With the exception of Manhattan—a market that’s the exception to many rules—the nation’s core coastal markets saw little, if any, cap rate compression last year.

The data, below, reflects the fact that those markets were already pretty heated in 2010, so cap rates didn’t have far to fall, even during a year in which interest rates fell to historic lows. While cap rates fell 100 basis points in Manhattan last year, the average cap rate actually increased in Boston and San Francisco. And there isn’t expected to be much of a rise in values in the nation’s core markets this year.

“Frankly, I don’t know that you can squeeze any more out of those markets,” says Greg Willett, vice president of research for Carrollton, Texas-based MPF Research. “At this point, you’re certainly paying enough for those properties that you have to question the return. The next phase, after you’ve bought up the best product in the most desirable markets, is to take that capital and put it into development.”

As a bellwether of the industry, consider Behringer Harvard. Throughout the recession, the Addison, Texas-based company was one of the industry’s most active and aggressive acquirers, a beacon of opportunistic investment. In 2010, the company spent an astounding $855 million on apartment buys, second only to industry titan Equity Residential.

But last year, Behringer Harvard wasn’t even among the Top 10 most active buyers.

“Cap rates have compressed to a level where you have to be very selective and maybe look at alternative locations to meet your return expectations,” says Mark Alfieri, executive vice president and chief operating officer for Behringer Harvard Multifamily REIT 1. “We’re very deliberate about our investment style, and with cap rates compressing, we’ve deployed capital in other areas,”

Like many multifamily investors, Behringer Harvard sees better yields in development these days. The company recently broke ground on its first in-house development project, not far from its headquarters in Addison, Texas. Behringer Harvard has also closed on a few land sites in Austin, Atlanta and Costa Mesa, Calif. and intends to break ground in those markets in the next 12 months.

Financiers have also followed this trend. Life insurance company Northwestern Mutual has always focused its commercial real estate lending efforts on apartments—about 27 percent of its loan portfolio is multifamily, as is about 31 percent of its equity portfolio.  
The life company had one of its biggest years in 2011, lending $4.5 billion to commercial real estate deals, $1.1 billion of which was in multifamily. Northwestern Mutual lent another $700 million to apartment developers last year by pairing a debt execution with its equity program—bringing its multifamily debt volume up closer to $1.8 billion.

But like many financiers, Northwestern Mutual knows it has to get creative to continue growing its book of business.

“We’ve already penetrated enough into the big markets and big deals, and so suddenly we’ve got to find some new tricks to expand our market share,” says David Clark, a vice president of Milwaukee, Wisc.-based Northwestern Mutual. “If you’re going to go into secondary and even tertiary markets, the sector you want to do it is apartments. It could be that we just need to beat the bushes to find more deals.”