Apartment Cap Rates Drop to Historically Low 5.6% Time to Sell

Apartment Cap Rates Drop to Historically Low 5.6% Time to Sell

In a show of strength, cap rates reached new historically low levels during the first quarter. We observe that the mean cap rate, illustrated by the dark blue line in the chart, declined by 40 basis points to 5.6% during the first quarter. As mentioned, this is a record low.

Moreover, it is first time that we have observed a mean cap rate less than 6%. It is important to emphasize that this is the mean cap rate for properties that actually traded during the quarter, not the cap rate for all properties. Nonetheless, a 40-basis-point decline is a surprise. And while I will always caution reading too much into one quarter’s worth of data, this development is noteworthy.

Not only are we at a relatively late juncture for apartments (measured by both the fundamentals space market and capital market cycles), but we haven’t seen a movement nearly this strong since the market was climbing out of the recession; and of course such a strong downward movement should be expected during such an environment. The strong downward movement is far rarer at this relatively late stage of the game.

This downward trend continues to pull down the 12-month-rolling cap rate, depicted as the red line in the graph. That metric now stands at a scant 6%, also a record low for apartment cap rates since Reis has been tracking the market. Like with most data points, a little context is important. If you look at the dashed, light-blue line in the graph above, you can see the average 12-month rolling cap rate since 2005 is 6.6%. That means that the current 12-month rolling cap rate is now 60 basis points below the average. While that is significant, it is not egregious. And as we have discussed in past capital markets briefings, this is a consequence of continued low interest rates, not of irrational exuberance. And while it is difficult to envision apartments cap rates continuing to compress at a rate anything like what transpired during the first quarter, we should also not expect cap rates to expand much in the near -term based on the outlook for apartment fundamentals. Therefore, cap rates are likely to remain in the high-5% to low-6% range over the next year or so.

Source: REIS Ryan Severino on Jun 1, 2016

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