Shrinking housing inventory, low interest rates, higher building costs driving compression in cap rates for this property sector  

Surging rental rates, dwindling inventory of single-family homes and apartments, low-interest rates, higher construction costs and brisk demand for housing nationwide are driving the multifamily sector’s stellar performance during the pandemic.

While other commercial property types like retail and hospitality recover from the pandemic’s economic impact, demand for multifamily housing has accelerated during the outbreak and is poised to show further gains. Only the industrial sector has fared as well since the pandemic struck this country more than a year and a half ago.

As a result of favorable forecasts for multifamily, investors have been shifting more capital into this property sector. Multifamily has attracted investors because of its low default rate on loans compared to other commercial properties, the growing need for housing, and its ability to thrive in an unprecedented health crisis that hasn’t been kind to other property types.

Some industry experts predict that multifamily property values will remain on the upswing for at least the next year or two, provided it doesn’t encounter headwinds that could dampen demand.

Over the past year, there has been a significant compression of capitalization rates for the multifamily market, posting a drop of between 50 basis points and 75 basis points nationwide. This is good news for investors, as a reduction in cap rates means higher values for properties which, in turn, can deliver robust returns on their investment.  

A striking example of how cap rates have compressed and multifamily values have shot up in recent months is the recent sale of a new Class A multifamily building in a mid-sized Southeastern city. The property recently traded at a cap rate of 4.75 or between 50 basis points 75 basis points lower than where the rate was hovering in early 2021, one of the worst periods for the COVID-19 virus in this country.

These rapid changes make it more challenging to accurately appraise multifamily properties. In this example, the appraiser had to look outside of the local market for representative comps because there were no comparable new Class A buildings in this market. Instead, it was effective to use new Class A properties in similar neighborhoods nearby for a more accurate comparison.      

Compressed cap rates for the multifamily sector is most pronounced in high-growth regions like the Southeast and Southwest, which are at or near record-breaking levels. Cap rates also have dropped in virtually all markets nationally. 

Multifamily Property Rental Rates Soaring

There are a number of factors fueling investor interest in multifamily assets. Like single-family home sales, multifamily rental rates have soared across the country in the pandemic era. Rental rates posted year-over-year double-digit gains in the top 30 markets, according to a recent report released by real estate data and research firm Yardi Matrix.  As of June, year-over-year rent growth was a 6.3 percent, above figures posted nationally before the onset of the pandemic. 

Multifamily rental rates could climb higher if building costs continue their upward trend, resulting in fewer available multifamily units to satisfy growing housing demand. Over the past year, the price of lumber and other construction materials has risen significantly due to pandemic-induced supply chain shortages. A shrinking construction workforce and escalating land prices also have contributed to higher construction costs.

Historically low interest rates and strong market liquidity also have bolstered demand to invest in the multifamily market. Inflation concerns could prompt the Fed to raise interest rates. But analysts following the central bank’s activities predict an uptick in U.S. interest rates isn’t likely to occur until late 2022 or early 2023, if at all.       

Throughout the pandemic, increased demand for multifamily has become quite a challenge for appraisers, especially in smaller markets. This is due a lack of current data available in a particular market that can be used to support the property’s value. And in some cases, like the one in the Southeastern city mentioned earlier, no comparable sales existed in the local market to support the valuation.

BBG’s significant valuation experience and, seasoned multifamily team, national presence and cutting-edge technology has allowed the firm to overcome such challenges in providing accurate and supported appraisals for the multifamily market. Let BBG’s highly trained professionals provide an objective, timely and supported analysis of your property’s valuation today.