Small Balance Apartment Cap Rates Compress
Preliminary findings show that cap rates tightened in recent quarters for multifamily properties backed by small balance loans. The spread between cap rates on small and large properties also narrowed.
Cap rates for properties backed by loans between $1 million and $5 million — including both properties sold and refinanced — declined in the fourth quarter of 2015 to a national average of 5.78 percent, according to preliminary end-of-quarter findings from Arbor and Chandan Economics. Reaching their lowest levels in the Arbor-Chandan Small Balance Trend series, cap rates fell by 11 basis points from the third quarter and are 54 basis points lower than a year earlier.
As financing has become more accessible for smaller private borrowers, the valuation gap between small balance properties and the overall market has narrowed. Across all apartment properties, the national average cap during the fourth quarter was 5.24 percent, 54 basis points lower than small balance. As shown below, that reflects a significantly smaller gap than the 80-basis point spread a year earlier.
Small balance properties tumbled to their largest discounts to the overall multifamily market in the immediate aftermath of the recession; the spread in Q2 2010 peaked at more than 120 points, reflecting an average small balance cap rate of 7.60 percent.
Preliminary estimates show the national average debt yield for small balance loans declined to 8.63 percent in the fourth quarter, equivalent to $11.59 in borrowing for every dollar of property-level net operating income (NOI). The average debt yield across all multifamily properties was 7.38 percent, reflecting a significantly higher encumbrance of $13.55 per dollar of NOI.
As compared to historic ranges, debt yields and cap rates for the multifamily sector overall are at their lowest levels on record. However, both debt yields and cap rate spreads for small balance properties remain above the most aggressive levels recorded prior to the recession and financial crisis.