Over the past year and a half, the real estate industry has seen an unprecedented clip in the rising values of multifamily properties.
Is this just a freak of real estate nature or is it supported by something substantial and fundamental?
Multifamily Property Values Continue to Soar in Smaller Cities and Suburbs
The past year and a half have somewhat caught industry professionals, experts, and insiders by surprise because of the unprecedented trend that multifamily properties are in right now. The demand for such types of property has increased phenomenally that it even had industry veterans scratching their heads in wonder.
However, as surprising as it may seem, some real estate professionals actually anticipated it would unfold like this. When asked if this trend surprised her, Aimee Morgan, co-head of multifamily valuation and managing director of JLL (a commercial real estate services firm) has this to say:
“Am I surprised? Yes and no,” says Morgan. According to her, the truly phenomenal value growth we’ve been seeing of late was brought to life by these two things: very strong performance metrics and very high investor demand. When these two are overlaid, the results come in the form of, in Morgan’s words, “really, really strong year-over-year—even quarter-over-quarter—value growth.”
Real estate data firm Real Capital Analytics (RCA) says that the apartment sector’s RCA Commercial Property Price Index (CPPI) has risen by 23.6% year-over-year in 2021 alone. This is considered the highest recorded increase to date and is even stronger than when investors purchased apartment buildings left and right to convert into condos to take advantage of the pre-Great Recession white-hot residential market.
Based on RCA’s data, the average price of an apartment building unit sold in 2021 was $459,212.
Executive VP and investment sales co-head of Berkadia, Keith Misner, describes the multifamily sector today as “aggressive.” According to him, investors are taking a more aggressive stance when it comes to approaching and considering investment opportunities.
Misner further elaborates:
“If someone bought an apartment complex 18 months ago, they can easily sell it now for 20 percent to 50 percent more than what they paid for it.”
Related: 6 Reasons You Should Consider Multifamily Investing
Increased Valuations Supported by Net Operating Income
What’s truly surprising is that the multifamily sector became the largest liquid US commercial property investment in recent history. It wasn’t always like that. Apartment asset investments only accounted for 24% of the total market share from 2005 to 2014. It went up to a whopping 41% in 2021 as secondary and tertiary market investments also began picking up.
According to RCA, more than $335 billion worth of multifamily properties were sold and traded in 2021, a trend that they claim is most likely to continue this year. Morgan says, “Liquidity is incredibly strong, and demand for multifamily assets is unprecedented.” These, according to her, are what made the transaction volume reach a historic high.”
This prediction might also be, in part, a product of Fannie Mae and Freddie Mac’s cap increase of $78 billion on multifamily purchases. However, while the increase could be easily credited to this, industry experts agree that the numbers are all based on facts.
To put this in perspective, about 460,000 multifamily units were absorbed last year which resulted in an exceeding growth in new stock. Because of this, the US occupancy rate at stabilized properties went up to 130 year-over-year basis points, a remarkable 96.1% spike through December 2021.
According to commercial real estate data and research company Yardi Matrix, the average monthly multifamily rent rates increased to $1,604. That’s an $8 per month increase from last December. Year-over-year growth went up to 13.9% with a 30-basis-point increase over the same month. The company also found that rental rates also went up by 20 or more percent in six of the top 31 US metropolitan areas as well as an increase of at least 10% in 28 of the top 31 areas. These markets already make up at least 90% of those being tracked by the company.
The numbers are valid. The math checks out. There is substantial evidence in the form of income to support the present valuation.
Related: How to Calculate NOI for Real Estate Investments
A Shift in Priorities
Perhaps one of the main reasons why multifamily properties in suburbs and smaller cities continue to appreciate is a pandemic-induced mindset and priority shift. Before the COVID-19 pandemic, urban properties and walkability were all the rage. COVID-19 changed all of that, especially when shelter-in-place was implemented and remote work became the new norm.
Morgan agrees that COVID has indeed altered people’s mindsets where priorities and space are concerned. She says that the massive migration into more suburban and car-driven markets was – and still is – mostly coming from larger urban markets. “Think Dallas-Fort Worth, Houston, Phoenix, and Tampa,” Morgan adds.
Garden-style apartments have consistently bounced from 60% to 70% total market share over the past decade or so. The numbers for 2021 aren’t that far off which shows these types of properties make up 66% of the market. The average unit price for garden-style apartments in 2021 was $359,714. To put this in context, urban property trades for the same period have an average price of $804,793.
The cap rates for both mid-to-high-rise apartments and garden-style apartment units averaged 4.5% by the end of 2021. However, it is important to note that the latter had a 50-basis-point cap rate compression compared to the previous year while the former only experienced a 30-basis-point decline. From 2009 to 2015, garden-style apartment assets’ cap rates averaged more than 100 basis points than mid or high-rise apartment buildings.
Morgan jokingly says that cap rates have been declining hourly because “That’s what it feels like these days.”
If urban properties were what made people go gaga in a pre-pandemic world, multifamily properties in smaller cities and suburban areas are the new darlings of investors and property buyers.
Related: 12 Best Multifamily Markets with High Cap Rates
The Bottom Line
With a large portion of 2021’s multifamily value growth taking place in smaller cities and non-metro areas, it would not be surprising to see it hitting higher marks this year, especially when Millennials and Gen Zs continue to migrate to smaller cities with units that give them more space. RCA CPPI showed a 25.1% year-over-year in these smaller areas versus a 10.7% year-over-year increase in the top six major metro areas in the country. This is highly important to note because under normal circumstances (read: non-COVID era), a 10.7% increase is already considered phenomenal.
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