Hello all,
I am trying to get my head around how people are thinking about cap rates in the multifamily sector in the coming years. I have found a lot of investor presentations, proformas, etc for mid-rise multifamily development deals from the last 24 months across the U.S that are contemplating scenarios with cap rate compression, no change, or only slight expansion.
Given how low-interest rates are, and the distance rumblings of a possible recession looming, it is so crazy to assume a 5 basis point expansion per year? 10 basis points?
well, simply a lot of deals will no longer work without assuming some type of cap rate compression -- especially with construction costs and land values. You see a big chase to ultra-luxury, because those are the only asset types that can still command a high enough premium and profit spread to justify the contributions required in today's market. That or a serious re-position or value add to the asset. But simply, buying and holding and waiting for compression and earning some CF along the way is no longer an accepted option...not that it ever really was, but people at least got away with it.
specific markets are also becoming more important than ever. With the general millenial trend becoming known, it's more important than even IMO to truly understand your market and location. Those that do will be able to unlock value outsiders wont.
Anyone who says they know what is going to happen to cap rates in the future is full of crap. A widely accepted industry standard for future sale valuations is expansion of cap rates by 5 bps per year. So, spot cap rates now are 4.50% and you are selling in ten years--underwrite stabilized year 11 NOI at a 5% exit cap.
50 bps spread seems a bit aggressive
Over 10 years? That's as "market standard" as I've ever heard it.
Most people / shops I have seen use 50-100 bps over ten years, depending on the deal and location (and if they need to stretch to win, it gets closer to 50 bps).
I usually look at the forward rate curves. We are getting live feedback from banks pricing floating rate debt more expensive today than fixed, meaning they are anticipating rates to continue dropping. I personally believe treasury rates are headed towards zero in the US for a variety of reasons, but still model cap-rates 3-5 years out on our merchant build investments with a 25-50 bps inflation factor depending upon geography and barriers to entry in the market to conservatively shit test/screen deals.
Why would floating rate be more expensive if rates are increasing and not fixed as well?
Rates are not increasing, look at the change in treasuries over the past 12 months. Rates will likely not increase going forwards either as America will close the yield gap with Europe/Japan to try to stimulate an economy that is rapidly turning over in the cycle.
You want to make sure that your deal isn't a disaster with cap rate expansion at the very least.
I think a lot of reasonable people are assuming a modest level of expansion... i.e. 5 bps per year as was previously stated. Flat cap rates would be a very aggressive assumption for base case underwriting and compression means you're dealing with an amateur (at this point in the cycle)... even if someone thinks compression is likely, they shouldn't/usually won't model that in today's world.
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