The Federal Reserve lowered rates for the second time in a row after their November meeting.
No doubt, this raises all sorts of questions by investors (and plenty of activity on Wall Street).
For those interested in investing in real estate, the number one question is: what does this mean? While only time can truly tell what will happen, we do have the benefit of established historical patterns to follow. While we cannot guarantee what will happen in the coming months, we have enough information to make an educated guess.
In this article, we’ll examine how Fed rates impact multifamily real estate and what might follow this recent rate cut.
Key Takeaways
If you just want the highlights, here are the key takeaways:
- The Fed lowered its benchmark by 25 basis points at the November meeting—following its first rate cut of 50 basis points in September—bringing the target federal funds range to 4.50% – 4.75%.
- While no one can say for certain, it is expected that the Fed will remain on a gradual path of bringing rates back toward neutral. New economic data (inflation, unemployment, jobs, etc.) could influence the timing of rate cuts in the coming year.
- Multifamily investors have many opportunities in a lower-rate environment, such as refinancing and portfolio expansion options.
Why Fed Rates Matter
Beyond impacting the outlook of Wall Street, Fed rates matter for a number of reasons – specifically, they impact multifamily real estate in the following ways:
- Cost of debt: The Fed rate directly influences the cost of borrowing for real estate investments. This affects both immediate acquisition loans and future refinancing opportunities. Even a 0.5% change in interest rates can significantly impact monthly debt service payments and, ultimately, cash flow to investors.
- Property valuations: Fed rates influence cap rates, which have an inverse relationship with property values (more on this later). When rates decrease, values typically increase, and vice versa.
- Competition for deals: Lower rates tend to drive more capital into real estate as investors search for yield, increasing competition for quality multifamily properties. This increased competition can make it harder to find good deals that meet return requirements, potentially forcing investors to either accept lower returns or take on more risk to achieve their target returns.
- Refinancing opportunities: The Fed rate environment heavily influences refinancing opportunities, which are often a key part of the business plan in multifamily investments. A lower rate environment might present opportunities to pull out equity through a cash-out refinance or reduce debt service payments, while a higher rate environment might force owners to hold properties longer than planned or accept lower proceeds from a refinance.
- Alternative investment comparisons: Fed rates affect returns across all asset classes, making some investments more or less attractive compared to multifamily real estate. When rates are very low, the relatively stable cash flows from multifamily properties become more attractive compared to bonds or savings accounts, but when rates rise significantly, safer investments like Treasury bonds might offer competitive returns with less risk and complexity.
You’re probably getting a sense of how lower Fed rates could ripple out into the market for multifamily real estate. Next, we’ll show you three key ways real estate investments could be impacted by the latest rate reduction.
How Lower Fed Rates Impact Real Multifamily Estate
Now let’s review three key ways that lower Fed rates impact multifamily real estate:
- Borrowing costs go down
- Demand and property values increase
- Cap rates compress
Borrowing Costs go Down
The purpose of Fed rate increases is to raise the cost of borrowing money. The goal of this is to reduce the money supply to tame inflation. This was the case from 2022 where inflation averaged 8% before finally dropping in 2023-2024 after the Fed increased rates.
While the Fed remains cautious about the future of inflation (especially as a few cost drivers remain stubborn), they have been willing to lower the cost of borrowing money slightly, giving people and companies access to more capital.
This leads to an increase in funds across the economy, from builders to buyers. In a period of high rates, many may put off purchasing a home in hopes of securing a better rate in the future. Now that rates are on their way down, this spurs a backlog of demand, which brings us to the next factor.
Demand and Property Values Increase
As illustrated above, high borrowing costs lead to a decrease in demand. That is because fewer people have an appetite to borrow funds during periods of higher interest rates.
However, when borrowing costs go down this opens the door for more to borrow and take on loans, which leads to an increase in demand for real estate and large projects. If you remember from your Economics 101 class, the supply and demand curve move in opposite directions. When demand increases, the demand curve shifts to the right, which results in an increase in prices.
The graphic is an oversimplification; however, the point still stands: increased demand will drive prices up, assuming supply does not change. This is why the Federal Reserve treads carefully with rate cuts, as they don’t want to spur inflation again after bringing it down.
Cap Rates Compress
As we mentioned earlier, reductions in interest rates tend to put downward pressure on cap rates.
This is because investors are willing to accept lower yields when their cost of capital decreases, as they target relative returns compared to other investment options. The spread between cap rates and the risk-free rate (typically measured against Treasury yields) tends to remain relatively constant, pulling cap rates down alongside falling interest rates.
It's important to note that cap rates don't move in perfect correlation with Fed rates. They are influenced by many factors, including local market conditions, property quality and location, supply and demand dynamics, economic growth expectations, and the risk premiums that investors require.
The downward pressure on cap rates in a lower interest rate environment creates a mixed scenario for syndication investors.
Lower cap rates mean higher purchase prices relative to the property's net operating income (NOI). For example, a property generating $500,000 in NOI at a 5% cap rate would cost $10 million, while the same property at a 4% cap rate would cost $12.5 million. This means investors need to contribute more equity for the same amount of cash flow.
The lower interest rates that typically accompany cap rate compression also mean lower debt service costs, which can help maintain cash-on-cash returns despite the higher purchase price. Additionally, syndicators often focus on value-add opportunities where they can grow NOI through renovations and improved management. This NOI growth can offset the impact of lower cap rates on overall returns.
Does This Mean It’s a Good Time to Invest in Multifamily Real Estate?
If you’re scratching your head wondering if now is the time to invest in multifamily real estate or if you should wait, this is a personal decision you need to make based on your investment goals and risk tolerance.
No one can predict the future or say that 2025 is the best year to invest in one asset over another. However, we can say that there are ways to strategically invest in multifamily that can put you in an advantageous position.
Things like:
- Selecting a growing market
- Investing in the right asset class and making targeted improvements
- Investing with a firm that has experience and a strong management team
While no one can predict the future, the above are factors you can control. It was not long ago that we wrote that now is a great time to invest in multifamily real estate, and we stand by that assessment.
Are You Looking to Invest in Multifamily Real Estate? Download Our Free Investor Guide
No one can control what the Federal Reserve does (and certainly not the impact of their actions).
But you can control when and how you invest.
If you’re looking to invest in multifamily real estate but are not sure where to start, we recommend downloading our free multifamily investing guide. We wrote it to show you the ins and outs of investing in multifamily real estate. Fill out the form below to get your free guide. In it, you’ll learn:
- The tax benefits of investing in multifamily real estate
- How to choose a firm
- The best markets to invest in
And more!
