It’s no secret multifamily valuations are through the roof with cap rates at all-time lows as capital pours into multifamily real estate, especially in high-growth southeast markets. In addition to cap rate compression, we’re experiencing unprecedented rent growth, driving values up further.

The combination of compressing cap rates and rent growth is leading to eye-popping valuations, most notable on a price per pound basis. In the Florida apartment market, where I’m most active, many 80’s vintage deals are trading for ~$350k+ per unit and new construction deals are eclipsing the $400k and $500k per unit mark. These prices are particularly noticeable as the same deals traded for half that value 2-3 years ago.

Let’s look at two deals that recently traded:

• 359 unit, 1984 vintage located on the east coast of FL. Traded for $156k/unit in 2017 and is now under contract for $350k/unit. The current owner did minor value-add work and the deal is trading for 124% of the previous sale price.
• 432 unit, 1973 vintage deal located on the west coast of FL. It traded for $69k/unit in 2015 and then for $96k/unit in 2018. It underwent a substantial reno and is now under contract for $217k/unit. The buyer intends to put $36k/unit into it ($269k/unit all-in basis) and sell it in 3 years for ~$332k/unit.

When you’ve followed these deals over the past 10 years like we have (and had the opportunity to buy years ago), it’s difficult to get comfortable paying 2x-3x the price it previously traded. It’s a psychological barrier that’s difficult to overlook.

I’m not saying today’s valuations are out of hand or buying at today’s values will lead to poor returns,  but to win deals in today’s hyper-competitive market requires a uniquely bullish view on the market.

Here’s how to think about buying deals today.

Compare price per unit to the cost to build new while ignoring prior trades. If you’re too focused on comp’ing out the price per unit, you’re never going to get deals done. You’re likely setting a record on a price per unit basis for 90’s vintage properties or for deals with 8’ ceilings. The more relevant comparison is the cost to build new in that market. If it’s a supply-constrained market with high land costs, the cost to build new garden-style product could be $400k+ per unit. When it cost $400k/unit to build, buying a nice deal that’s fully leased with upside at $350k may not look so bad.

Don’t put too much stock on the going-in cap and focus on the mark-to-market cap rate and stabilized yield-on-cost. Going-in caps, adjusted for taxes, are sub-2% on many deals in high rent growth markets. That’s tough to stomach, especially given that debt spreads are blowing out, but it’s also a bit misleading. With rents growing 30%+ over the past year, there’s significant loss-to-lease embedded in the rent roll. When marking all leases to market, the going in yield may be closer to 3.5% – 4%. Not terrible. Assuming this is a value-add deal, the stabilized yield is likely north of a 5%. If the property is in a quality submarket poised to experience outsized rent growth, it quickly becomes a solid deal. Owning a newly renovated property at a ~5.5% yield is less risky than building to a ~4.5% – 5% yield.

I’ve been hearing from many industry professionals that “now is a good time to buy and a good time to sell”. It’s definitely a great time to sell and very well may be a good time to buy as long as you’re selective, have a long-term time horizon, strategically add value, and have appropriate return expectations.  

Matthew Gottesdiener may have put it best.