August 2024 Multifamily Cap Rate Report
Multifamily Cap Rates Predicted to Remain Flat
According to CBRE, multifamily cap rates on A class properties expanded slowly from 4.63% in 2023 to 5.07 during the first quarter of 2024 and then remained flat in the second quarter of 2024 due to the large number of new A class properties entering the market. C class apartment buildings have had some cap rate expansion from 5.64% during the first quarter of 2024 to 5.76% during the second quarter. With rental increases this year averaging only 2.2%, and vacancy rates and concessions trending upward, plus a remaining 440,000 new apartment units coming online this year, it is unlikely that cap rates will expand further in 2024 as stated by Freddie Mac. A remaining 460,000 new units are expected to be completed in 2025 along with a further lowering of interest rates which is expected to keep cap rates from compressing much during the first two quarters. Declining net operating incomes due to rental growth being lower than inflation and increasing expenses for insurance, taxes and maintenance are compounding this direction by keeping net operating incomes low further holding multifamily prices flat.
Here is some good news for investors. Inventories were still very low during the first quarter of 2024, but now are improving as more sellers need to sell combined with a small decline in interest rates. Most experts agree that supply and demand in the marketplace is the greatest influence on property values and this is still the case today. As more properties are listed for sale, prices should come down a bit. It has been the slight increase in inventory that is likely responsible for a small amount of cap rate expansion on B and C class multifamily properties during the second quarter.
Although the economy has been outperforming expectations with inflation dropping below 3%, along with an increase in job growth and wages, interest rates still being on the high side are still keeping many properties on the market longer than average. This is likely the number one reason that I am predicting cap rates to remain flat through the third quarter of 2024.
Fannie Mae states that “much of the growth in multifamily property values over the past two decades has stemmed from price appreciation, rather than from net operating income increasing.” This trend is slowing with cap rates expanding due to net operating incomes declining in 2023 and the first quarter of 2024. This has been the result of increased operating expense, especially insurance, taxes and the cost of labor for maintenance. This is currently being exacerbated by flat rental growth. For a decade through 2021, with the exception of the short covid recession in 2020, rental increases have more than offset inflation on operating expenses. Rental increase in 2021 hit a record high of 13.5% which along with interest rates in the low 3% range allowed multifamily real estate prices to soar. With the Fed’s announcing last month a likely rate cut during their September 16-17 meeting, more properties should qualify for financing.
Why You Should Invest with a Long Term Hold Strategy Today
In summary, investing with a long-term hold strategy seems prudent today. With an abundance of new units coming on the market, rental increases being at a decade low, and vacancy, concessions and expenses on the rise, it is unlikely net incomes will improve much during the remainder of 2024 and going into 2025. You will need to make many low ball offers to land a deal that gives you a decent return on your investment and don’t plan on raising rents much in the near future unless they are considerably under market. Therefore, consider a 6 – 7 year hold period. It also would make sense to not lock a rate for more than three years with a prepayment penalty of not more than 2 years since rates will still be historically high through 2024. This will give you the opportunity to refinance when rates come down significantly in the future.
May 2024 Multifamily Cap Rate Report
Multifamily Cap Rates are Expanding
The good news for investors is that although inventories were still low during the first quarter of 2024, multifamily cap rates expanded 33 bps to an average of 5.40% which is a dramatic increase over the 44 bps expansion for the entire prior year according to CBRE. Multifamily cap rates expanded more slowly in 2023 from 4.63% to 5.07%. Declining net operating income, due to increases in operating expenses and flat rent increases, has been responsible for the decline in multifamily property values for both years.
According to CBRE, the main contributing factor has been the oversupply of 440,000 new apartment units in 2024 which is the largest in decades. This has been slowing down rent growth dramatically. This is compounded by over 900,000 units that are currently under construction. With vacancy and concessions on the rise in A and B class properties, multifamily cap rates are expected to continue to expand through the remainder of 2024.
Fannie Mae states that “much of the growth in multifamily property values over the past two decades has stemmed from price appreciation, rather than from net operating income increasing.” This trend is slowing with cap rates expanding due to net operating incomes declining in 2023 and the first quarter of 2024. This has been the result of increased operating expense, especially insurance, taxes and the cost of labor for maintenance. This has been exacerbated by flat rental growth. For a decade through 2021, with the exception of the short covid recession in 2020, rental increases have more than offset inflation on operating expenses. Rental increase in 2021 hit a record high of 13.5% which along with interest rates in the low 3% range allowed multifamily real estate prices to soar. Fannie Mae is predicting rents to only increase 1.5% in 2024, which is problematic since it is well below inflation.
Why You Should Invest with a Long-Term Hold Strategy Today
In summary, investing with a long-term hold strategy seems prudent today. Where shorter hold periods of 4–5 years worked well through 2021, it is advisable to buy with a 6-7 year hold period. Even with cap rates expanding, Return on investment (ROI) is at an historical low due to multifamily sales prices still being high due to ten years of historical low interest rates which ended in March of 2022. Therefore, this is a time of caution for investors who could be buying at the top of the market with high sales prices based on the low interest rates of yesterday. This is not a time to buy a property based on the hopes of raising rents in a year. It might take many years to raise rents enough to raise your ROI where it needs to be. My best advice is to wait until cap rates rise another 70 bps to invest. And be sure to make your offer based on the current actual net operating income and not pro forma.
October 2023 Multifamily Cap Rate Report
By Terry Painter/Mortgage Banker, Author of The Encyclopedia of Commercial Real Estate Advice, member of The Forbes Business Council
Multifamily Cap Rates are Expanding
The good news for apartment building investors is that multifamily cap rates have gone up slowly from the third quarter of 2022 to the third quarter of 2023 expanding 44 bps, from 4.63% to 5.07% according to CBRE. This has effectively lowered the average sales price on a $1 million property over the year by 8.8% or $88,000. As multifamily investors are welcoming lower sales prices, they are being hammered by rising interest rates that lower returns on their investment to unacceptable levels. Most of my borrowers are faced with having to negotiate a lower sales price or canceling the purchase after I size their loan and tell them they have to put 50% down. A year ago, this would have been 44%. At the beginning of 2022 our average multifamily borrower had to put about 35% down.
Multifamily Sales Volume and Loan Volume are Down
Multifamily sales volume and loan volume are at historical low levels. Cap rates need to rise a good deal more and interest rates need to come down before the commercial real estate market can recover. Rising interest rates that peaked at just under 8.00% at the end of October have collided with high multifamily prices further slowing down both purchases and loan originations. According to MSCI Real Capital Analytics, sales volume reached $89.6 billion through the first three quarters of 2023, which was considerably down from the $251.9 billion recorded during the same period of 2022. According to the Mortgage Bankers Association, multifamily loan originations were down by 49% from the previous year at the end of the third quarter 2023. As a commercial mortgage banker, our multifamily loan volume is down by over 70% this year.
Demand for Apartment Rentals is High
Multifamily cap rate expansion is being slowed by the high demand for multifamily rentals. High mortgage rates have pushed many would be home buyers into the rental market. According to Redfin, a home buyer now has to earn $114,627 annually to afford the medium priced home at $420,000. This puts their monthly payments 27% higher than rent on the average apartment. According to Cushman and Wakefield, demand for apartments for the third quarter 2023 was 89,280 units which was an 11% increase over the prior quarter but six times above last year’s third quarter increase of 13,000 units. This is also a result of economic strength in jobs and low unemployment.
Rent Growth is Down and Vacancy and Concessions are Up
High vacancy and slow rent growth are two metrics that historically have increased cap rates. This trend should create more cap rate expansion over the next year. According to Cushman and Wakefield, vacancy rates nationally have gone up over the past year from 6.5% to 7.8%. According to Fannie Mae, Annual rent growth through October of 2023 has decreased to 2.6% due to over 400,000 new units flooding the market out of the 730,000 new units expected to come on line in 2023. This is very low rental growth if you compare it with combined rental increase of close to 20% for 2021 and 2022. Most of the new supply of units were in high amenity A class complexes. This has effectively kept A class rental rates flat with high concessions. Rental concessions over all classes increased from 5.2% to 9.00% from a year ago. The average rental concession is one month free on a 12-month lease.
Should you Wait for Cap Rates to Go Higher to Purchase?
In my opinion, although cap rates have gone up, they are still unrealistically low when combined with today’s high mortgage rates, making investing risky. Ideally, commercial property values should increase based on rental growth, and not because low interest rates which bottomed out at 2.96% in December of 2021 made it possible. Sound economics just do not support today’s cap rates based on what investors need to earn. The average cash on cash return with 50% down is hovering around 4.20% after loan payments. Many of my clients have told me they can earn 5.25% investing in CDs. Why should they buy rental property today with those numbers? And sure, many sellers and their real estate brokers will try to sell you in the operating memorandum that rents are under market. But are they with rental increases calming down? My advice is to wait until sometime in 2024 with the hope that interest rates will come down a lot along with sales prices. Hope that this additional time is not friendly to sellers who have to sell. Over the past 26 years doing this job, I have made many loans on properties that came up for sale at lower prices due to loan maturity, economic hardship, divorce or death.
Sources
CBRE: https://www.cbre.com/insights/briefs/higher-rates-push-up-prime-multifamily-cap-rates-in-q3
Fannie Mae: https://www.fanniemae.com/media/49331/display
Cushman and Wakefiled: https://cw-gbl-gws-prod.azureedge.net/-/media/cw/marketbeat-pdfs/2023/q3/us-reports/multifamily/us_multifamily_marketbeat_q3-2023.pdf?rev=951e0cd95c77403cbc6c67609f5e17b8
MSCI: https://www.msci.com/research-and-insights
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