Multifamily properties continue to see high demand. Financing new apartment construction or acquisitions, though, has become challenging with rising interest rates.

The uncertainty is the problem. That’s what makes financing commercial real estate acquisitions and construction loans so difficult today. Just ask Fritz Waldvogel, senior vice president in the Minneapolis office of Colliers Mortgage. He says that there is still plenty of interest among investors and developers in commercial real estate. The challenge is making the numbers work, with the uncertainty over rising interest rates scuttling many potential deals.

We recently spoke with Waldvogel about the state of the commercial financing industry. This industry veteran said that financing deals is no easy task today. But the future? He’s optimistic that the second half of 2023 will see an influx of new financing requests.

Here’s some of what Waldvogel had to say:

Has the volume of commercial financing requests slowed because of rising interest rates?
Fritz Waldvogel: Even with the volatility of the last 12 months, there has been a lot of quoting activity. But deals aren’t coming together as quickly as they once were. The deals that are happening are mostly loan assumptions. We aren’t seeing as many new placements. The 10-year Treasury has been all over the board, up and down. It’s challenging to feel good about financing until you have a deal that is rate-locked.

How difficult has the uncertainty over rates been for the financing industry?
Waldvogel: It’s hard to feel good about the debt markets. The agencies, Fannie and Freddie, are still open for business. But there is a big gap between where current pricing is based on sellers’ expectations and what buyers can afford to pay. We are not seeing as many transactions closing on the sales side.

What kind of financing deals are you still seeing today?
Waldvogel: We work on a lot of multifamily transactions. There are new deals in this space, but a higher percentage of them are loan assumptions. The debt is already outstanding. A new buyer can come in and assume an existing note. In those cases, the buyers don’t have to worry about the volatility of the debt markets. If you are looking at a 10-year term loan that was closed two years ago, there are still eight years remaining. The interest rate on that might be in the threes. That’s a very attractive rate today.

There is definitely some sticker shock today when we are quoting rates to people. When we started quoting deals in the 6% to 7% range, people’s jaws almost dropped to the floor.

I guess that begs the question, have we been spoiled a bit by how low interest rates have been?
Waldvogel: We have had a good run of super low interest rates. That meant a lot of transaction activity. But now, you don’t have as many deals that can be refinanced. We did a lot of refinances in 2020 and 2021. There just aren’t as many deals today that make sense for a refinance.

What about next year? Do you think we’ll see a bit more stability in 2023?
Waldvogel: I think there will continue to be volatility in the market next year. But at some point, people will start transacting again if the interest rates have settled down in some way. We need a tighter band of interest rate fluctuations so that people feel better closing deals. As you get into next year, more debt sources should come back. The life insurance companies and bridge lenders that are currently not in the market should be coming back next year. When we have more alternatives to the agencies, developers and investors will have more options.

How have interest rates impacted the demand for construction loans?
Waldvogel: I spoke with a developer last week who said that developers were facing a two-headed monster. They have higher interest rates that impact getting deals financed but also construction costs that are still fairly high. The combination of those two has put a lot of deals on the sidelines. If interest rates come down a little next year and construction costs come down, we’ll start to see more of those deals. But there has been quite a bit of supply that was planned for the next six to 12 months that is not moving forward.

We are seeing the same thing on the multifamily side. Rent growth has been really strong over the last six or seven years. What we need now is to get rents down. To do that, we need more supply. But because of higher interest rates and construction costs, we are not seeing that new supply.

Do you still see great demand from renters for multifamily space?
Waldvogel: The fundamentals of the multifamily market are still strong. You are seeing solid occupancy in the Midwest and solid rent growth. The volatility that is making life challenging is more because of capital markets issues than any fundamentals in the apartment market.

Why has demand for multifamily remained so high for so long?
Waldvogel: I’ve been in the business about 10 years on the lending side. Rents just continue to go up. We need more housing in this country. And with rates going up, that has made single-family housing less affordable. That pushes people to rent longer. The single-family rental space has become a hot asset class. That space should continue to perform well during the next five years. Millennials and members of Generation Z want a house and a yard. But they can’t afford to buy a house. Renting a single-family home is a good solution. You feel more settled down than you do when you are living in an apartment. You have a yard and more space, but you still are renting. Over the last two or three years, we’ve been seeing more capital flowing into that space. The higher interest rates have only pushed that demand higher. The demographics were already there. The higher rates just make that market even more appealing.

What do you look at when determining if a financing request is a solid one?
Waldvogel: We focus heavily on the property’s financial performance and take into account the borrowers’ overall experience. We look at both. You have to make sure that the financial performance is strong, but you also need an understanding of who your borrower is. The borrowers’ experience level plays a role, too.

A lot of buyers have moved into the multifamily space during the last seven or 10 years. They came from other asset classes as demand for multifamily just kept rising.

You mentioned earlier that the country is still seeing a shortage of housing. Is that changing at all?
Waldvogel: On a macro level, the country is severely under-housed. That’s especially true with affordable housing or even market-rate housing. It is very challenging to keep up with the demand that is out there for housing. To get more, we need local governments and the private sector to work together to make deals happen. We need new housing desperately.

Looking into the future, what do you see in the financing market for next year?
Waldvogel: I am still bullish that 2023 will see activity pick up, especially in the second or third quarter. I think 2023 will be better than 2022 in terms of the number of requests that ultimately get done.