Apartment Capital Market Update, Q3 2018

Apartment Market: National Cap Rate Trends



The declining trend in apartment cap rates, as illustrated in the chart above, is a familiar yet still unexpected story, given that the Fed has raised its overnight borrowing rate by 25 basis points in each of the last four quarters and in seven of the last eight quarters (moving from 0.5% to 2.25%). Not only did the average apartment cap rate decline in the quarter by 20 basis points to 5.4% (the lowest ever), but it has declined in five of the last six quarters. As we have discussed before, the average apartment cap rate is defying conventional wisdom that cap rates move with interest rates.  This is likely due to two reasons.  First, the data is subject to selection bias: cap rates are calculated based on properties that traded in the quarter and, very often, sales are heavily weighted by higher-end properties in high-priced markets. This seems to have been a factor, as the mean transaction value per square foot increased to $189,000 in the quarter – the highest ever and 10% above the previous quarter’s average of $171,000.

Overall transaction volume jumped to $23.3 billion in the third quarter from below $19 billion in the second quarter, in line with an average of $23.1 billion per quarter in 2017.  This means that larger properties traded in the quarter and these generally have lower cap rates than smaller properties.

The other likely reason why cap rates fell in the third quarter is due to investor preference for this asset class over other property types.  The apartment fundamentals presented in Reis’s Q3 Quarterly Briefing showed that, although the average apartment vacancy rate increased in the quarter to 4.8% from 4.4% a year ago, the effective rent growth was positive at 1.2% in the quarter and 4.2% for the year.  Thus, despite the increase in construction, the apartment market remains healthy and in demand for investors.

The 12-month rolling cap rate fell 10 basis points to 5.6% in the quarter – also the lowest ever.  The red line in the chart above clearly shows a declining trend in apartment cap rates over the last four quarters after it had stagnated at 6.0% for the previous four quarters.

Although most cap rates should start to increase in line with the jump in the 10-year Treasury note, the apartment cap rates will likely stay disproportionately lower than other property types over the next few quarters as this remains a preferred asset class.


Apartment Market: National Sales Volume Trends



This chart demonstrates the growth in apartment sales volume since 2013. We have separated out the volume for the top 10 metros from the remaining 40 metros in the top 50 (more than 90% of the transactions occur in the top 50 markets).  The top 10 metros are New York City, Los Angeles, San Francisco, Boston, Phoenix, San Jose, Seattle, Chicago Atlanta, and Denver. These cities combined accounted for 58% of the total volume.

As this chart shows, sales volume in the top 10 metros jumped in the third quarter to 13.5 billion dollars from 7.7 billion dollars last quarter. This represents the second highest volume ever. New York City alone saw $2.7 billion in transactions led by 101 West End Avenue ($416 million dollars) and a Long Island City tower ($284 million). Now that Amazon has selected Long Island city for one of its second headquarters, we might see more sizable transactions in this submarket.

Outside of the top 10, the next 40 metros saw little change in overall volume. The third quarter volume of 9.6 billion dollars was just under the average quarterly volume of 2017, which was 10 billion dollars.

This chart shows that investor interest in multifamily properties is still strong, and interest in gateway cities is higher than in non-gateway cities. These trends have steadily lowered the average apartment cap rate.


Analysis by Barbara Byrne Denham. Denham is a Senior Economist in the research and economics department at Reis, the team responsible for the firm’s market forecasting, valuation, and portfolio analytics services. Throughout her 20-year career, Barbara has written a number of white papers on the commercial real estate market.