The multifamily (apartment) investment market continues to lead the way among real estate segments as a favorite for investors nationally. Locally, the same is true with student housing (near the University of Illinois) being the preferred investment of choice. According to data provided by Whitsitt & Associates, capitalization (cap) rates for “on-campus” multifamily sales have generally been in the 7.5% to 8.0% range since 2007. However, investor interest in this property segment began to put downward pressure on cap rates in 2011. Cap rates in 2011 were clustered in the 7.1% to 7.6% range, and sales in the first quarter of 2012 have shown additional downward pressure. Multiple sales in 2012 have resulted in cap rates below 7.0% which have put these assets on par with some of the lowest risk real estate investments in the nation. (For more information on capitalization rates: http://en.wikipedia.org/wiki/Capitalization_rate )
Rents have certainly increased since the housing meltdown, but not at the same rate that cap rates have fell. The result is that investors are paying more for properties without the guarantee of higher future returns. Why is student housing in particular so popular? Part of the equation is that people return to college during and after a recession in order to increase their earning potential. If one cannot get a good paying job out of high school, college looks like a good place to be while the economy turns around (for those who can afford it). Money cannot “sit on the sidelines” forever which likely explains why investors are looking for alternatives to the volatile stock market and ultra low bond rates. When these investors look at the real estate market, multifamily housing is the clear favorite. Thus competition for these assets pushes rates down. The long term outlook for multifamily housing (student or otherwise) remains solid, but the rapidly declining cap rates beg the question: “how low will cap rates fall?”
We saw a similar trend in 2005-2006 when cap rates for the retail and office segments were the lowest in the nation (5.0% – 6.0%). Locally, those same assets that sold at unbelievably low cap rates (many to out of state investors) are now bank-owned or have already sold at dramatic discounts. The major difference this time around is that a major recession would not hurt vacancy rates on multifamily housing like it did for retail and office as a result of the Great Recession. Instead, the economy would need to have a dramatic turnaround to hurt vacancy and rents (and therefore values) on multifamily properties. Quick explanation: higher employment and higher salaries would result in more single family home buyers and thus lower rents and higher vacancies in the multifamily sector. Also, the opportunity to make a good salary without a college education would drive down enrollment at most universities, thus hurting student housing values.
The likelihood of such a dramatic shift in the economy is very low (in my humble opinion), which points towards the continual appreciation of student housing values. New construction and the addition of units to the market could hurt vacancies; but the continued unavailability of capital, high land values in campustown, and still relatively high constructions costs make it unlikely that developers could saturate the market. Student housing is far from a “no-brainer” investment with location, age, and functional obsolescence being major factors to consider. Falling cap rates and rising values will continue to price many buyers out of the market, eventually slowing the decline in cap rates. How low will they go? We’ll just have to wait and see.
Matt Wavering is a commercial real estate broker with Coldwell Banker Commercial Devonshire Realty and can be reached at 217-352-7712 or mjw @cbcdr.com
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