As borrowing costs rise, can high apartment valuations persist?

This article is the third in a series exploring the impact of rising interest rates on the U.S. multifamily housing market.Click hereto read the second article.

In May, apartment property transaction prices continued to set new historical records, but as interest rates climbed, some observers began to question whether such high valuations could be sustained.

According to MSCI data, the Real Capital Analytics Commercial Property Price Index (CPPI) showed apartment prices rose 23.7% year-over-year in June.

However, rising borrowing costs are prompting buyers to demand price reductions from sellers and squeezing some potential investors out of the market, and these observers believe apartment prices face downward pressure.

"Valuations must inevitably come down," said Aaron Cohen, Chief Operating Officer of CGI+, a Woodland Hills, California apartment owner. "Many properties are trading at capitalization rates below 3%, and valuations are indeed unreasonable."

But not everyone agrees with Cohen. Others believe that continued global investor interest in apartments and strong fundamentals will continue to support valuations.

Is a price correction imminent?

Earlier this year, CGI+ listedthree apartment communities in Southern California for sale, but after assessing the market, it withdrew them because it could not achieve desired prices.

Cohen estimates that actual transaction prices are 10% lower than broker valuations. He expects prices to fall 20% to 30% over the next six months.

"This is just the beginning," Cohen said. "If interest rates continue to rise, valuations must decline, otherwise investors will face lower returns."

Swapnil Agarwal, CEO and founder of Houston apartment owner Nitya Capital, holds a similar view.

"I think pricing on these assets will decline significantly," Agarwal told Multifamily Dive. "This is just the beginning."

Daniel Jacobs, partner and head of credit at New York-based ACRE, said the biggest risk in the interest rate environment is that rates could rise sharply, putting pressure on borrowers' debt service capabilities. ACRE is an institutional fund manager that invests in multifamily properties as both an owner and a debt provider.

"I don't think we're there yet," he said. "We're focused on the next 12 to 18 months. If rates rise and financing costs increase, it will continue to push valuations down."

Capital influx may provide support

Over the past two years, capital fromaround the worldhas continued to purchase U.S. apartments, and some indicators show market interest is still growing. MSCI said the number of independent buyers in the market in the second quarter of 2022 increased by 13% compared to the same period in 2021.

Ric Campo, CEO of Houston-based Camden Property Trust, noted that some buyers are all-cash transactions and therefore unaffected by interest rate fluctuations. This REIT can issue stock and acquire equity, making it one of the cash buyers.

"There is still a lot of capital looking for investment targets,"Campo told Multifamily Dive in May。

Can fundamentals continue to support valuations?

Over the past year,record rentshave driven apartment demand. Although rent growth may slow, the supply-demand dynamics for multifamily housing remain strong.

"People are paying relatively high prices, but they are also getting substantial growth," Campo said. "That's why there is a fairly solid floor under prices. With such strong income growth, prices won't fall."

If rents decline, valuations could be impacted. But Jacobs believes that won't happen in the short term. "Multifamily fundamentals remain strong," he said. "We continue to see strong rent growth and very high occupancy. Our portfolio is performing extremely well."

In fact, economic volatility could further boost the sector. Kyle Draeger, senior managing director of multifamily debt and structured finance at CBRE Capital Markets in Los Angeles, noted that apartments are often viewed as the safest commercial asset class during turbulent times: "If you're going to shift to an asset class, it's likely to be multifamily," he said. "From a stability perspective, affordable housing is even better, with no liquidity issues."

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