Cap Rate Trends of Major US Cities

National Multifamily Cap Rate Trends Q4-2021

The cap rate is typically calculated by dividing a building's net operating income (NOI) by the fair market value of the building. As a result, a high or rising cap rate is deemed more desirable. This is because a high cap rate implies that the building is more profitable per dollar of investment and has a higher return on investment.

As of 2021-Q4, the Freddie Mac Multifamily Apartment Investment Index (AIMI®) national average Benchmark has various changes. The 1-year cap rate benchmark decreased by 2.37%. Meanwhile, the 5-year benchmark only decreased 0.78%, while the 10-year benchmark decreased 7.62% for multifamily apartments. This is derived from the following factors.

110% Increase to Housing Price Index (10-Year)

Between Q4 of 2011 and 2021, housing prices ballooned as they recovered from the national housing crisis. As the fair market value of homes climbed, the inverse happened to the federal cap rate averages. The 7.62% cap rate decrease between the periods is due to housing prices increasing faster than the NOI index. As a result, multifamily units became less profitable as housing prices rebounded.

0.58% Decrease in Mortgage Rates (5-Year)

Mortgage rates reached rock bottom lows of 2.95% in 2021-Q4. This resulted from the Federal Reserve lowering interest rates to provide economic stimulation throughout covid. This had the effect of increasing property valuations more than the increase to net operating income.

Lower interest rates incentivize more homebuyers. This is because the cost of borrowing decreases, and more buyers can qualify for loans. The decreased mortgage rates are a factor behind the 43.57% 5-year multifamily price index increase. Rising property valuations decrease cap rates because they are the denominator. The 0.78% decrease in average cap rates for the 5-year benchmark is due to the lower mortgage rates stimulating demand and raising prices.

16.5% Increase in NOI (1-Year)

NOI is calculated by subtracting operating expenses and vacancy/credit losses from revenues. The net operating income index ballooned between Q4 of 2020 and 2021. While this would have a positive effect on cap rate increases, the 1-year cap rate index decreased by 2.37%.

Although NOIs saw astonishing growth, the national cap rate decreased because property prices grew faster. For example, during the same 1-year period, the national multifamily price index increased by 19.60%.

Moving forward, the expiration of various rent control moratoriums and the gradual return to normalcy will likely lead to an increase in revenues. Additionally, higher inflation rates will allow landlords to increase inflation-adjusted rental agreements significantly.

However, rising interest rates and economic downturns may affect operating expenses and vacancies. What remains to be seen is if revenues will grow faster than operating expenses over the coming years. This will have a positive impact on NOI, and cap rates around the country.

Cap Rate Trends Comparison

Cap Rate Trends for New York vs Los Angeles

Highest 10-Year Cap Rate Increase

Chicago ranked as the top city for 10-year cap rate increases. It was second place for one and 5-year cap rate increases, following New York. Over ten years, Chicago saw the benchmark multifamily cap rates increase by 18.51%. This contrasts with the national average, which decreased by 7.62%. This implies that multifamily units in Chicago became more profitable per the fair market value of the building. Meanwhile, the cap rate index increased 21.38% over five years and 11.12% over one year. The astonishing increase can be traced back to Q1-2017.

Flatlining Chicago Price Growth

The Chicago multifamily price index increased 11.45% from Q1-2017 to Q4-2021. This flatlining growth positively affects increases in the cap rate index. This is because the market value of real estate is the denominator of the cap rate formula. This suggests that if property values increase more significantly than NOI, there will be slower cap rate growth. The slowing price growth of Chicago multifamily properties is part of the dramatic cap rate increase.

Decreasing Mortgage Rates

The real estate industry widely understands the effect of decreasing mortgage rates on cap rates. A lower borrowing cost decreases the income needed to break even on a property.

The average 30-year fixed-rate mortgage in Chicago decreased from 3.94% in Q1-2017 to 2.95% in Q4-2021. This significant drop helped landlords become more profitable and increased the city's ranking for cap rate increases.

What's important to note is that this drop in mortgage rates was not unique to Chicago. It was a national trend. So while decreasing mortgage rates may have impacted cap rate increases, it's likely not the only or most significant factor.

NOI Increases

Chicago's NOI increased 25.75% from Q1-2017 to Q4-2021. This increase can be attributed to decreased operating expenses and vacancy/credit losses. As mentioned earlier, the decrease in mortgage rates was also a significant cost reduction for landlords.

To put these NOI changes into perspective, covid rent freezes prevented increases to monthly rent on Chicago. This suggests that most of the NOI changes were influenced by a cost reduction.

Lowest 10-Year Cap Rate Increase

Las Vegas has consistently seen one of the most significant cap rate decreases across the United States. Over ten years, the city has seen a 31.46% reduction compared to the national average of -7.62%. Over five years, the cap rate has decreased by 16.77%. However, Las Vegas also ranked second for a 1-year decrease, dropping 8.71%. The decrease is primarily due to ballooning property price increases.

258.6% Increase in Housing Price Index (10-Year)

As previously mentioned, increasing property values have an inverse effect on cap rates. Las Vegas' dramatic cap rate decline can be traced back to when property prices bottomed around ten years ago. Afterward, the multifamily price index increased 212.02% between Q4-2011 to Q4-2021.

If property values increase faster than NOI, cap rates decrease. This is because price increases are the denominator of the cap rate equation. So an increase in property prices will result in a decrease in the overall cap rate. Las Vegas' significant price increase is likely due to the city's intense job and population growth.