Mid Atlantic Real Estate Journal — 2013 Forecast — January 11 - 24, 2013 — 13C
www.marejournal.com
2013 F orecast
By Mark Scott, Commercial Mortgage Capital The case for Lower Multifamily Cap Rates
A
ttend any number of multifamily confer- ences around the Tri-
decline. What’s more, the low interest rate environment could also dip cap rates even deeper, and it appears that this will remain in place for the next several years. In Sep- tember, the Federal Reserve announced that it would keep interest rates near-zero well into 2015 even if the economy starts to recover. One of the most significant factors driving multifamily rental rates is a multi-gen- erational trend toward leasing and away from homeowner- ship. Specifically, Generation Y consumers who have been hit hard by the recession may
not be able to purchase a mort- gage, and many enjoy the con- venience of urban rental space. The Baby Boomer generation is also pursuing rental hous- ing, as many Boomers look for living options that require less personal maintenance or seek to convert their home equity into much-needed retirement income. At a recent speech at the Operation HOPE Global Financial Dignity Summit in Atlanta, GA, Federal Re- serve Chairman Ben Bernanke noted that “homeownership rates [which have slipped nearly 4 percentage points from their 2004 high of 69%]
have declined because fewer households have chosen, or have been able, to become new homeowners in recent years. Buying a home usually means obtaining a mortgage, and the data show that the pace of mortgage lending has fallen considerably on a national ba- sis.” He goes on to note that the reduction in mortgage origi- nations and home purchases for “all groups relative to the pre-crisis period partly reflects weakness in the effective de- mand for housing rather than the unavailability of mortgage credit, with unemployment, income loss and income inse-
curity preventing many house- holds from purchasing homes, and concerns about the future direction of the labor mar- ket, housing prices, and the economy more generally keep other potential buyers on the sidelines.” In the meantime, these groups are providing a hefty boost to the apartment rental market, which should drive down cap rates. But the biggest wildcard in this whole cap rate debate might just be the home mort- gage interest tax deduction. The current deduction, which is lauded by most homeown- continued on page 16C
State region and cap rates are sure to be a topic of dis- cussion. But while many suggest that cap rates for multifamily rental prop-
Mark Scott
erties will flatten in the future or even rise, I would argue that they can (and likely will) go lower. There are number of fac- tors driving this compression, including a healthy amount of cash that is ready to return to the market; record low interest rates; and a desire among both Generation Y consumers and the Baby Boomer generation (some 76 million strong) to forgo homeownership in favor of renting. But what’s argu- ably most important to the cap rate debate will be the fate of the home mortgage interest deduction. First, let’s follow the cash flow. There is a strong stable of Real Estate Investment Trusts that have large amounts of cash they are looking to de- ploy, and multifamily is cur- rently the most stable asset class available. In September, the Multifamily Production Index (MPI), released by the National Association of Home Builders (NAHB), improved for the eighth consecutive quarter with an index level of 54. It is the highest reading since the second quarter of 2005. The MPI, which mea- sures builder and developer sentiment about current con- ditions in the apartment and condominium market on a scale of 0 to 100, rose from 51 in the first quarter to 54 in the second quarter. We have seen top-quality multifamily rental product trade anywhere from a 4% to 4.8% cap – an indication that this product is indeed favored by investors. This rate is not entirely surprising given that these are best-in-class build- ings that will certainly see rents rise. However, we are also seeing an increased inter- est among investors looking to purchase older product at a lower basis since there is ulti- mately more upside following either a cosmetic renovation or major rehab. For these value added investment opportuni- ties, expect to see cap rates
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