Prime Multifamily Metrics Continue to Increase in Q4
January 18, 2024 3 Minute Read
Despite the Federal Reserve holding interest rates steady since July, unlevered internal rate of return (IRR) targets, going-in cap rates and exit cap rates for prime multifamily assets increased slightly in Q4. Across-the-board decreases are expected once the Fed begins cutting interest rates, likely by midyear.
Figure 1: Quarter-over-Quarter Change in IRR Target & Cap Rates
The average prime multifamily going-in cap rate has increased by 170 basis points (bps) to 5.06% since Q1 2022, exceeding the pre-pandemic 2018-2019 average by 85 bps. Though some additional expansion is likely, even as the Federal Reserve prepares to cut interest rates, underwriting assumptions for prime multifamily assets are likely nearing their peak.
The spread between going-in and exit cap rates fell to 11 bps in Q4—the smallest since CBRE began the survey in 2014. This positive spread likely will continue as long as economic conditions do not deteriorate significantly. The U.S. overall average exit cap rate is not expected to decrease in the near-term, so it is unlikely to fall below the going-in rate. However, on a market-by-market basis, cap rates have already inverted in Chicago (Q4 2022) and Washington, D.C. (Q3 2023), though these inversions began to reverse in Q4. Parity between cap rates is now being seen in New York, Philadelphia, Phoenix, San Francisco and Seattle.
Figure 2: Going-In & Exit Cap Rate Spreads
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 15 bps in Q4 to 5.06%, while the average exit cap rate increased by 11 bps to 5.18%. Underwriting expectations for annual asking rent growth over the next three years decreased slightly in Q4 to 2.4%.
Unlevered IRR targets rose by 18 bps in Q4 to 7.68% and reached their widest spread over going-in cap rates (262 bps) since CBRE began the survey in 2014.
Figure 3: Buyer Valuation Underwriting Assumptions for Prime Class A Multifamily Assets
For the ninth consecutive quarter, Austin had the lowest risk requirements on an underwriting basis among the 15 prime multifamily markets tracked by CBRE. Washington, D.C. moved up several spots in the ranking as the only market with improvements on all three underwriting metrics. Austin, Phoenix and Seattle were unchanged in Q4. Most other markets saw only slight underwriting deterioration, which suggests markets will continue stabilizing until the Fed begins to cut interest rates.
Eleven of the 15 markets recorded going-in cap rate increases in Q4, three of which (Boston, Dallas-Ft. Worth and Los Angeles) were by more than 25 bps. Exit cap rates were unchanged in five of the 15 markets, while Washington, D.C. saw a moderate decrease. The remaining markets had an average increase of 22 bps.
Figure 4: Buyer Valuation Underwriting Assumptions for Prime Class A Multifamily Assets by Market, Q3 2023
Note: 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 the Fed begins to cut interest rates, improved underwriting metrics should lead to increased multifamily investment activity in 2024.