The upward year-over-year trend in apartment transaction volume continued in the first quarter. New York-based research firm Real Capital Analytics (RCA) reported that sales of significant apartment properties jumped 7.7 percent in the first quarter, improving 47 percent compared to the first quarter of 2010. Simultaneously, the volume in dollar value fell from $13 billion to $7.7 billion, a 40 percent drop, from a very strong fourth quarter of 2010.

Garden apartments led the charge. They jumped 80 percent year-over-year to $4.7 billion in volume. Mid- and high-rise sales grew at a more modest 14 percent clip year over year. The offering volume for garden apartments in first quarter was $7.2 billion, which is about twice the mid/high-rise total. Cap rates for garden apartments are around 7 percent, while mid- and high-rises are at around 4 percent. “The yields are better in garden,” says Ben Thypin, senior market analyst for RCA.

Local Shifts
Last year, the major East Coast metros seemed to dominate sales. In the first quarter, other markets caught up. For instance, sales in Manhattan and Washington, D.C., fell (though Boston saw sales rise). "There seems to have been a slight pivot away from the primary East Coast markets. It was mostly because of too much competition for what little high-quality inventory is available, not lack of interest," Thypin says.

California markets such as Los Angeles and San Francisco saw improvements (though San Diego and Orange County recorded declines). Tertiary markets, including Broward County, Fla., and California's Inland Empire, showed strength. "People are venturing deeper into secondary markets and asset classes," Thypin says. "They're looking because there's not that much Class A inventory out there."

Across all sales, 26 percent were distressed. But even that pace is slowing down. Only $3 billion was added to the apartment distress rolls in the first quarter. That was the lowest level since the third quarter of 2008 and well below the average quarterly addition of $6 billion in 2009 and 2010.

RCA noted that one reason for the decline is that lenders are seeking more resolutions than restructuring with distressed loans. "The apartment market is seeing more resolutions than restructurings as compared to other property types," Thypin says. "The properties that haven't been resolved or restructured yet are often in more complex and hairy situations."

Future Outlook
RCA expects apartment sales to continue improving through the year, though they aren’t expected to match the pace in the resurgent office and hotel sectors. There were $4.3 billion in apartment deals under contract, but not closed, at the end of the first quarter. So, that will provide an early jolt to second quarter numbers.

The listing market is also starting to pick up with sellers bring $10.9 billion of new offerings to market. And since they match current cap rates, they have the potential to sell soon. Cap rates, in fact, stayed flat in the first quarter at 6.7 percent. “The rise in long-term treasury rates over the past two quarters had given rise to concerns about upward pressure on cap rates,” RCA said in its report.

Still, Thypin acknowledges that volume is slow enough that a few trophy assets can skew the cap rates. Cap rates and per-unit-pricing have fallen more sharply for assets in the $30 million range than for assets in primary markets. RCA thinks that means that “apartment investors are placing a smaller premium on primary market location, having stronger relative preference for asset scale and quality than market location,” according to the report.

In fact, average cap rates could move higher because Thypin says a lot of stuff on the market now isn’t as high quality as stuff that has previously sold.

"If they're trading for distressed prices, cap rates will be higher and price per unit will be lower," he says. "There's only so much good inventory out there. What's on the market now is not as high-quality inventory as we have seen trading over the past 18 months. As a result, we may see weaker pricing going forward."

Despite the uptick in the last couple of quarters, things still trail the heydays of 2006 and 2007. For instance, first-quarter volume was still slower than every quarter of 2008, except for the fourth quarter. And those numbers were pushed by the amount of deals put under contract in the last quarter of 2010.

"After next quarter, we'll have a better idea of how much more will transact," Thypin says. "We're certainly heading back toward normal, but we're probably a couple of years away from getting back to where we were in 2006 and 2007."