Multifamily investors are navigating a more challenging investment landscape than in recent years. While long-term conviction in the apartment sector remains intact, today’s environment continues to be shaped by low initial cash flow, elevated borrowing costs, softer-than-expected apartment performance, and broader economic uncertainty.
The combination of low rates, strong household formation, and rising rents that defined the last cycle isn't a template investors can rely on. Instead, the current cycle rewards disciplined underwriting and careful asset selection.
Lack of Cash Flow
The first challenge is cash flow, particularly for investors focused on current yield. By and large, the multifamily investment industry remains in or very close to negative leverage territory, which has been the case since early 2022. Predictions of higher cap rates or lower interest rates continue to prove overly optimistic—investors have seen glimpses of hope that either part of that equation improves, only for the tide to turn in the opposite direction due to macroeconomic and world events, most recently the conflict in Iran. As a result, the balance of total investment returns is still skewed heavily toward value creation at exit rather than cash flow received during the hold period.
For either dynamic to change, the market needs to see some combination of the following:
Meaningfully higher sales volume: Despite the cash flow challenges, there is still enough capital seeking deployment in conventional multifamily to keep cap rates down if property sales volume remains so far below the historic average. However, we have recently observed isolated situations in individual cities where a spike in properties marketed for sale have resulted in higher yields. Sales volume is unlikely to spike in every market simultaneously, so the opportunities to buy at elevated cap rates are likely to occur at specific times in individual markets.
Interest rates drop: Of the difficulties facing our industry in recent years, the availability of debt financing has not been one. The abundance of debt has kept spreads near all-time lows, but the base index (typically the U.S. Treasury or SOFR) remains stubbornly elevated. As a reference point, the last time the five-year U.S. Treasury was near 4% prior to 2022 was all the way back in 2007, just before the Great Financial Crisis. Seeing any meaningful relief in treasury yields or SOFR will require expectations for future inflation to come down, which continues to be hampered by high oil prices and tariff-related cost pressures.
The spread between multifamily Class A cap rates and the 10-year Treasury yield remains well below its historical average, leaving investors with less compensation than usual for taking on real estate risk. (Source: Zelman, a Walker & Dunlop company)
Capital migrates away from multifamily: The most frightening and, hopefully, least likely path to higher yields is for investment capital to migrate away from apartments, therefore reducing competition for future acquisitions. Throughout the 2010s, a greater share of both domestic and international institutional capital flowed into multifamily, as investors recognized the attractive risk/return profile of the residential rental space when compared with other commercial property types. Barring significant regulatory changes that materially alter the investment outlook for multifamily, capital is unlikely to change its view of apartments as one of the more reliable “safe haven” investments.
Low Hire, Low Fire, Low Household Formation
Even if cap rates or interest rates begin to improve, softer apartment fundamentals may continue to compound the cash-flow challenge. Operators are competing for a smaller-than-expected pool of renters, which limits rent growth, keeps concessions in the market longer, and makes it harder for investors to quickly grow their way out of a low initial yield.
Investors might expect apartment operating fundamentals to be in significantly better shape since the U.S. unemployment rate has consistently stayed in the low 4% range (4.3% as of March per BLS data) and a drastic reduction in new supply deliveries. But in the “new economy,” with lower immigration and greater uncertainty about the near- and medium-term economic outlook, new household formation remains tepid. While property occupancy and overall absorption of new apartment units are not so bad as to describe them as problematic, the lower-than-expected household formation limits upward pressure on rents. Concessions are also proving to be more persistent than hoped. As properties compete for a smaller-than-expected pool of renters, incentives like free rent and reduced deposits that were introduced to drive lease-up are proving difficult to walk back, even as occupancy stabilizes.
New apartment deliveries continue to taper downward, with U.S. apartment construction down to ~55,000 units nationwide in the first quarter. Apartment fundamentals should improve, but the pace will likely be more measured and gradual than otherwise expected.
Expense ‘Noise’ Can Be an Opportunity
With capital markets limiting cash flow and apartment fundamentals providing less lift than expected, expense management becomes a more important part of the investment story. In today's market, the spread between well-run and poorly run assets is wider than ever. For investors willing to do the work, that gap is where the opportunity lies.
An under-the-radar theme in recent years is the widening variation of controllable expense levels across specific properties. In many ways, running apartments became more efficient, and the delta between the better and worse operators has shrunk in the last couple of decades. However, more recently, the expense levels that specific owners are choosing to operate properties are gapping out for a few reasons:
Proptech advances: The dizzying array of new tools available in everything from marketing to payroll management has led to improvements in management practices. However, these tools are certainly not all created equal—many are costly and have questionable benefits. Many property management firms are “beta-testing” different tools in the hope of uncovering future benefits, but, in the meantime, many properties are paying “an innovation tax” for expensive services.
Capital-starved assets: The other root cause of inefficiencies in expense management is more investment-cycle driven. Specifically, there are two primary categories that are impacting expenses: properties that were purchased at or near the peak of the last cycle and properties on the tail-end of a longer-than-expected hold period.
Peak buys: Many of the assets that traded in late 2021 and early 2022 are experiencing forms of distress, whereby owners are choosing to invest less CapEx than originally planned. When less of the “big ticket deferred maintenance items” are addressed, often properties suffer from higher operating expenses.
Long hold periods: The prevalence of assets owned longer than the originally intended hold periods is leading to more ongoing expenses as well. When CapEx budgets established at acquisition are exhausted and many owners do not have the desire or capability to inject new equity into assets, larger expenses would need to be funded out of cash flow.
The trick for investors is identifying which expenses can be rightsized or addressed through capital improvements.
In a market where easy cash flow and quick rent growth are no longer reliable tailwinds, the investors who do that underwriting work carefully—and with a firm understanding of what is actually in place at the asset level—are the ones most likely to find the opportunities that others miss.