By Jim Costello on April 24th, 2017
Coauthored by Elizabeth Szep.
U.S. apartment deal volume has dropped at double-digit year-over-year rates for four months in a row. With deal volume down so sharply, market participants are asking what is driving the pullback. Are buyers no longer in the market or are sellers simply not motivated to bring assets to market? The answer: a little from column A, a little from column B.
The apartment sector has seen the strongest price growth among asset types since the Global Financial Crisis according to the Moody’s/RCA CPPI, and was the only property type to see an increase in investment volume in 2016 compared to the year prior. But with the rush to place money in these assets, prices have been pushed to their limits and pricing expectations between buyers and sellers are beginning to diverge – selectively.
To better understand the pricing expectations we looked at the degree to which sellers have had to move off of their initial asking prices as they bring apartment assets to market. Over the last year there has been a clear and growing disconnect on pricing in the 6 Major Metros (6MM) versus the Non-Major Metros (NMM).
On average, over time, sellers have achieved 94% of their asking price when bringing apartment assets to market in the 6MM versus 93% in the NMM. Since Q1’16, however, sellers in the 6MM have seen a steady decline in the pricing they can achieve when bringing assets to market. The 95% level achieved in Q1’16 slipped to only 93% in Q1’17.
By contrast, in the NMM sellers are still achieving more than their historic averages when bringing assets to market. Final sale prices came in at 95% of the ask in Q1’17 for apartment assets in the NMM.
Not coincidentally, deal volume was stronger in the NMM in 2016 than in the 6MM. Buyer and seller price expectations were better aligned in these markets and deals will continued to be done. In the 6MM, deal volume fell 13% in 2016 versus 2015 while it grew 16% in the NMM.
In conclusion, one may expect a bottlenecking of deal volume in Major Metros until sellers realign their price expectations with the current buyer pool. In this time of uncertainty and expectations for rising interest rates and cap rates, historically low single-digit cap rates may be seen more as a risk than a promise of value.