How Institutional Investors View Apartments Today

Brennen Degner

Navigating the multifamily real estate landscape through the discerning eyes of institutional players offers a varied spectrum of insights and evolving strategies. Our detailed analysis of feedback from over 30 prominent institutional joint venture partners sheds light on the contemporary narratives defining the market.

What we found is that the majority of those surveyed have adjusted their yield objectives, to converge around a yield on cost above 6.75 percent. This shift arises from the perfect financial storm created by rising interest rates, unprecedented insurance premiums and other OpEx, and a tempering rental market. These elements together exert pressure on property valuations, necessitating investors to recalibrate and rethink their strategies.

READ ALSO: Multifamily Reacts to Interest Rate Pause

Recalculating risk

There’s also a marked change in investor sentiment with regard to the the once-favored pre-1990s era value-add assets. Today’s narrative has dramatically shifted as most institutions now sidestep these assets. The few that show interest demand returns on par with high-risk development projects, specifically an IRR exceeding 20 percent. Concerns around functional obsolescence, rising renovation costs, and the inherent risks that generally fail to justify returns underpin this shift.

Lowered expectations

Rent growth paints a picture of cautious optimism. Projections of around 3 percent rent growth are common in many regions, but there’s palpable unease in overbuilt areas, notably within the Sun Belt. Here, the pendulum swings towards flat or even negative growth due to oversupply concerns and doubts about timely product absorption. However, a silver lining emerges with anticipated reductions in permits and delivery expectations in the future. This suggests that these saturated markets could regain their stability and once again witness consistent rent growth. The ultimate result is varying growth projections of negative, flat and modest, which further impact valuations and are a key component of the bid-ask spread we continue to see.

Distress assets in the spotlight

Feedback indicates that institutional partners are heavily inclined towards assets displaying signs of distress. The allure isn’t restricted to traditionally distressed assets but extends to those with compelling stories: sellers pinned by floating rate debt, those entangled in liquidity challenges due to redemption issues, or properties tethered to failed business strategies. The collective sentiment is clear: Assets without a distressed backstory find fewer takers.

Single-family not a fad

Worth noting is the growing interest in the single-family build-to-rent sector. Many institutional stakeholders recognize its resilience and potential, no longer dismissing it as a passing phase. As the multifamily arena grows in intricacy, this niche emerges as a viable alternative for portfolio diversification.

What it all means?

The multifamily real estate sector, though navigating through a series of challenges, presents a myriad of opportunities for the informed and discerning investor. In these fluctuating economic times, the emphasis lies in making informed, strategic decisions. For institutional investors, the shared insights from their peers could be the guiding compass they seek.

A sustained environment with cap rates hovering around or surpassing the 6 percent mark could spell more than just transient difficulties for the multifamily sector. While we’ve witnessed respectable revenue gains over the past half-decade, escalating operational costs, particularly in insurance which has surged by three to five times, have substantially chipped away at these gains. Such cost inflations don’t add tangible value at the property level for residents, but they directly undermine property valuations. If investor sentiment necessitates multifamily transactions at close to or above a 6 percent cap rate, we’re not just examining the repercussions of 2021 and 2022 financing anomalies. It’s a broader challenge, where most of the value amassed in multifamily over the last six years might be at stake due to enduring higher rates and these mounting costs.

Brennen Degner is CEO, DB Capital Management.