Prime Multifamily Cap Rates Show Improvement

For the first time in two years, financial and operational metrics are improving for Class-A multifamily properties, says CBRE.

“Going-in cap rates, exit cap rates and unlevered internal rates of return (IRRs) targets for prime multifamily assets improved slightly in Q1 for the first time since the Federal Reserve began raising interest rates in early 2022,” they wrote. “These improvements indicate that key underwriting metrics may have peaked in anticipation of possible rate cuts later this year.”

The change in going-in and exit cap rates was slim, standing at 12 basis points in 2024 Q1. But it was still the first time, after eight consecutive quarters, for a positive stance since the Fed began raising interest rates in 2022 to fight inflation.

CBRE expects the positive spread to continue “unless economic conditions unexpectedly deteriorate.” In the near term, don’t expect the exit cap rate to fall under going-in rates. Average prime multifamily going-in and exit cap rates dropped by 6 basis points to 5.00% and $5.12

But that’s on the average. Some individual markets — Chicago in 2022 Q4; Washington, D.C. in 2023 Q3; and Philadelphia in Q1 2024 — have already seen inversions, where the going-in rate is now higher than the exit, which should mean better deals for both buyers and sellers.

“Unlevered IRR targets decreased by 9 bps in Q1 to 7.59%,” they wrote. “All but two (Chicago and Philadelphia) of the 15 prime multifamily markets tracked by CBRE had either stable or lower IRR targets in Q1. Denver (-100 bps) and Los Angeles (-50 bps) had the biggest reductions.”

Austin had the lowest risk requirements for the tenth consecutive quarter. First three years annual rent growth underwriting is 1.5%. Going in cap rate was 4.25% to 4.75% and the exit cap rate was 4.50% to 5.00%. The unlevered IRR target was 5.75% to 6.25%.

Average buyer valuation assumptions for prime Class-A multifamily assets across the 15 top metros CBRE looked at included $4.42 per square foot, 2.3% rent growth for the first three years, 7.59% unlevered IRR, going-in cap rate of 5.00%, exit cap rate of 5.12%, and holding period of eight years.

But if CBRE is correct in thinking that the movement has been in anticipation of rate cuts later this year, it’s unclear how many rate cuts might be coming or when. As both CPI and PCE inflation have begun increasing, more from the Fed are saying there is no hurry on their part to cut the benchmark federal funds rate.