As the saying goes, a rising tide lifts all ships, and what a tide it has been for the multi-housing sector locally, regionally and in virtually every market across the country.
We’re now three years into this post-recession cycle. It’s a period marked with capitalization-rate compression, mounting levels of buy-side competition, falling costs of debt, stable- to slightly improving macro economic fundamentals, and development engines moving from a slow idle to full throttle.
At the same time, rent and occupancy growth has trended up nicely with occupancies perhaps achieving and exceeding maximum sustainable levels.
We started 2013 strong with a clear imbalance of supply and demand in the transaction space. Far more equity than available quality acquisition opportunities was coming into the market.
Indianapolis and many other secondary markets nationally have seen an influx of new capital seeking to establish a beachhead or increase levels of investment exposure due to the predictable seasonal rhythm of the Indianapolis area multi-housing market and the steady year-over-year gains.
It’s interesting to look at what’s happened to the risk premium, or spread, between capitalization rates and U.S. Treasuries for multifamily locally comparing the last pricing cycle (2005-2007) to the current pricing cycle (2010-2013). The premium is fairly thin through the last cycle, generally hovering around 100 basis points in what became a feeding frenzy with quality multi-housing property being the main course. There was little risk priced into multi-housing investment property.
Then the world changed and trading of quality assets as we knew it was suspended during most of 2008 and 2009. The markets warmed back up in mid-2010 as the first A grade assets went back to the open market.
What ensued was quite interesting. Through a combination of slightly higher cap rates (’10 compared with ’07) and yields for Treasuries quite a bit lower, the risk premiums exploded to 350 to 450 basis points.
This has fueled what has now become a three-year run-up in pricing of multi-housing product. Over the past four months we’ve withstood 150 basis points of interest rate increases, a trend typically inversely linked to investment property (including multi-housing) values. Although we now exit one of the most rapid changes to interest rates ever sustained, and it’s largely as though it never happened. In the wake of this 150-basis-point movement, we’ve seen virtually no impact to cap rates on A and B grade assets.
So, the equity has absorbed all of the rate increase, in the form of lower equity returns demanded.
Consequently, the days of 400-basis-point risk premiums appear to be over for multi-housing. The buy-side market will settle for spreads somewhere in the 250 to 350 basis-point range on transactions that will be closing over the next 90 days.
We’ve really only had an adverse impact to one spoke of the wheel—cost of debt. The equity remains as hungry as ever. Rent and equity fundamentals are not improving at the rate they did last year but are still favorable, and single family does not appear to be an overly concerning threat.
In May 2013 we reached an inflection point locally where we had recovered all 45,000 jobs lost 2008 through 2010, and as of July 2013, we were up 7,800 jobs over peak 2007 levels. We see decoupling of households occurring—which is fueling household creation and the tendency to rent longer before taking the single-family plunge—a trend that represents perhaps a permanent shift in thinking.
We saw $311 million trade in all classes of multi-housing in 2012 and $211 million trade year-to-date in 2013, including record suburban pricing and continued diversification and sophistication of the sources of capital eager to deploy investment dollars to the Indianapolis market.
Year-end 2013 volume will likely exceed 2012 volume, and we expect further gains in volume locally in 2014.•
LaMotte is senior vice president, CBRE Indianapolis-Cincinnati Multi-Housing Group. Views expressed here are the writer’s.