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Compressed Cap Rates and Higher Risk Pushes Multifamily Investors to Forgo Older Assets

With a shrinking delta in cap rates between assets of different vintage, many investors opt to go with lower risk newer properties and fewer capital expenditures.

Over the past few years, the delta between cap rates and valuations for older multifamily properties—those completed before 1996—and newer properties has narrowed. In fact, it’s narrowed so much so that investors who’ve traditionally preferred to buy older apartment assets are now “trading up” to much newer properties.

Orion Real Estate Partners is one such investor. The Los Angeles-based firm recently acquired Remington Ranch, a 180-unit apartment community in San Antonio that was built in 2008. With 80 percent of the property’s units in original condition beyond cosmetic repairs, Remington Ranch is “an ideal candidate for a value-add unit renovation,” according to Marc Venegas, principal with Orion Real Estate Partners.

While Remington Ranch features all the physical amenities that residents expect in a newer property, it lacks the quality of finishes of a recently completed building. This “makes it easier” for Orion to execute its business plan, Venegas notes, adding that the firm plans to invest approximately $2.6 million in interior and exterior improvements.

“Historically, when you bought an older property, you got a better price per unit and a better cap rate than you would on a newer property, which gave you more ability to push rents and make a return,” Venegas says. “But over the last few years, those spreads went away, and investors weren’t getting the same benefit for buying older properties that they used to. Old or new, you were almost paying the same cap rate.”

That’s why Orion decided to go new or go home. “We thought: if we’re going to be paying these prices, we might as well look for newer, nicer properties so if the economy turns, we can hold for the next 10 years and not have to spend money on deferred maintenance like boilers and roofs,” Venegas says. “While all that is important, it doesn’t generate any additional rent or better returns.”

Delta between older and newer narrows

At WMRE’s request, real estate data firm CoStar Group conducted an exclusive analysis of multifamily deal volume over the past several years, focusing on cap rate compression for properties built within the past 15 years and those built prior. From 2014 to 2022, the average cap rate for both older properties and newer properties decreased substantially.

The average cap rate for older properties compressed to 4.3 percent from 6.2 percent, while the average cap rate for newer assets compressed to 3.8 percent from 5.3 percent, according to CoStar.

“Over the past five years, older properties really got priced up,” says Andrew Rybczynski, a principal consultant for CoStar Advisory Services who conducted the analysis. “They’re not trading at the same discount they used to.”

A more relevant number, however, is the delta between cap rates for older and newer properties: in 2014, the delta was 0.9 percent vs. 0.5 percent in 2022.

As prices for value-add apartment properties were built up during the prior cycle, investors started facing lower yields on cost when compared to their long-term cost of debt, according to Kai Pan, managing director and head of multi-housing property sector with JLL Valuation Advisory. “The rapidly rising prices for value-add apartments presented a challenge for investors to find deals that would achieve a targeted yield spread. This effect has now been magnified in the current rising interest rate environment, possibly causing investors to look to newer or core assets.”

CoStar’s Rybczynski also discovered that multifamily properties built within the last 15 years are increasingly accounting for a larger share of acquisitions, both in terms of dollar volume and number of units. In 2021, properties built during this period accounted for 32 percent of acquisition market share vs. 22 percent in 2018. The market share for older properties, meanwhile, saw a miniscule increase from 10.6 percent to 11.0 percent.

“When we look at the spread between share of multifamily product that’s trading, we can see that investors are angling more toward newer product,” Rybczynski says.

Are older assets riskier assets?

The Klotz Group of Companies was one of the first apartment investors to start “trading up” into newer properties. In 2015, it started moving away from thousands of lower end, older properties to acquire higher-end, newer vintage properties, according to Founder and CEO Jeff Klotz.

“We felt the value created was a lot more sustainable, consistent and impactful to the resident and community,” he says. “People are what drive profits, and trading up with your assets essentially allows you to ‘trade up’ [with] everyone you encounter, including vendors, lenders, employees, residents, etc.”

Experts say there several reasons that investors are now “trading up”: 1) the expense of maintaining an older building outweighs the return 2) the cost of insurance for older buildings relative to newer buildings 3) the discount-to-replacement cost and 4) renter sensitivity to inflation and economic downturns. 

Ultimately, multifamily investors who are choosing to invest in newer properties point to the increased risk inherent in older buildings. Bonaventure, an Alexandria, Va.-based apartment investor and developer that has been known to hold properties for upwards of 50 years, is investing most of its resources in developing new communities and buying newer assets.

Earlier this year, Bonaventure acquired Vida East at Church Hill in the Church Hill neighborhood of Richmond, Va., through an UPREIT transaction. Built in 2018, the 178-unit property offers renter-wish-list amenities, including controlled access, hardwood floors, designer cabinetry and granite countertops.

“We generally view older buildings as riskier assets, although they may have greater upside, and we’re willing to give up a little upside to protect against the downside,” says Dwight Dunton, founder and CEO of Bonaventure. “If we are trading up, it is primarily because the expense of maintaining an older building is now outweighing the return, and we view the risk of holding the older asset as greater than trading up into newer assets.”

Value-add expands beyond older properties

Smart investors have realized that acquiring older assets and renovating them is not the only way to execute a value-add strategy.

“Ten years ago, value-add was a relatively simple prospect and more clearly defined as buying an older asset and undergoing a physical renovation,” says Matthew Levy, head of investments for Stoneweg US LLC, a Florida-based real estate investment firm. “Given the increased competitiveness of the market, the term value-add has broadened quite a bit, and owners and investors have broadened their horizons on ways to create and unlock value within multifamily assets.”

Levy says value-add now includes managerial value add, financial value-add and physical value-add, not to mention ESG-related value-add, which can have an impact for some investors that goes well beyond the bottom line.

Like many other multifamily investors, Stoneweg US has shifted its acquisition focus from pre-1990s properties to much newer assets. Most recently, its acquired Amaze @ NoDa Apartments, a 298-unit community in Charlotte, N.C. built in 2020.

Consisting of two four-story, elevator-serviced buildings, the class-A multifamily property offers units with chef-style kitchens, walk-in showers with subway-tile accents, stainless-steel appliances and premium vinyl flooring throughout. It also features resort-style amenities including: a sky lounge with an outdoor bar area, a gaming section, fitness center, swimming pool furnished with cabanas and a firepit and a bark park and pet spa area.

“While these heavier lift older assets do have large potential growth prospects, they also come with a high degree of risk in terms of deferred maintenance, capital expenditures, riskier business plans, higher insurance premiums and functional obsolescence for some of the older properties,” Levy says. “We feel that the risk adjusted returns for 90s/00s and new construction projects that still have some sort of value-add component to them is a far better prospect for our investors.”

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