Grunge surface
Bjarne Henning Kvaale Grunge surface

“How low can it go?”

That was the question on everybody’s minds for most of 2010, as interest rates reached historic lows. Cap rates for Class A apartments compressed in concert as investors jumped off the sidelines and threw down the gauntlet.

Meanwhile, the limbo stick just kept dropping. Behind the dip, of course, was the spiraling 10-year Treasury, which started the year at 3.85 percent, but wiggled down to 2.4 percent in October, which meant borrowers were locking in 10-year rates with the agencies in the low-4 percent range—a level unheard of, even in the heyday.

As a result, the acquisition activity came rolling in at year’s end in a flurry: Consider that Freddie Mac closed $3.6 billion in multifamily loans through the first six months of the year, but by the fourth quarter, it was closing $2 billion per month.

“At some point, people will look back and say, ‘We’ll never see those rates again,’” says Mike May, who leads the multifamily division of McLean, Va.-based Freddie Mac.

Unfortunately, the gathering momentum may only be temporary. In less than a month, interest rates shot up nearly 60 basis points (bps). The 10-year Treasury went past 3 percent again in early December, sending all-in rates past 5 percent and throwing a cloud over transaction velocity and cap rate compression as the apartment industry headed into 2011.

“We all knew rates would rise. The question has always been: When?” says Don King, head of agency production for Boston-based CWCapital. “When there’s a dramatic upward movement in rates, you will get a fairly dramatic slowdown in transactions. And it’s particularly painful while the market is changing.”

Despite the rise in rates, experts say underwriting will be more borrower-friendly in 2011, thanks in large part to the return of competition from life insurance companies, mortgage REITs, banks, alternative lenders, even bridge and mezz financiers. And the simultaneous decline in the dominance of Fannie Mae, Freddie Mac, and the Federal Housing Administration will only shift the pendulum of power between lenders and borrowers even further.