When compared to previous recessionary periods, today’s real estate cap rate spread is remarkably divergent. Heading into the recessions of 2001 and 2008, cap rate spreads were over 50% below their long-term average and primed for a correction: real estate assets were simply overvalued. Leading up to the Great Recession, commercial real estate cap rates compressed to historic lows and as the financial markets collapsed and liquidity evaporated seemingly overnight, cap rates had nowhere to go but up. Multifamily cap rates nationwide increased, on average, approximately 1.50% resulting in price adjustment of over 25%, varying by market. A similar pricing readjustment is not expected in today’s disparate environment. Going into the current market downturn, the real estate cap rate spread was at its long-term average and has since increased over 50% above that average.
While the cap rate spread provides a key measure, signaling an absence of wild price swings for multifamily real estate, other indicators only supplement this conclusion, notably the sheer volume of capital awaiting allocation and the outlook for multifamily relative to other commercial real estate classes. According to data from Preqin Ltd., private equity firms across the globe hold an estimated $328 billion in “dry powder” for real estate deployment. Data in early 2020 from Jones Lang LaSalle, one of the largest commercial real estate firms worldwide, showed that new capital raised in 2019 surpassed $100 Billion for the first time and in the U.S. alone “dry powder” is nearly $200B, close to the historic high set in 2018. With near-historically high spreads between the 10-yr Treasury rate and multifamily cap rates, the amount of “dry powder” sitting on the sidelines, and the unprecedented disruption in alternative CRE classes such as retail and hospitality, the yield for multifamily is expected to remain near historic lows and may see further compression heading into 2021 and 2022.
While the pricing outlook remains relatively stable for multifamily, so too does the income generated by these assets. While other commercial real estate classes like office and retail face rising delinquency and questionable long-term demand, multifamily fulfills the basic need for shelter without the subjection to social distancing measures. Throughout the COVID-19 crisis, this unfettered demand is illustrated in multifamily’s resilient rent collections relative to other real estate classes. According to the National Multifamily Housing Council, nearly 91% of apartment tenants made May rent payments, making multifamily’s collections almost double that of free-standing retail and even outperform the healthcare sector. Armed with a resilient track record through the pandemic’s most difficult period, investment decisions must be made by quantifying the risk to future income growth. Fortunately, the future, especially in states like Texas, shows resilience as well.