How Inflation Impacts Multifamily Investments
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Key Takeaways
- Inflation results in a higher cost of goods and services, impacting business operating costs.
- The Federal Reserve raises interest rates to combat inflation, increasing borrowing costs.
- Despite higher operating and borrowing costs, multifamily investments tend to perform well during inflationary periods.
Hundreds, if not thousands, of articles have highlighted rising prices and interest rates. Inflation is making everything from gas to food more expensive. In response, the Federal Reserve is increasing interest rates to fight inflation. So far, the net result is both higher prices and higher borrowing costs, shocking the markets with high levels of volatility.
Inflation’s Impact on the Economy
Inflation describes the overall increase in the cost of goods and services. Since 1914, it averaged 3.27% annually. In 2022, the inflation rate topped 10% in June and July, reminding many of the runaway costs seen in the 1980s.
Higher than average inflation erodes purchasing power, leads to higher interest rates, and is often followed by a recession. These market conditions threaten investments as stock markets enter bear market territory.
Cost of Debt
The Federal Reserve generally responds to high inflation levels by raising interest rates, which increases borrowing costs and slows the economy. Individuals with revolving debt or variable rate loans experience higher prices almost immediately. Those seeking new debt also pay more. Businesses face elevated operating expenses and borrowing costs, which result in slowdowns and often lead to layoffs.
Property Management Expenditures Escalate
Inflation raises the cost of supplies and wages, increasing operating costs for all businesses, including apartment complexes. Prices on labor, renovations, and necessities like electricity and landscaping all go up. Properties with fixed-rate loans may not experience more significant debt costs.
Demand in the Multifamily Housing Market
Recessionary conditions negatively impact much of the economy. Yet, multifamily housing tends to be resilient because it fills a primary need. Here are three trends that buoy up multifamily investments even in recessionary times:
1) Higher loan costs often price first-time home buyers out of the market. In 2022, housing prices and interest rates continue to rise, requiring many would-be buyers to rent.
2) Growing population: The population continues to shift to urban areas creating high-growth pockets. These areas feature good-paying jobs but a shortage of housing to accommodate demand.
3) Housing shortage: Building permits for single-family homes and apartment buildings never caught up after the 2008 recession. The result is an anticipated shortage of housing units until at least 2035.
Net Impact for Investors
While multifamily investments experience elevated operating costs, landlords can pass on these expenses to tenants through higher rents. In the five largest metro areas, rents have increased an average of 13.4%, nearly 4% above the inflation rate.
Despite economic conditions, apartment complexes in growing regional markets will likely see strong demand. These two factors allow well-managed multifamily syndications to remain a low risk, despite fears of an impending recession.