Higher Rates Push Up Prime Multifamily Cap Rates in Q3

Both going-in and exit cap rates for prime multifamily assets increased slightly in Q3 after the Federal Reserve’s 25-basis-point interest rate hike in July and the steady rise in the 10-year Treasury rate during the quarter. Although we expect that cap rates likely are near their peak, they could increase slightly into early 2024 if rates continue to rise.

Figure 1: Quarter-over-Quarter Change in Interest & Cap Rates

Source: CBRE Research, Q3 2023.

The average prime multifamily going-in cap rate has increased by 155 basis points (bps) to 4.92% since Q1 2022, exceeding the pre-pandemic 2018-2019 average by 70 bps. Though some additional expansion is likely, particularly if the Fed raises rates again in November or long-term rates continue to climb, underwriting assumptions for prime multifamily assets are likely nearing their peak.

The spread between going-in and exit cap rates fell to 15 bps at the end of Q3—the smallest spread since CBRE began a quarterly survey of its investment professionals in 2014. This spread likely will remain positive provided that economic conditions do not deteriorate significantly. Average exit cap rates are not expected to decrease in the near-term, so it is unlikely that they will invert on a national basis. However, an inversion or parity between cap rates has occurred in some markets, such as Chicago, New York, Phoenix, Seattle and Washington, D.C.

Figure 2: Historical Comparison of Going-In & Exit Cap Rates

Source: CBRE Research, Q3 2023.
Note: Survey was not conducted for six quarters throughout the COVID-19 pandemic due to lack of trendable market activity and price discovery.

After holding steady in Q2, the average prime multifamily going-in cap rate increased by 19 bps in Q3 to 4.92%, while the average exit cap rate increased by 12 bps to 5.07%. Underwriting expectations for annual asking rent growth over the next three years decreased slightly in Q3 to 2.6%.

Unlevered internal rate of return (IRR) targets rose by 29 bps in Q3 to 7.51% and reached their widest spread over going-in cap rates (259 bps) since CBRE began the survey in 2014.

Figure 3: Historical Summary of Buyer Valuation Underwriting Assumptions for Prime Class A Multifamily Assets

Source: CBRE Research, Q3 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.

For the eighth consecutive quarter, Austin had the lowest risk requirements on an underwriting basis among the 15 prime multifamily markets tracked by CBRE. Although risk metrics did not improve in any market during the quarter, they were unchanged in Houston, Los Angeles and New York. Most other markets saw only slight underwriting deterioration, which suggests markets will continue stabilizing once the Fed has ended the current rate-hiking cycle.

Ten of the 15 markets recorded going-in cap rate expansion in Q3, four of which (Atlanta, Chicago, Dallas-Ft. Worth and Miami) by less than 25 bps. Exit cap rates were unchanged in six of the 15 markets, while two (Dallas-Ft. Worth and Washington, D.C.) saw slight decreases. The remaining markets had an average increase of 29 bps.

Figure 4: Buyer Valuation Underwriting Assumptions for Prime Class A Multifamily Assets by Market, Q3 2023

Source: CBRE Research, Q3 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.

Once interest rates stabilize, an improvement in underwriting metrics should lead to increased multifamily investment activity in 2024.