Fed Stays Steady but Multifamily Cap Rates Keep Climbing
But CBRE expects things to start unwinding when the Federal Reserve cuts interest rates.
There’s a lot of anticipation about the Federal Reserve potentially lowering interest rates. Markets have been pricing in more 2024 reductions than seem likely to occur.
But according to CBRE, multifamily markets haven’t jumped on a second coming of Alan Greenspan’s “irrational exuberance.” Instead, their “unlevered internal rate of return (IRR) targets, going-in cap rates and exit cap rates for prime multifamily assets increased slightly in Q4. Across-the-board decreases are expected once the Fed begins cutting interest rates, likely by midyear.”
Assuming, of course, that inflation doesn’t continue the upward bounce that December saw and that conditions continue to give the Fed reasons to keep thinking rate reductions.
Increases have largely been going on since the second quarter of 2022. The going-in cap rate in multifamily is up 170 basis points to 5.06% since then. That’s over the pre-pandemic average in 2018 and 2019 by 85 basis points. The average exit cap rate was up 11 basis points to 5.18%.
The going-in and exit cap rates did fall by 11 basis points in the last quarter of 2023, which is a low since CBRE started its survey in 2014.
Overall, for prime Class A multifamily properties, average annual rent growth underwriting for the first three years went from 4.5% in April 2022 to 2.4% in December 2023. Unlevered target IRRs went from 5.79% to 7.68%. Going in cap rates were 3.37% and now they’re 5.06%. Exit cap rates from 4.13% to 5.18%. Spread between going-in and exit cap rates was 76 basis points and now is 11. The holding period went from 8.9 years to 8.5 years.
Of the 15 prime multifamily markets that CBRE tracks, 11 saw going-in cap rates increases on Q4. Boston, Dallas-Ft. Worth and Los Angeles saw increases of more than 25 basis points.
“This positive spread likely will continue as long as economic conditions do not deteriorate significantly,” they wrote. “The U.S. overall average exit cap rate is not expected to decrease in the near-term, so it is unlikely to fall below the going-in rate. However, on a market-by-market basis, cap rates have already inverted in Chicago (Q4 2022) and Washington, D.C. (Q3 2023), though these inversions began to reverse in Q4. Parity between cap rates is now being seen in New York, Philadelphia, Phoenix, San Francisco and Seattle.”