March 8, 2023
By Terry Painter/Mortgage Banker, Author of “The Encyclopedia of Commercial Real Estate Advice” Wiley Publishers
With home sales falling for the last 11 months of 2022, according to Yahoo Finance, prices continue to drop during the first two months of 2023. But even more dramatic evidence of home value declines is KB Homes having 68% of its orders for new homes canceled during the last quarter of 2022 according to Fortune Magazine, Does this mean that Multifamily Apartment Building prices are dropping too? You might think so, but this is like comparing apples with tangerines. Why? Because the prices of homes is based on supply and demand plus mortgage rates, and multifamily prices are based on what an investor needs to earn based on the property’s net operating income and the size of the loan that the NOI qualifies for with current mortgage rates.
But there is evidence that apartment building prices are coming down. According to Co-Star, multifamily prices went down slowly by 1.5% during the last quarter of 2022, with the average multifamily cap rate going up by 38 basis points to 4.49% in the last quarter of 2022 according to CBRE, which means prices are starting to come down.
Demand for multifamily properties was very high for the first half of 2022 forcing prices to record highs. But with mortgage rates soaring this put a damper on both supply and demand and today they are both at a record low which is keeping prices high. In fact, they haven’t both been this low since 2009 as the economy was starting to recover from the great recession. Why? Because buyers are afraid they are buying at the top of the market and are not willing to pay those prices, and sellers, knowing this is not a good time to sell with rates being so high are mostly not listing their properties. Makes much more sense for sellers to wait until rates come down again. I expect that multifamily prices to come down in 2023. Here are 5 reasons why:
5 Reasons Why Apartment Building Prices Will be Going Down
1. Rents are Flat — Fannie Mae in their 2023 Multifamily Outlook Report expect rents to only go up 1.5% in 2023, with rental concessions and vacancies to go up. The number one tenet of commercial property valuation is: For Values to Go Up, Rents Have to Go Up. This is because the value in the income approach of a commercial appraisal is based on the property’s net operating income. When rents increase this goes right to the bottom line increasing the NOI.
2. There are Going to be Too Many Units for Rent — According to Fannie Mae, there was a negative -103,485 units left unrented at the end of 2022. This combined with the 783,000 New Units that are coming on line in 2023, will create an overabundance of apartment units on the market which should continue to keep rents flat and raise vacancy and concessions. An example of a rental concession is signing a year lease in exchange of getting half off your second month’s rent.
3. Demand is Slowing — Again, according to Fannie Mae, Investors Purchased 70% Fewer Multifamily Properties in the last quarter of 2022. This is proof that demand has slowed dramatically. Why? Because investors just couldn’t make the numbers work at such high prices combined with those insanely high interest rates.
4. Inflation is Still High — Too many renters are already paying more than they can afford with inflation still at 6.4% – especially with rents having gone up over 20% in the last two years. Wages have certainly gone up too, but not enough to keep up with inflation and those already high rents.
5. Mortgage Rates Are Going to Stay High — As mentioned, low mortgage rates was what made it possible for apartment building prices to get so high in the first place. This is simply because investors were able to qualify for a much larger loan. But until the Feds achieve their goal of bringing inflation down to 2%, they are likely going to keep raising short term rates which trickle up to long term rates. Come on now, how much is an investor willing to put down on a loan? It used to be 20 – 25%. Now they have to put more like 45 – 50% down and are then insulted with less than a 4% return on their investment. This is simply not sustainable.
My advice is to wait to buy an apartment building. Keep checking prices for multifamily properties on LoopNet weekly. Be sure to determine the property’s actual cap rate based on actual income and expenses. When cap rates go up by at least 75 – 100 bps, this will be a good time to buy. You can go with a 50 bp increase in cap rate if rents are well below market. You will likely have to wait until the last quarter of 2023 to achieve the best results. That’s because it takes time for commercial property appraisals to reflect a current drop in prices, as they will need more sales comparables at lower prices to accomplish this. The silver lining is that as time goes on there are always property owners that have to sell – usually because of the owners finding a great value on a replacement property, partners needing to split up, divorce or death.
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