Multifamily Cap Rates, IRR Unchanged as Sector Awaits Interest Rate Action

Following quarterly increases for two years due to rising interest rates, going-in cap rates, exit cap rates and unlevered internal rate of return (IRR) targets for prime multifamily assets remained unchanged for a second consecutive quarter in Q2. This trend could be due to expectations that the Fed will begin cutting interest rates later this year.

A going-in cap rate estimates the yield an investor can expect from a property when they first acquire it while an exit cap rate estimates the expected yield on a property investment when it’s sold. Unlevered IRR estimates the annualized rate of return on an investment excluding debt financing.

The spread between going-in and exit cap rates showed a slight decrease to 11 basis points during the quarter, according to CBRE’s Prime Multifamily Underwriting Survey. The average prime multifamily going-in cap rate fell by four bps in Q2 to 4.97%, while the average exit cap rate fell by five bps to 5.08%.

“The narrower spread between going-in and exit cap rates resumed a downward trend that lasted for eight consecutive quarters from Q4 2021 to Q4 2023,” the report said. “The overall average exit cap rate for prime multifamily assets is not expected to fall below the going-in rate before pricing recovery begins in earnest.”

Exit cap rates have remained lower than going-in cap rates on a market-by-market basis in Chicago since Q4 2022 and in Washington, D.C., since Q3 2023. The previously inverted cap rate market in Philadelphia reached cap rate parity while Austin and Dever’s spread fell to parity, the report said.

Unlevered IRR targets increased slightly in Q2 to 7.63%. All but three of the 15 multifamily markets studied had either stable or slightly higher IRR targets in Q2. Phoenix and Washington, D.C., were the only markets with reductions.

For the 11th consecutive quarter, Austin had the lowest risk requirements on an underwriting basis, according to the report. Most markets remained unchanged quarter-over-quarter, with only Washington, D.C., Phoenix, and Dallas moving slightly up the list from underwriting metric improvements or from downgrades of other markets.

Five markets, including Boston, Los Angeles, Miami, Philadelphia and Phoenix, had moderate going-in cap rate decreases in Q2, while seven had no change. Going-in cap rates increased 25 bps or less in three markets – Austin, Denver and Seattle. Exit caps were unchanged in 11 markets, while Boston, Miami and Phoenix had slight decreases. Dallas was the only market with an exit cap rate increase, up by 13 bps, according to CBRE.