Midwest momentum: Search for yield fuels robust multifamily sales

ST. LOUIS, MISSOURI (March 10, 2022) - From an investment standpoint, the Midwest often gets overshadowed at the institutional level by the highly desirable sunbelt and coastal markets. As a result of the competitive bidding environment in these markets, the Midwest apartment sector has stepped into the spotlight, with a surge in new capital that is pushing cap rates into record low territory across the region. The increased demand we are seeing is fueling historically low cap rates and overall pricing.

Last year, Northmarq’s Midwest brokerage team sold $560 million in multifamily assets totaling 5,300 units in six states. That momentum has continued into the first quarter of 2022, with a deep pool of buyers pursuing investment opportunities in secondary and tertiary markets throughout the Midwest. Demand has been heightened by investor’s perceived pricing discount, compared to other markets; we have seen twice as many buyers at the table on nearly every deal, compared to 2 or 3 years ago.

One of many recent examples of the growing investor interest in the Midwest is the sale of Fairways at Lincoln, in Lincoln, Nebraska. Built in 2007, the property’s 613 units offered immediate scale for an out-of-state investor trying to enter a market that does not have high trade velocity historically. The sale closed at the end of last year, after we received 260 signed confidentially agreements from buyers across the country and 24 written offers. While these stats are typical for a similar deal in a primary market, it was extremely competitive for a property located in a Midwest town of only 350,000 residents. The asset ended up selling at a 3.75 percent cap rate, with significant nonrefundable earnest money at the contract execution, and an expedited closing timeline for the market. Investors from across the country were drawn to Lincoln’s strong market fundamentals and the potential for significant rent growth after moderate renovations to the units.

At a national level, multifamily assets posted double digit rent growth with record low vacancies in 2021. According to Freddie Mac’s 2022 Multifamily Outlook, annual rent growth was 10 percent last year, while vacancy rates declined to 4.8 percent. Although Midwest markets might not have the dynamic fundamentals like Phoenix, Charlotte, or Dallas, many local owners are benefitting from exceptional rent growth, in some cases up to 15 percent year over year. Many of our clients that own thousands of units in several states have reported double digit portfolio rent growth over the last 12 months. This staggering year-over-year rent growth is unprecedented in the Midwest.

Cap rates have continued to compress as rent growth and revenue assumptions grow. Currently, our team has multiple Class B and C properties under agreement at cap rates in the low to mid 3 percent range. Last week, we accepted an offer for a 97 percent occupied, 1960s property in St. Louis at a 2.75 percent cap with significant nonrefundable earnest money. Although cap rates have compressed, the overall return thresholds for buyers have stood firm. Inflation has been driving rents. While operating costs are up, increased rents have outpaced expenses, leading to significant increases in bottom line revenue. Buyers remain bullish on their ability to achieve successful yields, even at the aggressive pricing environment in today’s market. If rents continue to surge at recent levels, it is difficult for a property not to appreciate significantly over five to seven years, which will bolster an overall IRR.

Another factor fueling the robust deal flow is good liquidity in capital markets. Lenders across the board, from the agencies to life companies and banks, are eager to finance all types of rental housing. These lenders are bullish on multifamily of all types including workforce and market rate apartments to build-to-rent developments. Northmarq recently closed on a $46 million construction loan for the Flats at Wildhorse Village in Chesterfield, Missouri, a high-end suburb of St. Louis. There was strong demand from both local and national banks in providing the construction loan for this project due to many factors, including multifamily in Chesterfield being highly sought after.

Investors need to keep an eye on several trends that could impact their underwriting. The top-of-mind topic right now for most investors is increasing interest rate environment. However, supply chain issues, inflation, and other factors like the war in Ukraine will also ultimately affect our economy in the long-term. Macro-level rent growth will be heavily analyzed this year, even more than usual, due to the concern that multifamily fundamentals will start to “normalize.”

Is the Midwest a seller’s market or buyer’s market? Frankly, it is both. Investors continue to find good investment opportunities to fit core, core plus and value-add strategies across the Midwest. If the fundamentals we have today are here to stay, there will be many opportunities for investors to double or even or triple their equity position in a relatively short amount of time. On the sell side, current valuations are as high as ever, inciting many owners to consider a disposition while taking advantage of the market. At the end of the day, multifamily is an extremely sustainable investment over time. People are always going to need a roof over their head, especially when times are as challenging as now to buy a home.