In the October 2024 edition of GVP insights, we’d like to focus on a key factor in multifamily investing: the relationship between interest rates and cap rates. Understanding how fluctuations in interest rates impact cap rates can give us a clearer view of current and future investment opportunities.
What’s Driving the Current Opportunity?
Recent shifts in interest rates have created a unique market environment for multifamily investing. As interest rates rose, cap rates followed, leading to lowered property valuations. This has presented opportunities for investors to acquire properties at discounted prices. The downside, however, is lower cash flow due to higher borrowing costs. Investors now face a choice: accept lower initial yields for higher potential upside down the road or seek safer alternatives like Treasury bills, which currently offer higher returns but no upside potential. The key question remains: How long will T-bills be an attractive investment vehicle?
Why Now
Timing is crucial in today’s market. As the Federal Reserve has taken steps to raise rates, cap rates have widened, pushing valuations down, particularly for older multifamily assets that have fallen out of favor. However, this creates the potential for significant appreciation when cap rates eventually compress as interest rates stabilize or fall. Investors who act during this period of market lag when cap rates are still elevated but interest rates start to decline may capture both value and future upside.
The Stability of Multifamily
Despite these fluctuations, multifamily remains a stable asset class, as evidenced by the continued willingness of agencies to lend on these properties. Multifamily assets offer long-term stability, even in times of higher interest rates, making them attractive in both down and up markets. The Fed is beginning to signal a shift in policy, and while we can’t predict the exact path, we believe interest rates and cap rates tend to move together. This lag between the two creates a window of opportunity for investors to secure deals before cap rates compress and property values rise.
Supporting Insight
According to industry research from CBRE, cap rates since 1995 show that for every 100-basis point change in the 10-year treasury yield, cap rates for multifamily assets increased between 70-80 basis points. The actual effect depends on several factors, such as market conditions, property type, and investor sentiment. In more stable primary markets with high demand, cap rates may increase less dramatically, while in secondary markets with lower demand, the impact may be more pronounced.
Additionally, the chart below is a visual representation of cap rate expansion in primary versus secondary markets from 2018 to 2024. The gap between the two lines highlights the cap rate spread, showing how secondary markets like Phoenix and Las Vegas have seen more significant increases compared to primary markets like Los Angeles and New York. This chart can help visualize the greater expansion and potential yield differences in these markets.
By closely monitoring interest rate changes and their impact on cap rates, Gelt Venture Partners is well prepared to navigate the current market dynamics. The recent rise in interest rates has created opportunities to acquire properties at discounted valuations. While current cash flow may be less attractive compared to alternatives like T-bills, the potential for value appreciation as cap rates compress offers a compelling long-term opportunity. Multifamily assets remain a stable investment, supported by continued agency lending and strong market fundamentals. Given these factors, now is a critical time to consider multifamily investments as part of a balanced portfolio strategy.
Should you have any questions, require further insights, or wish to discuss potential investment strategies tailored to your portfolio, please don’t hesitate to reach out to our team. We are committed to providing you with the expertise and support needed to make informed real estate investment decisions. We thank you for your continued trust in our analysis and guidance.