Cap Rates for Prime Multifamily Assets Stabilize in Q2

Both going-in and exit cap rates for prime multifamily assets were little changed in Q2, leading to a record-low spread between the two, according to the latest CBRE Prime Multifamily Underwriting Survey. This pause in cap rate expansion mirrors the Fed pausing interest rate increases in June. Since the Fed is expected to raise the federal funds rate by a quarter-point later this month, multifamily cap rates likely will see some additional modest expansion. However, we expect that cap rates will expand more slowly than interest rates will rise, meaning that cap rates are very near their peak.

Figure 1: Historical Summary of Buyer Valuation Underwriting Survey for Prime Class A Multifamily Assets

Source: CBRE Research, Q2 2023.
Note: Survey was not conducted for six quarters throughout the COVID-19 pandemic due to lack of trendable market activity and price discovery. Data in the above table is from the 10 most recent surveys.

After increasing between 20 and 40 basis points (bps) in each of the past three quarters, the average prime multifamily going-in cap rate increased by only 1 bp in Q2 to 4.73%. Exit cap rates fell by 5 bps. Underwriting expectations for annual asking rent growth over the next three years remained unchanged in Q2 at 2.90%.

Unlevered internal rate of return (IRR) targets showed slower expansion, increasing by just 23 bps in Q2 to 7.22% and creating the widest spread between going-in cap rates (249 bps) since the survey began in 2014.

Figure 2: Buyer Valuation Underwriting Survey for Prime Class A Multifamily Assets Ranked by IRR Target & Cap Rate

Source: CBRE Research, Q2 2023.
Note: The statistics are estimates of current buyer underwriting assumptions for the highest quality asset in the best location of a particular market. The quoted prime rents reflect the level at which top-tier relevant transactions are being completed. Estimates are based on the expert opinion of local CBRE investment professionals.

Source: CBRE Research, Q2 2023. Note: The statistics are estimates of current buyer underwriting assumptions for the highest quality asset in the best location of a particular market. The quoted prime rents reflect the level at which top-tier relevant transactions are being completed. Estimates are based on the expert opinion of local CBRE investment professionals.

Four of the 15 markets (Atlanta, Chicago, Philadelphia and Seattle) recorded additional going-in cap rate expansion in Q2, while two markets (Boston and Dallas-Ft. Worth) saw going-in cap rate compression for the first time in seven quarters. The remaining nine markets had no change. Exit cap rates were unchanged in 11 of the 15 markets and lower in Boston, Dallas-Ft. Worth and Miami. Only New York had slightly higher exit cap rates.

Figure 3: Historical Comparison of Going-In & Exit Cap Rates

Source: CBRE Research, Q2 2023.
Note: Survey was not conducted for six quarters throughout the COVID-19 pandemic due to lack of trendable market activity and price discovery.

Since Q1 2022, the average prime multifamily going-in cap rate has increased by 137 bps to 4.73%, eclipsing the pre-pandemic (2018 – 2019) average by 52 bps. Though further expansion could occur after an expected Fed rate hike this month, underwriting assumptions for prime multifamily assets will likely peak in Q3. Even as exit cap rates have seen a slight pull back, the spread between going-in and exit cap rates is a slim 21 bps and appears to be stabilizing. Average exit cap rates are not expected to compress significantly in the near-term, so it is unlikely that an inversion occurs between the two. However, markets such as Chicago, New York, Philadelphia and Phoenix are either experiencing an inversion or parity between cap rates.

Figure 4: Average Annual Rent Growth Underwriting for Next Three Years

Source: CBRE Research, Q2 2023.

Underwriting assumptions for prime multifamily annual rent growth for the next three years did not change in Q2 after several quarters of deceleration. Although gateway markets have a slightly better average rent growth outlook, secondary markets are picking up the pace and could surpass gateways later this year. The long-run average for rent growth assumptions is approximately 3.1%, slightly higher than the 2.9% expected as of Q2 2023. As markets stabilize, rent growth assumptions likely will drift higher and eventually settle near the long-run average.

Multifamily investors remain cautious in the current environment, though many markets are seeing little additional fundamentals degradation. Once interest rates stabilize, there should be an increase in activity by buyers, sellers and lenders.

Note: The quarterly results from the CBRE Prime Multifamily Underwriting Survey are estimates of current buyer underwriting assumptions for the highest quality assets in the best location in 15 markets throughout the nation. Estimates are based on the expert opinion of CBRE investment professionals in these markets.