Multifamily Underwriting Assumptions Are Up Over Pre-Pandemic Times

Underwriting has gotten tougher in multifamily, according to a new analysis from CBRE — at least for prime assets. That probably isn’t a shock to many in the industry. Interest rates are up, as are concerns about property owners who purchased and set strategies when rates were very low and available leverage high.

What once could be rationalized by the ongoing rise of expected multifamily net operating income no longer can be. Rents are clearly decelerating and no one knows where the bottom will be. In the last quarter of 2022, the net percentage of domestic banks tightening standards for multifamily CRE loans was 36.4 percent, according to data from the Federal Reserve. They had been climbing all last year and absent some sudden turnaround, that percentage will keep climbing.

“The average multifamily going-in cap rate increased by 38 basis points (bps) to 4.49% in Q4 2022, exceeding the pre-pandemic Q4 2019 average of 4.16%,” wrote CBRE. “Heightened market volatility and higher borrowing costs have pushed the cap rate up by 113 bps over the past nine months.”

Those are averages but there are some significant differences by market. “Markets where multifamily cap rates increased rapidly in the second half of 2022 in response to rising interest rates are expected to see no additional increases early this year,” the firm wrote. “However, markets with more measured cap rate expansion last year are expected to see notable increases in Q1 2023.”

The annual average rent growth for the first three years in underwriting dropped 0.7% in the third quarter of 2022 and another 0.5% in the final quarter. The going-in cap rate was up 36 basis points in Q3 and another 38 in Q4. Exit cap rates were up 21 and 22 basis points respectively in Q3 and Q4, returning to pre-pandemic rates, while the holding period dropped by 2.3% in Q3 but grew 4.7% in Q4. And the spread between going-in and exit cap rates dropped first by 15 and then 16 basis points.

“CBRE’s Q4 2022 Prime Multifamily Underwriting Survey found that investors are projecting 3.1% annual rent growth over the next three years, down from a 3.6% forecast in Q3 but equal to the level of the 2014 to 2019 period,” the firm wrote. “Investors are slightly more optimistic about rent growth in gateway markets (3.25%) than non-gateways (2.97%).”