Prime Multifamily Underwriting Reacts to Market Volatility

After reaching their lowest levels in Q1 2022 since CBRE’s Prime Multifamily Underwriting Survey debuted in 2014, average underwritten cap rates for prime multifamily assets increased by 39 basis points (bps) to 3.76% in Q2 due to rising interest rates.

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

Source: CBRE Research, Q2 2022.
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 eight most recent surveys.

Most other underwriting metrics also saw a reversal of trend from Q1 to Q2. Underwriters are forecasting 4.3% average annual rent growth over the next three years. While this was down slightly from 4.5% in Q1, it remained well above the three-year annual rent growth expectations of just 1.8% in our 2020 survey. Average exit cap rates increased by 30 bps in Q2 to 4.43%, while internal rate of return targets increased by 25 bps to 6.04%. While exit cap rates increased in Q2, they were still below pre-pandemic averages. Average asking rent was the only metric to improve in Q2, up by 4.3% to a record $4.43 per sq. ft. Austin, Chicago and New York contributed the most to Q2 rent growth.

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

Source: CBRE Research, Q2 2022.
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.

All markets surveyed had average going-in cap rates above 3.0% in Q2. Previously, Austin, Dallas, Houston, Phoenix and Seattle had cap rates at or below 3.0%. Dallas (+88 bps) and Seattle (+75 bps) had the biggest cap rate increases in Q2. Exit cap rate increases were more subdued for most other markets, typically between 25 and 50 bps.

Figure 3: Historical Mid/High-Rise Sales Volume

Source: CBRE Research, Real Capital Analytics, Q2 2022.

Even with more conservative underwriting, Q2 investment volume in mid/high-rise assets (encompassing prime and other Class A properties) increased by 42% year-over-year. Mid/high-rise assets accounted for 34.4% of total U.S. multifamily investment volume over the past four quarters—in line with historical averages. The balance was in garden-style assets, which increased by 30.8% year-over-year.

Multifamily investors have recently become more selective in their acquisitions amid ongoing market volatility, increased debt costs and global economic uncertainty. While bid/ask price gaps for multifamily assets are deal-by-deal specific, sellers generally recognize there are significant embedded gains over the past few years that enable them to offer modest discounts.