reserve kept rates unchanged, leaving short-term rates at a 23-year high since last July. While the Fed still anticipates rate cuts later in 2024, Chair Jerome Powell continues to express caution in their approach.

“We’re in a situation where if we ease too much or too soon, we could see inflation come back,” said Chair Powell in March. “If we ease too late, we could do unnecessary harm to employment.” With optimism for a rate cut early this year gone, the potential longer-term impacts are starting to dominate industry conversations as providers continue to grapple with skyrocketing operational expenses while awaiting the Fed’s next decision point this summer. Many owners and operators are navigating these specific economic hurdles –– and more widespread distress in the market –– for the first time.

Here are a few of the most pressing challenges facing the rental housing industry as we enter the second quarter of 2024.

Variable Rate Loans

Top-of-mind for many throughout rental housing are the impacts on variable rate loans, many of which have reset. While these loans undoubtedly offer benefits –– especially when rates fall –– the current environment is resulting in drastic changes amid elevated rates. As rates remain elevated, the potential impacts are only compounding and reaching larger segments of the industry.

Even in this challenging environment buying and selling is occurring, though at a fraction of what it was before. A resurgence in sales is expected as we get further into the year, especially as we begin to get a clearer picture of the economy’s direction.

Financing

Financing and refinancing remain a concern as increased borrowing costs can make refinancing difficult for some owners. New developments in particular struggle to secure financing at favorable rates, and with the pressure of higher rates, operators at large are urged to carefully analyze their finances and consider refinancing strategies to weather the storm.

Alarmingly, as new properties with lower rents –– and, more specifically, rent concessions –– enter the market, we’re seeing lenders conducting stricter “stress tests” to assess the risks associated with new loans. This can lead to them questioning the feasibility of proposed rent prices, which further impacts project viability. The good news is that the summer leasing season is on the horizon, which promises to bring some resiliency in pricing to markets that are not over-supplied.

Debt

A significant portion of multifamily debt, approximately $1 trillion, is set to mature within the next four years, raising concerns about potential defaults and losses by 2028. Specific areas of concern include newer construction –– much of which is Class A –– as well as markets that recently experienced rapid growth post-pandemic, such as Boise, Phoenix and Austin. The balance to this is that the pause on new development we are currently seeing will make for a more competitive market in 2025 and 2026.

Operating Expenses

While nothing new, the impact of skyrocketing insurance premiums –– especially in areas prone to natural disasters –– has resulted in increased cost volatility and greater uncertainty in the development space. This trend is largely expected to persist, in large part due to ongoing environmental concerns. Older properties are likely to face the brunt of the impact, with trouble securing affordable insurance without significant upgrades.

Research from the National Leased Housing Association conducted last summer found that a whopping 29% of housing providers saw premium increases of 25% or more for their 2022-2023 policy renewals. Even more, a staggering 93% of respondents said they would take action to mitigate cost increases.

Additionally, while they have certainly eased over the past year, it’s worth noting that the impacts of inflation –– which upticked slightly at the start of the year but has since eased –– and enduring labor shortages continue to exert pressure on essential operating costs.

Construction and Development

While we saw apartment supply and deliveries remain at record highs in 2023, expected growth in construction is likely to be delayed, with activity already showing signs of slowing down. Building permits are declining, with some projects even facing cancellations or delays due to higher interest rates.

As for new apartment developments, a significant shift is underway. For the first time in over a decade, low-rent suburbs are witnessing more new construction than high-rent suburbs. Additionally, high-rent suburbs and urban cores have seen a decline in their share of new construction compared to historical averages. We saw this trend, which started in 2021, continue into the latter half of 2023, with nearly half of the new units being built in low-rent suburbs.

In an environment where more housing of all types and price points is desperately needed, a prolonged period of elevated rates only exacerbates the problem at hand. To meet demand, account for a current rental housing shortage and address affordability challenges, the U.S. needs to build a staggering 4.3 million new apartments by 2035. The current environment and factors at play, namely increased rates, make this goal that much harder to achieve.

Hope for the Future

There is no doubt that the challenges facing the industry today are serious; such a drastic increase in operating costs –– fueled with increased regulation at every level of government –– jeopardizes the long-term viability of our housing ecosystem, including affordability.

There is still, however, plenty of room for optimism for commercial real estate’s bright spot. For one, economists express hope that if owners and operators can weather the current headwinds, a more steady growth should return in 2025 and 2026. Further, demand should remain steady, especially with high mortgage rates that keep renting significantly more affordable than buying.

Finally, rate cuts –– if they come as expected in the next few months –– will provide some much-needed optimism for the future and help facilitate a stronger 2025 and beyond.

Bob Pinnegar is President and CEO of the National Apartment Association

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