Can cap rates drop even lower?

The national average cap rate for apartment transactions hit 5.6% in July, down from 5.7% in the middle of the year, according to market research firm Real Capital Analytics. And as we enter the fourth quarter “busy season” with a still-healthy risk premium, that national average will most likely see further compression.

“I wouldn’t be surprised to see it tick down again by year's end, depending on what the 10-year Treasury does,” says Kim Betancourt, director of economics for the multifamily division of Fannie Mae.

The yield on the 10-year Treasury continues to hover at historic lows, and that's kept the risk premium—or the gap between the 10-year Treasury and a given cap rate—in a sweet spot. So, as long as interest rates remain low, today’s historically low cap rates still pencil out.

Unlike the compression seen during the height of the last upturn nine years ago—when the average risk premium was only about 110 basis points—today’s market isn’t being driven by the short-term view (i.e., condo converters) but by a long-term perception of multifamily as a safe haven.

“Right now, investors are getting compensated for their risk, and I think when you look at all of the commercial property types, multifamily is still viewed as one of the safest,” says Betancourt. “I think it’s a question of, if you’re an investor, where else are you going to invest?”

In the wake of the Brexit vote, more international capital may target U.S. commercial real estate in general—and multifamily in particular—creating even more competition for deals.

“As global capital looks for places to invest, I think U.S. real estate directionally looks good, and the multifamily story, even though we’re late in the cycle, still seems compelling to a lot of investors,” says Mitchell Kiffe, a senior managing director with brokerage firm CBRE.

Kiffe has seen an acceleration in Chinese private equity looking to find a home of late, and he points to that trend as well as the recently announced $1 billion fund created by the German firm HANSAINVEST, in a partnership with Bell Partners, as examples of foreign capital stepping up.

But investor appetite has generally shifted, and some of the trends that characterized the 2015 transaction market are evolving as investors search for yield.

“There’s less capital interested in core Class A multifamily communities, and there’s more investor demand in the value add space and, perhaps to a lesser extent, in the core-plus space,” Kiffe says.

What’s more, the large portfolio- and entity-level transactions, such as the massive Home Properties or Associated Estates deals of last year, have quieted down, the MAA–Post merger notwithstanding.

“We really have seen a major drop-off,” says Kiffe. “There have been some portfolio trades, but they’re smaller. So I’d say portfolio transactions have been less, but the one-off, the modestly sized portfolio transactions, have held up pretty well, and we would expect the fourth quarter to be very strong.”