Multi-Family Housing Valuations Entering the Middle Innings

February 19, 2015

Multi-Family Housing Valuations Entering the Middle Innings Photo

With sub-zero temperatures outside, I am driving past Punxsutawney, Pennsylvania, where Phil cruelly sentenced the Northeast to an additional four weeks of winter. In the hope spring may arrive sooner than one pessimistic groundhog is forecasting, I could not help working a baseball reference into my title this week.

This week's chart highlights a historical perspective on valuations of multi-family properties and capitalization (cap) rates -- a property's income divided by its total value. Cap rates are broken out by showing the ten-year U.S. Treasury yield and adding a cap rate spread, a measure of how much real estate investors are paid above a risk-free rate. Multi-family housing has been the best performing sector of the real estate market since the financial crisis, and, as this chart illustrates, valuations are now higher than their pre-crisis peak.

Despite an already healthy recovery, we believe the multi-family real estate sector in the U.S. is poised for gradually improving valuations over the next five to ten years due to a combination of fundamental and demographic factors:

  1. Cap rate spreads are priced reasonably; the spread is 350 basis points today versus an average spread of 310 basis points over the past fifteen years. Long-term interest rates in the U.S. are expected to remain "lower for longer," helping to limit upward pressure on real estate cap rates.
  2. Multi-family vacancy rates are at twenty-year lows, which is clearly supportive of rents going forward. Additionally, the new supply of both single-family and multi-family housing looks to be balanced and in-line with expected demand.
  3. Trends in the domestic labor market have been gradually improving since the financial crisis. Average monthly payroll growth was $225k during 2014, the highest level since 1999. Better employment conditions combined with pent-up housing demand from Millennials should drive significant growth for multi-family housing.
  4. Technological advances are dramatically changing the ways Americans shop and work today, which is likely to negatively impact valuations for some retail and office properties. However, demand for better living space will likely never fall victim to disruptive innovation.

Key Takeaway: Despite signs of weakening lending standards within the overall commercial mortgage-backed securities (CMBS) market, we continue to have a positive outlook for the multi-family real estate market. We believe multi-family CMBS offer the best relative value opportunities within both the residential and commercial mortgage fixed income sectors.

And thankfully, pitchers and catchers report this week!

Tags: Chart of the Week | Employment numbers | Real estate | Multi-family housing | CMBS

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The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.

This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.  This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.

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