The Interest Rate Balancing Act: Keeping Multifamily Syndications Afloat

by Elliot Derhay

Over the last 15 months, the federal reserve has raised interest rates with unprecedented speed. Never has the cost of getting and paying a mortgage, and since I make my living as a general partner in multifamily syndications, the fed’s actions have dramatically impacted my business. Thankfully my partners and I do have safeguards in place to protect investors, but that certainly doesn’t mean that we haven’t been impacted by the fed’s actions.

Understanding the relationship between interest rates and multifamily syndications is crucial for syndicators and investors alike, as it can determine the success or failure of a project. In this article, we will explore how interest rates impact multifamily syndications, (and basically all real estate), and strategies for navigating these fluctuations.

At a very high-level interest rates primarily affect two key areas: financing and cash flow.

Relative to finance interest rates directly impact the cost of financing a multifamily property. When interest rates are low, borrowing costs are lower, making it more affordable for syndicators to acquire properties and fund renovations. Conversely, when interest rates rise, borrowing costs increase, which can put pressure on the syndication’s returns and overall profitability. Since I have very strict requirements for my projects, those challenges have led me from executing 6 to 8 syndications annually, to only one project in 2023.

Interest rates also can dramatically affect the cash flow of multifamily syndications. As borrowing costs increase, syndicators may need to charge higher rents to cover expenses and maintain profitability, and that often leads to occupancy challenges. Since we’ve had ridiculous inflation at the same time, as these interest rate hikes it results in watching every penny of the budget. Because outside management companies have been overcharging for many of their services, we are beginning to self-manage most of our assets. Many of my colleagues have started management subsidiaries for their properties as well.

And obviously the most challenging aspect of the environment that we are in is the rising cost of debt service. We purchased rate caps for all our properties which limits the amount of interest rate increases. Most importantly, we underwrote the properties so that they can still achieve our plan at that cap rate. Additionally, all our properties have significant equity at this juncture. However, when those rate caps expire, we will need to sell, refinance, or extend those caps, all of which cost money. To prepare for those expenses, almost all good syndicators including us, have suspended distributions to investors for the time being. Over the last 10 years we have enjoyed very little interruption in overall income and with that, investor distributions. Even though it’s not fun, history has demonstrated multiple times that if the property income can stay positive, if expenses can be managed while still executing the business plan, that those distributions accrue, and we will all be very glad that we hung in there during a tough couple of years.

In the short term, we continue to stay in daily contact with our lenders. They are very willing to work with us on loan terms, as well as share their knowledge and experience with navigating markets like this. We are constantly getting BOV’s (broker’s opinion of value), from our broker partners, making sure that our equity is growing and keeping our fingers on the pulse of our markets. We try to keep in close contact with our investors and share the problems, the solutions, and the wins. After all, we are investors too.

In conclusion, interest rates are a critical factor in the success of multifamily syndications, and the best operators employ strategies to navigate, and most of all, stay ahead of, market fluctuations. The chaos in the market is unlike anything I’ve seen, but we are staying the course and are confident that this too will pass, and we will be better and stronger for it.

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