The tight pricing by the market reduces the 'cushion' built into pricing against rising interest rates, but if fundamentals remain robust driving NOI gains, pricing will remain firm regardless of fluctuations in yields. However, the risks to NOI growth are rising as well.

In the short term, development activity has increased rapidly and new supply is now matching demand levels, resulting in stagnant to slightly rising vacancies nationwide. While rent growth has remained strong to this point, continued supply additions will weigh on growth, slowing NOI gains. This effect has been particularly acute in many large, high-profile markets such as New York City, Miami, San Francisco, Boston and Seattle. While these large, high-profile markets are most extreme in terms of shifting fundamentals and cooling property pricing, many other US apartment markets are on a similar, less extreme trajectory.

Longer-term, the homeownership rate appears to be at or near a bottom for the cycle, having dropped to a level not seen since the 1950s, and any gains would become a headwind for apartment absorption, especially as the millennial cohort ages.

While the outlook for apartment demand remains strong and there are many markets that are not as far along in the development cycle, risks appear to be rising for the apartment sector. CRE investors have priced the sector for perfection, despite the shifting sands in both monetary policy and fundamentals. Perhaps it is time for investors to take stock of their apartment holdings, and calibrate their portfolio holdings before the consistently upward trajectory shifts.

Chris Muoio is senior quantitative strategist at Ten-X Research. The views expressed here are the author's own.

IRVINE, CA—The apartment sector has enjoyed the strongest and most consistent recovery since the recession. One fallout from the housing bust was a massive decline in homeownership, resulting in a surge in apartment absorption, as people shifted from owning to renting. The surge in demand resulted in plummeting vacancies and surging rents, even as demand in other property segments struggled in the face of the sluggish economic recovery, whetting investor appetite.

Coupled with a steady fall in interest rates, the result has been 74 consecutive months of double-digit annual growth rates in US apartment pricing per the Moody's CPPI. This has been reflected in cap rates, which continued to fall in the fourth quarter to 5.6%, per Real Capital Analytics data.

However, there are reasons to be skeptical that this robust pricing environment can perpetuate, as there are multiple risks cropping up that pricing has not adjusted to reflect. The first is the rise in interest rates. Interest rates appear to have bottomed for the cycle at the end of 2016 and appear set to head higher as inflation expectations are rising, wage growth is solid and the Fed is poised for further tightening.

A rise in interest rates is often cushioned by the risk premium or cap rate spread baked into the market. We saw some of this in the fourth quarter as rates rose, as apartment cap rate spreads fell. However, the spread of apartment cap rates to Treasuries measures just 310 basis points, some 40 bps below the 10-year historical average. This means the cushion against a rise in interest rates is very thin. This is reinforced by cap rates themselves, which measure just 5.6%, some 70 bps below their historical average.

The tight pricing by the market reduces the 'cushion' built into pricing against rising interest rates, but if fundamentals remain robust driving NOI gains, pricing will remain firm regardless of fluctuations in yields. However, the risks to NOI growth are rising as well.

In the short term, development activity has increased rapidly and new supply is now matching demand levels, resulting in stagnant to slightly rising vacancies nationwide. While rent growth has remained strong to this point, continued supply additions will weigh on growth, slowing NOI gains. This effect has been particularly acute in many large, high-profile markets such as New York City, Miami, San Francisco, Boston and Seattle. While these large, high-profile markets are most extreme in terms of shifting fundamentals and cooling property pricing, many other US apartment markets are on a similar, less extreme trajectory.

Longer-term, the homeownership rate appears to be at or near a bottom for the cycle, having dropped to a level not seen since the 1950s, and any gains would become a headwind for apartment absorption, especially as the millennial cohort ages.

While the outlook for apartment demand remains strong and there are many markets that are not as far along in the development cycle, risks appear to be rising for the apartment sector. CRE investors have priced the sector for perfection, despite the shifting sands in both monetary policy and fundamentals. Perhaps it is time for investors to take stock of their apartment holdings, and calibrate their portfolio holdings before the consistently upward trajectory shifts.

Chris Muoio is senior quantitative strategist at Ten-X Research. The views expressed here are the author's own.