Chicago’s once-red-hot multifamily investment market has chilled a few degrees amid higher interest rates, rising inflation and more big investors sitting on the sidelines to see how it all plays out.

But there are still deals to be had, money at the ready, and fundamentals like a gaping housing shortage that had panelists at Bisnow’s Multifamily Annual Conference in Chicago confident any lull in the action will be temporary.

“I think there’s sort of the pig-going-through-the-python [situation] here that we’re going to eventually digest,” National Equity Fund President and CEO Matt Reilein said at the Oct. 6 event, held at Loews Chicago Hotel. “I do think we will move into smoother territory, probably the end of ’23 and into ’24.”

Tenant demand for apartments turned negative in the third quarter after several quarters of strong rent growth, the first time it has done so in three decades, according to RealPage Inc., which clocked 82,000 units returned to the market across the U.S. for the quarter.

That hasn’t completely spooked investors, though it is giving them some pause.

While the spigot is still flowing, albeit less forcefully, KeyBank Senior Vice President Todd Linehan said many are awaiting more tempered inflation numbers, a better understanding of how high the Federal Reserve might go in raising rates, and more capital markets activity on the investment sales side to gauge what’s happening with real transactions.

In the short term, that has increased multifamily cap rates nationally and led to a slowdown in deals, Linehan said.

“It’s a challenging, challenging market,” he said. “You just can’t solve for a 300-basis-point increase, roughly, or 250 over 12 months.”

McCaffery Interests Director of Investments Brian Munin said the pace of the volatility has been the biggest pain point, one that has already killed a few deals he was working on.

“There was just brutal timing where the 10-year [Treasury yield] would bounce 25 basis points in the course of a few days,” Munin said. “And we’re seeing that this week as well.”

McCaffery Interests’ Brian Munin, National Equity Fund’s Matt Reilein, KeyBank’s Todd Linehan, West Loop Community Organization’s Damone Richardson, Ryan’s Greg Salter, and CliftonLarsonAllen’s Jim Milliken

Yet there is still optimism capital won’t rest for long — not least due to a major supply-demand imbalance that has resulted in a national housing crisis. There are approximately 6.8 million fewer housing units than needed due to underproduction and the loss of existing units, according to a national estimate prepared by Rosen Consulting Group for the National Association of Realtors.

Multifamily also remains a favored asset class among banks and life insurers and is supported by government-sponsored enterprises like Fannie Mae and Freddie Mac. And multifamily is in a unique position of easily adapting to an inflationary environment, thanks to constantly evolving rents and leasing that can move with the market, Linehan said.

“Certainly, we’re seeing it seems to be a smaller world, the acquisition market has slowed down as buyers and sellers need to feel out what the proper level is based off new interest rates,” Linehan said. “But transactions are still occurring, and we’re still fairly active, just maybe off of the crazy high of this time last year.”

“Deals can still pencil,” Munin said, adding rising rates would weed out deals that shouldn’t have happened in the first place “and put some more focus on really good deals, the ones that should be funded.”

P3 Markets’ Phillip Beckham III, Project Management Advisors’ Jeffrey Zogby, Skender’s Joe Pecoraro, JDL’s James Letchinger, Oak Park Economic Development’s John Lynch, Luxury Living Chicago Realty’s Aaron Galvin, and Thomas Roszak Architecture’s Thomas Roszak

Conditions are changing how deals are put together.

Munin said his firm is building in extra time to assess the market and lock in rates during the due diligence period of negotiations. McCaffery Interests is also seeing the return of land contributions, “sellers wanting to stay in the deal with us and contribute and be a partner for the long term versus just selling to get out.”

That is happening in the affordable housing space as well, Reilein said, as localities kick in land or soft dollars to get projects built. More deals are making use of American Rescue Plan funding, which can now be directed to affordable multifamily developments as a result of legislative and regulatory changes this year.

“And I’m not advocating for this necessarily … but looking at short-term versus long-term rates, look at hedging specific to the interest rate risk on your portfolio and/or new projects — not looking just at individual projects, looking at your global debt position,” Reilein said. “Given the volatility, there are a lot of opportunities out there, and we’re seeing a number of our larger developers start to have those conversations where they haven’t had to literally in 15 years.”

Affordable Housing Investment Brokerage’s Kyle Shoemaker, Preservation of Affordable Housing’s Kathleen Day, DL3 Realty’s Tania Kadakia, and Red Stone Equity Partners’ Cat Vielma

West Loop Community Organization President Damone Richardson said developers need to be more flexible in how projects are financed going forward, taking note that those who took on floating rates are likely in for short-term pain

“I’m seeing folks look to alternative sources for funding,” Richardson said. “People are trying to access [property assessed clean energy] funds to help offset some of those costs in lieu of, say, mezzanine financing. Nobody knows what’s really going to happen next. So I think that there are sources, but right now, we are in kind of a wait-and-see mode.”

Ryan Cos. Vice President of Capital Markets Greg Salter said many national banks have explicitly told him they are out of the market on making construction loans until next year. But super-regional banks like Linehan’s KeyBank are very much open for business.

Large national banks are requiring 9% debt yields that bring leverage on construction loans into the high 50% to 60% range, he said.

33 Realty’s Mary Gibala, McCaffery Interests’ Kimberly Williams, Magellan Development’s Renee Wersching, Greystar’s Colleen Darken, Daniel Management Group’s Roger Daniel, and Xfinity Communities’ Javier Jugo

“One of the great things actually about the regional banks is they’ll make policy exceptions and go sort of around the credit committee and, if they believe in the deal, get you up to 65%,” Salter said. “So the debt is still there, it’s just tougher underwriting and lower leverage.”

Linehan said things get murkier for deals that involve three or four banks, but the market is robust for projects in the $20M to $40M range and involves a single bank lender.

“There’s no rosy investment opportunity in this rising interest rate environment, so multifamily continues to be a strong investment opportunity,” Linehan said. “It just might not match the yields of the past 10 years.”