Multifamily Bargains Coax Investors Off the Sidelines
Upward movement in the 10-year Treasury has slowed momentum some, but the trajectory of deals is generally positive.
Last year, multifamily investment volume sank from the weight of 11 interest rate increases between March of 2022 and July of 2023. Now it seems that a vibrant market is starting to return.
According to Colliers and MSCI Real Assets, multifamily investment volume surged in Q2 2024 to $38.8 billion, an increase of 82 percent quarter-to-quarter and 19 percent year-over-year. This brought transactions in line with pre-pandemic Q2 averages between 2016 and 2019.
Transaction volume dipped in the third quarter to $35.8 billion—due to fewer large portfolio transactions. But volume was still up 9 percent year-over-year.
Improving market conditions and a rise in below-replacement-cost opportunities have converged to beckon investors back to the market. The rise in the 10-year Treasury in September following the Fed’s 50 basis point cut to its benchmark rate has put some stress on multifamily’s upswing, but transactions pros are generally optimistic.
Construction has peaked and investors can now underwrite with greater confidence than in recent quarters because they can predict market recovery, noted Aaron Jodka, director of Research, Capital Markets | U.S. for Colliers, in a report. Fundamentals are rebalancing and there is a brighter future for rent growth. Buyers are seeking neutral leverage, and basis plays are an attractive and popular bet.
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The Q2 deal boost was mostly due to Blackstone’s $10 billion acquisition of apartment REIT AIR Communities. But, even without this big-ticket trade, transaction volume would still have been up 35 percent quarter-over-quarter, though down 3 percent year-over-year to $85.7 billion, according to a report by CBRE. KKR also acquired a portfolio of 18 newly built, mid- and high-rise urban multifamily assets located mostly in Southeastern and coastal markets, for $2.1 billion. The leading 2Q markets for transaction investment volume were Los Angeles ($7.5 billion), New York ($6.8 billion) and South Florida ($4.9 billion).
A time of challenges
Overall transaction volume has fallen significantly—down 60 to 70 percent since its peak in 2021, while multifamily asset valuations troughed in Q4 2023, when treasuries spiked north of 5 percent, noted CBRE Executive Managing Director Kelli Carhart, who leads the firm’s multifamily investment advisory platform.
As a result, investment sales volume was flat midway through 2024, compared to 2023, at roughly $60 billion, and volume will likely remain flat or increase slightly by 5 to 10 percent by the end of the year with help from a treasury rally in August and September, Carhart suggested.
“Multifamily has faced a number of headwinds for some time, but there is now ample evidence conditions are firming, and likely to draw new buyer appetite,” said Jonathan Woods, COO at Excelsa Properties. He noted that oversupply at the peak of the cycle, higher borrowing costs and increased operating expenses, such as insurance, taxes and payroll, had led to a period of underperformance in terms of occupancy and rental growth, and lower expectations for returns.
“Many properties cannot increase rents fast enough to counteract these pressures and also achieve measurable increases in value,” contended Dave Mikkelsen, director of investor relations at Investors Management Group. He noted that the high cost of debt is having the greatest impact on multifamily values because it drives up cap rates, makes debt service more expensive and cuts into net income.
But, Joseph Iacono, CEO & managing partner at Crescit Capital Strategies, doesn’t expect to see a lot of investor movement in the market until rates drop another 50 basis points or more.
“I’m not yet convinced the Fed is ready to make cuts to that level,” he said. “We’re also seeing rental growth slowing in the Sunbelt region, while operating expenses are climbing nationally.”
What’s stimulating investor activity
However, the 20 to 30 percent drop in values, along with positive fundamentals—strong demand, exceptional absorption, continued low vacancy at 5.5 percent and an easing of new deliveries and construction starts, as well as slow, but positive rent growth—have poised multifamily for a turnaround. CBRE reported that 126,600 units were absorbed in Q2—the sixth highest quarter in 20 years, signaling that vacancy should fall toward its long-run average of 5.0 percent in subsequent quarters.
Grant Hayes, manager of Market Intelligence for the U.S. Capital Markets Group, Multifamily at Avison-Young, noted that multifamily has comprised 47.1 percent of investment sales activity over the last 18 months, the most of any other asset class. And while rent growth has stalled over the last 12 months, rent growth remains 17.5 percent above 2019 levels.
Despite the high number of new units delivered in Q3 2024 (4,000), demand kept pace with supply, with 360,000 units absorbed—a 44 percent increase over total absorption for the full year in 2023, according to a Cushman & Wakefield report. Rents, meanwhile, inched up 2 percent after hovering at 1.5 percent for the past year.
A total of 609,000 units are currently under construction, but with interest rates what they are, developers can no longer make new projects pencil, and construction starts are now nearly at a standstill. This is setting the stage for tighter vacancy and more meaningful rent growth, the report noted.
According to CBRE, Q3 2024 multifamily transactions increased 5.0 percent year-over-year, totaling $34.2 billion compared with $32.4 billion in the third quarter of 2023. While the number of transactions decreased by 5.9 percent (down from 1,197 in 2023 to 1,126 in Q3 2024), the amount paid per transaction increased by 11.7 percent (up for $27.2 million in Q3 2023 to $30.4 million).
The price paid per unit also increased by 8.6 percent, with 137,251 units sold on average for $249,000 per unit compared with 141,961 units sold for on average $229,000 per unit in Q3 2023. The report noted that cap rates peaked in Q2 2024 at 5.66
While the Fed’s recent 0.5 percent rate cut had little impact on lending rates or loosening of lender purse strings, Hayes noted that the average multifamily cap rate did move down slightly from a peak of 5.66 percent in Q2 2024 to 5.63 percent in Q3 2024, CBRE reported, noting that caps will continue fall as the Fed cuts rates.
“We are seeing some momentum, which we anticipated would build throughout 2024 as the Fed enters a rate-cutting cycle,” Carhart continued. “With the rally in treasuries and increased capital participation, we are seeing values stabilize and even cap rate compression, but this will vary by asset type and geography.” Boston and Sunbelt core-plus markets continue to have the tightest cap rates.
Traditional buyers of multifamily properties were on the sidelines for a period of time, particularly institutional buyers and crowdfunders, leaving primarily private asset managers and family offices as the sole profile of buyers, Woods noted. “Now all market participants are back seeking opportunity before conditions strengthen further,” he said, adding that deals that did not trade previously are coming back to market at discounts.
Why sellers sell or don’t
Sellers, Carhart said, are motivated by a need to create liquidity, loan maturities and end of fund life, while buyers are driven by discounts to replacement cost, ability to acquire newer, quality product previously out of reach and market forces, like diminished over the next two years and the significant price differential between renting and buying, which portend higher demand and rent growth. She predicts a marked increase in capital participation in this sector as a more favorable rate environment and improved market fundamentals drive cap rate compression.
“Opportunistic buyers are looking to purchase distressed assets at a discount, but there are less distressed sales than we expected,” added Mikkelsen, noting that owners are grinding through this market correction knowing that if they can make it through, they’ll see better results on the other side.
When the market tightened, Woods noted, investors had expected a wave of foreclosures from deals funded with the wrong debt, be it CMBS, bridge or variable rate agency loans. While there are some opportunities due to forced sells, there are not nearly as many as anticipated. “Clearly there are a lot of lender discussions to ‘extend and pretend,’ or recaps with preferred equity filling the gap has allowed many of these situations to muddle along,” he said
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Multifamily continues to be an excellent long-term investment, Iacono said. The hitch is availability. “Buyers would like to buy today based on current metrics but are finding that to be difficult because sellers are holding onto their assets hoping that interest rates will continue to fall and that values will begin to climb,” he said, suggesting that the delta between the bid and the ask is beginning to narrow, but it hasn’t happened on a large scale yet.
A tremendous amount of new deliveries, particularly in some Southeastern markets, has slowed rent growth. But, with the high cost of debt now halting new construction, absorption should be able to catch up with deliveries and multifamily should rebound. “We have a national housing shortage, so it’s only a matter of time before we see additional growth in the sector,” he emphasized.
While foreclosures were down 80 percent in Q3 2024 compared to Q1 2024, Hayes suggested that multifamily values may not have reached the bottom yet since nearly 500,000 new units will be delivered over the next 24 months, and multifamily comprises more than 60 percent of loan maturities between 2025 and 2032.
Student housing is a specialty segment that continues to enjoy robust investment activity. J.D. Goering, senior vice president of Acquisitions at Landmark Properties, noted that while multifamily values have fallen in the broader residential market, student housing values have remained strong and attract bids that often exceed initial valuations.
Major institutional players are attracted to the sector’s resilience. “Institutions feel pressure to acquire quality assets that offer stable income and potential for appreciation and are drawn to the sector’s strong fundamentals, including strong early lease-up rates for the 2025-26 academic year,” Goering said. “They are looking to partner with established, successful operators in the student housing space.” Goering believes this positive momentum will drive increased sales volume in the coming quarters.
Sellers, he said, are motivated by a desire to capitalize on the strong performance and lease-up rates seen at Tier 1 universities, particularly those in Power 4 conference markets: “They see an opportunity to sell core and core-plus assets while demand is high.”
An optimistic outlook
Carhart believes that investment activity will continue to build as interest rates and market fundamentals improve. She expects to see noticeable improvement in market fundamentals following the peak in new deliveries in the third quarter of 2024. “We will see values improve and a continued recovery over the next 24 to 36 months,” she predicted
It’s difficult to call the bottom of any market, Woods said, since borrowing costs increased after the first rate cut, clouding the picture and posing risk to an upside. “But I suspect we will look back on the end of 2024 and recognize this was a great time to buy with stronger operating conditions and greater competition for assets,” he said.
