Searching for Cap-Rate Resiliency? Look to Middle-Market Multifamily

Most investors would agree that the multifamily market has been unpredictable over the last four years. Following the onset of the pandemic, market rate multifamily cap rates compressed alongside plunging interest rates. When interest rates rapidly expanded starting in March 2022, cap rates eventually followed—after a long standoff on pricing—and investment activity has plunged, down 64% in 2023.

In contrast, middle-market multifamily deals—defined as deals ranging from $5 million to $15 million—have been a standout performer in the market, showing resiliency and cap rate stability through the last four years of market volatility. As Walker & Dunlop explains, deal flow has remained healthy in the middle market space as a result.

Middle Markets Show Cap Rate Stability

In 2021 and 2022, while market-rate multifamily cap rates compressed, middle-market deals experienced less dramatic compression. “This is because middle-market multifamily properties generally don’t achieve the same low cap rates as institutional multifamily properties,” says Jared Sobel, a senior managing director at Walker & Dunlop.

Today, investors are looking for stability and a higher entrance cap rate to mitigate downside risk, and middle market properties are offering the ideal investment profile. As Sobel explains, the middle market often includes workforce housing, which has historically outperformed market rate properties during economic dislocation and offers more attractive cap rates.

“Deals with a mission focus typically have a higher cap rate,” says Sobel. “In a higher interest-rate market, the most attractive deals are going to be those with a higher cap rate.” As a result, the sector has maintained deal flow this year compared to market-rate multifamily properties.

Securing Capital Requires Finesse

While the middle markets are providing an attractive investment profile to investors, the capital environment remains challenging across deal types. Middle-market borrowers are sometimes less experienced and typically have less cash on hand than larger institutions. As a result, securing capital can be especially challenging in this space.

At a minimum, Sobel notes that lenders are looking for investors that have an existing portfolio of at least three properties with five or more units. “This will help to meet the needs of the agencies and get the borrower through the credit process,” says Sobel.

In addition to the borrower profile, market volatility has also created challenges. Sobel says it isn’t unusual in the current environment to see a 5% to 10% swing in proceeds. “This is a fluid process because of how volatile the interest rate market is. There are so many deals we are working on now that looked completely different just 60 days ago,” he explains. To offset some of the capital challenges and get deals across the finish line, Sobel’s team is running multiple scenarios on each deal and utilizing tools like rate buy downs.

“Nothing is set in stone,” he says, “but we lay all of the options out for our clients.”

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