Loan rates increasing means Fewer Multifamily Transactions
Pricing Uncertainty and the implications for Cap Rates
First American Title’s senior commercial real estate economist, Xander Snyder, wrote in the Economic Insights blog how the restricted number of comparable deals, as a result of decreased multifamily transaction volumes, affects multifamily cap rates. Multifamily Q4 2022 transaction volume had the lowest fourth-quarter dollar volume, and number of buildings sold, since fourth-quarter 2014. Fewer transactions imply fewer comparable sold properties (comps), and fewer comps imply increased pricing uncertainty for both buyers and sellers.
The Multifamily Potential Cap Rate (PCR) model contributes to quarterly variations in the multifamily PCR. In the fourth quarter, the PCR was 4.5 percent, 0.2 percentage points lower than the actual multifamily cap rate of 4.7 percent. The most noticeable adjustment in recent quarters has been a slowing in multifamily transaction volume, which is pushing the PCR upwards rather than being the dominant downward mover during the pandemic-era boom.
This pricing disparity between buyers and sellers (I call it the emotional gap) will keep transaction volumes low and cap rates high until there is greater market pricing agreement. As more "motivated" acquisitions occur, there will be more comparable transactions with which to evaluate property valuations, reducing pricing uncertainty and leading to a more liquid market. Cap rates will most certainly continue to rise until then. - Xander Snyder
Gap in Multifamily Cap Rate
The difference between the real multifamily cap rate and the multifamily PCR indicates the possibility of changes in the actual cap rate.
The actual national multifamily cap rate was 0.2 percentage points higher than the potential cap rate in the fourth quarter of 2022, indicating that both the actual and potential multifamily cap rates appear to have bottomed out in 2022 and are now climbing.
Model for All-Asset PCR in the Fourth Quarter of 2022: The All-Asset PCR Model from First American calculates a prospective national cap rate for all asset classes based on several CRE market variables such as rental revenue, current occupancy rates, interest rates, the quantity of commercial mortgage debt in the economy, and recent property price patterns.
·The potential cap rate (PCR) model for multifamily properties is based on the historical relationship between multifamily transaction volume, annual changes in renter household formation, and multifamily mortgage flows. It is updated quarterly and aggregated nationally. Cap rates are a measure of the projected yield, or return, on an investment property, provided no financing is utilized.
The all-asset PCR was 5.0 percent in the fourth quarter of 2022, a 0.4 percentage point rise from the third quarter.
Denver Market Analysis
In analyzing the Denver MSA, I looked at class B, C and D properties with 10-100 units. The primary change we have seen is length of time to sell and price per unit increasing.
I. 2021
a. Cap Rate – 5.3%
b. Sale Price/Unit- $228,822
c. Average units – 31
d. Average months to sale – 4.4
II. 2022
a. Cap Rate – 4.6%
b. Sale Price/Unit- $220,530
c. Average units – 32
d. Average months to sale – 4.2
III. October 2022-February 20, 2023
a. Cap Rate – 4.8%
b. Sale Price/Unit- $237,748
c. Average units – 29
d. Average months to sale – 5.3