Underwriting assumptions for prime multifamily assets are starting to stabilize for the first time since the Federal Reserve began raising interest rates last year, according to the latest research from CBRE.

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The average multifamily going-in cap rate rose by 23 basis points (bps) to 4.72% in the first quarter. This marks the first significant quarterly deceleration in cap rate expansion, after seeing increases of 39, 36, and 38 bps in the three preceding quarters.

According to CBRE, cap rate deceleration aligns with the slowing of unlevered internal rate of return targets, exit cap rates, and rent growth in the first quarter.

“Since Q1 2022, the average going-in cap rate has expanded by 136 bps to 4.72% and now eclipses the pre-pandemic average by 51 bps,” stated the research brief. “Though further expansion is expected, underwriting assumptions for prime multifamily assets will likely peak in the second half of 2023. Even as expansion for going-in cap rates has been more dramatic than exit cap rates, a positive spread has remained between both, though the margin is slimmer than ever at 27 bps.”

Among the 15 major multifamily markets tracked by CBRE, Austin has the lowest risk requirements on an underwriting basis for the sixth consecutive quarter. No market saw improved multifamily metrics, but markets with fewer changes, such as Boston and Seattle, improved on the risk spectrum.

Five markets had no additional expansion of going-in cap rates in the first quarter compared with all 15 recording higher going-in cap rates in the third and fourth quarters of 2022. According to CBRE, “this provides additional evidence of broader stability in multifamily underwriting assumptions.” In addition, 10 markets had no additional exit cap rate expansion in the first quarter versus only two in the fourth quarter.

Over the past two quarters, underwriting assumptions of annual rent growth for the first three years of prime multifamily deals have decreased. CBRE’s research brief stated that the type of markets driving rent growth appear to have changed, with gateway markets having higher average rent growth assumptions, opposite of what was seen in early 2022. While gateway markets suffered the most during the pandemic due to out-migration, markets like Boston and New York have bounced back as people return to the cities.

The long-run average for rent growth assumptions is approximately 3%, which is slightly higher than the 2.9% expected as of the first quarter. According to CBRE, as markets stabilize, assumptions for rent growth should drift lower but will eventually settle near the long-run average.

“Multifamily investors remain cautious in the current environment, though many markets are seeing little additional degradation of their fundamentals. Once interest rates stabilize, there should be an increase in activity by buyers, sellers, and lenders,” according to the research brief.