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UNIONDALE, NY—Like so many quarterly analyses and reports coming out of Q1, Arbor Realty Trust's Q1 Small Multifamily Investment Trends report provides a significant but only partial look into how this sector has fared since the novel coronavirus entered the US and proceeded to upend the economy. The report, produced in conjunction with Chandan Economics, indubitably shows that the multifamily sector is experiencing a significant amount of pain with liquidity, risk tolerance and uncertainty affecting these landlords.

Yet at the same time incoming data also suggests that the sector is performing better than the worst-case scenario forecasts.

For starters, small multifamily prices, as measured by the Arbor Small Multifamily Price Index, slowed in the first quarter of 2020. According to initial estimates, while small multifamily prices are up 5.5% from one year ago, they receded by 0.9% from the fourth quarter of 2019.

On a year-over-year basis, valuations have increased for 37 consecutive quarters, dating back to mid-2010. "Whether valuations have merely hit a pause or there is an impending period of contraction remains to be seen," the report says.

Falling benchmark interest rates and agency support should provide some positive pricing momentum and insulate asset valuations from an extended slowdown, all else equal.

National average cap rates for small multifamily properties widened by 8 basis points in the first quarter of 2020, reaching 5.8%.

The most recent reading, in all likelihood, reflects a point of inflection, the report said. "Through February, both real estate and the economy generally were still improving on a year-over-year basis. It wasn't until early to mid-March that COVID-19 had started to upend all aspects of normal business operations."

In times of uncertainty, investors demand more yield to hold risk. As a result, cap rates may see further upward pressure in the coming months across all real property sectors, the report predicted.

"The extent to which small multifamily will see more or less pain than the broad real estate average will depend on several evolving factors — none more important than the dependability of in-place cash flows."

Another datapoint of interest: The cap rate spread between small multifamily and the rest of the sector fell to 44 bps through the first quarter of 2020, the lowest reading since mid-2016. While small multifamily cap rates rose through the first three months of the year, they did not rise as much as the rest of the sector, causing the spread to narrow.

In the months ahead, the small multifamily sector's resilience should come into greater focus as more performance data becomes available, the Arbor report concluded. "As the country gets back to work, end of the month rent bills should become less of an anxiety inducing topic, and multifamily should be one of the first areas of real estate to see cash flows return close to normal."

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