Recent multifamily investment volumes indicate an early but potentially growing emphasis on low-rating properties. Indeed, as the chart below shows, from the first quarter of 2010 through the first quarter of 2013, Class B and C sales transactions were substantially higher than those for Class A properties. (The data do not reflect the recent, $16 billion Archstone–AvalonBay–Equity Residential transaction, in order to avoid skewing the results.)
A further look at the Class A and B transactions shows that their shares have changed gradually over time. In 2010, following the recession, the percentage of Class A transactions was close to 30 percent of all sales, and Class B transactions represented close to 40 percent. Between 2011 and 2012, however, the proportion of Class A transactions slipped toward the 20 percent to 30 percent range, while the portion of Class B transactions moved up, fluctuating above 40 percent.
More recently, between the last quarter of 2012 and the first quarter of this year, Class A transactions represented only, on average, 19 percent of all multifamily sales, while the average Class B transaction share during these two quarters was 47 percent. In the first quarter of 2013 alone, the Class A and B numbers were 13 percent and 53 percent, respectively. Preliminary second-quarter 2013 data roughly support these observations, with a split of 20 percent and 48 percent, respectively, between Class A and B transactions.
The Meaning Behind the Numbers
More data are needed to establish a trend, because although the slippage in Class A sales may seem significant, the change may be due to the gradually shrinking number of top-quality properties available for sale. Investor preferences may be shifting toward less-sophisticated properties because high-end properties may not now offer the return opportunities they tendered early in the recovery.
Conversely, lower-end properties may still be priced reasonably and perform well when properly marketed and managed. These properties appeal to young households with sizable student and consumer debt who are willing to trade luxury for cost and location. The communities may also attract renters who continue to rebuild their finances after transitioning out of the recession’s distress situation.
The potential shift between the class transactions, does, however, seem to be supported by the gradual compression in cap-rate spreads between high- and low-end–property transactions. Between the first quarters of 2012 and 2013, the cap-rate spread between Class B/C and Class A property transactions shrank by about 25 basis points, and the cap rates associated with Class B/C transactions declined by more than 50 basis points. The compression, which is also observed using preliminary second-quarter 2013 data, suggests that investors have progressively bid up the prices of low-rating properties.
ISO ROI
Although volume variations will likely be gradual and continue to fluctuate from quarter to quarter moving forward, one thing is clear: As the multifamily cycle peaks, especially in the top-tier property segment, investors will inevitably search for additional return opportunities by turning to more-basic, less-stylish, but well-occupied properties. This change will become even more evident if financing continues to be affordable and available.
Luis Mejia is director of research, multifamily, for PPR, a CoStar company. He can be reached at [email protected].
