Underwriting Assumptions Stabilize for Prime Multifamily Assets

Multifamily has been needing some good news. Now, it has it. For the first time since the Fed began raising interest rates in early 2022, underwriting assumptions for prime multifamily assets are starting to stabilize, CBRE reports. 

The average going-in cap rate increased by 23 basis points to 4.72% in the first quarter of this year, which follows increases of 39, 36 and 38 basis points in the three preceding quarters, according to CBRE.

The numbers mark the first significant quarterly decrease in cap rate expansion since the Fed initiated its latest round of rate hikes. In addition, the first quarter saw other metrics decelerate, including unlevered internal rate of return targets, exit cap rates and rent growth.

Certain cities deserve special attention. For the sixth consecutive quarter, Austin had the lowest risk requirements on an underwriting basis among 15 major multifamily markets that CBRE tracked. Furthermore, no market had improved multifamily metrics, but some had fewer changes such as Boston and Seattle. Also, all markets recorded higher going-in cap rates between the third and fourth quarters of last year, and five had no additional expansion in the first quarter of the year–more evidence of broader stability in multifamily underwriting assumptions.

Since the first quarter of last year, the average going-in cap rate has expanded by 136 bps to 4.72%. That now eclipses the pre-pandemic average by 51 bps. Further expansion is anticipated but underwriting assumptions for prime multifamily assets are likely to peak in the second half of this year. As expansion for going-in cap rates has been more dramatic than exit cap rates, the spread between them remains, albeit a slimmer margin.

Not surprisingly, underwriting assumptions of annual rent growth for the first three years of multifamily deals have declined over the last two quarters, CBRE also reported. The types of markets spurring the growth have changed. Gateway markets now have higher average rent growth expectations versus what occurred early last year. The gateway markets had suffered the most during the pandemic due to migration from some of their cities, yet some like Boston and New York have now experienced people returning. As more markets stabilize, rent growth assumptions are expected to move lower and end up near a long-run average. 

For now, multifamily investors remain cautious as a group, CBRE concludes. But the shared thinking is that once interest rates stabilize, there should be an increase in activity by three key groups–buyers, sellers and lenders.