EOY 2015 Apartment Cap Rate Trends

Given our understanding of apartment market fundamentals, it should come as no surprise that this property type also continues to be the strongest performer on the capital markets side. In the graph below, we observe that the mean cap rate, calculated on a dollar-weighted basis by quarter and illustrated by the dark blue line in the chart, declined by 20 basis points to 6.0% during the third quarter.

If we look at the 12-month rolling cap rate, shown as the red line in the graph, it declined by 10 basis points to 6.1%. Once again, these metrics have hit post-recession lows and the small 10-basis-point spread between the two continues to tell us that apartment cap rates are not just low today but have been consistently low.

Although it seems like apartment cap rates cannot continue to fall, they continue to defy some expectations. Over the last year, the mean cap rate and the 12-month rolling cap rate are both down 40 basis points. While fundamentals have remained strong in this sector as we previously discussed, such low cap rates continue to prompt speculation that the market is either in a bubble or nearing a bubble. So let’s examine this empirically.

EOY 2015 Apartment Cap Rate Trends

Take a look at the calculated mean 12-month rolling cap rate over the last ten years or so, which is shown on the graph above as the dashed light-blue line. The current 12-month rolling cap rate is roughly 50 basis points below the mean 12-month rolling cap rate. That is another 10 basis points wider than it was last quarter. 50 basis points, while not enormous, is substantial and is beginning to push into territory that we rarely see.

With interest rates remaining at such low levels, it is easy to see how this is fueling speculation about a bubble. But remember, low cap rates only portend a bubble if fundamentals don’t justify valuations. And in the case of the apartment market, fundamentals remain strong through the third quarter of this year which is driving ongoing demand for apartment properties.

Over the last 12 months, effective revenue in the apartment sector has grown by roughly 4.3%. That’s roughly 60 basis points ahead of the year-over-year growth rate from last quarter demonstrating strengthening in the market. Until we see that growth rate slow, which we forecast will occur over the next four to five years, expect demand for apartments to remain robust and cap rates to remain low, even in the face of rising interest rates.

Source: REIS Ryan Severino on Dec 15, 2015


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