Multifamily cap rates, which have been steadily falling during the pandemic, are being squeezed by the rising cost of capital.
This will ultimately put pressure on the sector’s property values, according to new research from Moody’s Analytics. “Without continued unprecedented rent growth, the darling multifamily asset class likely carries the most risk of value decline while the benchmark US Treasury rate is on the rise.”, analysts warn.
Cap rates have remained static even if Q3 has now started to show a little increase for industrial, office, and retail. According to Kevin Fagan and Xiaodi Li of Moody’s, ” For multifamily, cap rates have continued to decline, which, along with tremendous rent growth, has propped up multifamily values compared to equities and other investments.” However, the multifamily sector will ultimately see fewer buyer offers and higher property yields due to the rising cost of capital and growing worries regarding ex-ante exit cap rates. Therefore, pressure on multifamily property values will come from the Fed raising rates and the banks doing the same with loan interest rates.
Moody’s economists point out that rising 10-year treasury rates have driven CMBS loan interest rates significantly higher than in prior months, and both are expected to keep growing. But while the cap rate for industrial properties began to rise in Q3 2022, multifamily rates kept falling. Fagan and Li state that “cap rates with tight spreads are highly likely to increase under the upward pressure of rising interest rates.” They add that this raises the question of how much rent growth is required to stop a decline in value. As of Q3, spreads between cap rates and loan interest rates for the sector were clocked at 0.76%.
If a CRE investor wishes to leave in five years and the cap rate increases from 5% to 6.5%, they claim that the average annual rent growth must be higher than 5.4%. The exit value would be less than the current value in that case. Even while multifamily growth rates from Q3 2021 to Q3 2022 were 8.2% annually, a sustained average growth rate of 5.4% is significantly higher than any previous record.
In the end, the pair claims that narrow cap rate spreads and rising interest rates are “warning indicators.”
Fagan and Li assure, “We will keep a close eye on those numbers.”
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