May 2025 Multifamily Cap Rate Report
May 15, 2025
Multifamily Cap Rates Slightly Compressed in Q1 2025
According to Freddie Mac, first quartet 2025 Multifamily Cap rates compressed by 7 basis points (BPS). CBRE is reporting a 6 bps compression during the first quarter. The majority of this compression occurred in C class and value add properties. The return on investment for value-add assets declined as the price per door increased. This has made this asset class more difficult to finance. Class A and B multifamily properties have had a small expansion of 5 bps during this period. This is largely due to the large number of new Class A properties entering the market. These properties have stabilized with vacancies at 9% largely due to rental concessions.
Market Inventory of Properties for Sale has Increased
Buyer and seller sentiment across all asset classes improved during the first quarter which has increased buyer demand. There was a 12% increase in properties listed for sale which improved this metric according to Freddie Mac. This has happened as interest rates declined slightly, only to rise again. Purchases remain low as investors wait for the implications from the Trump administration’s changes in policy. This has been compounded with the Fed holding the federal funds rate steady and interest rates remaining high.
Q3 to Q4 2024 Cap Rates Expanded
The recent market compression although small has been welcomed by sellers. This has been a welcome change from the second half of 2024. From Q3 to Q4 of 2024 multifamily cap rates expanded an average of 15 bps on A and B Class properties, going from 4.90% to 5.05%. They also expanded an average of 14 bps on Value-Add properties, going from 5.24% to 5.38% during this period. C Class properties stayed flat during this period.
Slight Cap Rate Compression Predicted for Q2 and Q3 2025
Experts agree that supply and demand in the marketplace has the greatest influence on multifamily property sales prices. Although sellers have slightly lowered prices recently, Net Operating Incomes have declined which has compressed cap rates. This tug of war will keep multifamily cap rates from compressing much further in Q2 and Q3.
Current prices just do not pencil for most investors who are not willing to pay yesterday’s high prices with today’s high interest rates. After obtaining a 65% loan, most buyers today are left with less than a 4% cash on cash return.
Rent Growth Has Flattened
According to Fannie Mae, rent on multifamily properties increased by only 2.4% in 2024. Yardi Matrix reported rents in Life Style A and B Class properties down year over year in Q1 2025 and predicts a slight increase during Q2 and Q3.
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 has been slowing since 2022 due to net operating income declining during the last two years. This has been the result of increased operating expenses, primarily insurance, taxes and the cost of labor for maintenance.
Why You Should Invest with a Long-Term Hold Strategy Today
Investing with a long-term hold strategy seems prudent today. With an abundance of new units still coming on the market, rental increases being flat, and vacancy, concessions and expenses on the rise, it is unlikely net operating incomes will improve much during the remainder of 2025. You will need to make many low ball offers to land a deal that gives you a decent return on your investment. Most importantly, don’t plan on raising rents much in the near future unless you can land a property with considerably under market rents. Therefore, consider a 6 – 7 year hold period. With interest rates still high, it would also make sense to not lock a rate for more than three years with a prepayment penalty of not more than 2 years. This advice is based on the prediction that rates will stay relatively high throughout 2025 unless there is a recession.
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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