Look for Cap Rates to Head Higher

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With strong local fundamentals for apartment investment and healthy prospects for employment growth supporting apartment values. Cap rates were averaging in the mid-5 percent to low-6 percent range for most of 2007. The accompanied chart reflects data collected through 3Q2007 and primarily Class-A assets. Investor demand is strong for A product in A locations, and for B product in B locations of the valley. Only in the past few months of 2007 have I noticed that Class-C rates have begun to compress - in the high-7 percent range...I think they may head even higher.


I predict investors going forward will require higher yields on their investments...(cap rates), and acquisitions based upon pro forma is basically a non-starter. Especially for Class B/C properties under poor management or locations. If the property can't show a cash flow at acquisition it will be difficult for the investor to finance these deal, thus causing cap rates to increase in order to clear the market.


Cap Rates may rise across-the-board but the gap between Class-A and B/C may widen further. For the past few years B and sometimes C properties have been trading at the same cap rates as prime Class-A. For well located, well managed deals, I've been successful in selling those deals that are true value-add with prospects for redevelopment. That should continue for 2008 as well. But, owners in off-locations may need to buckle-up, their ride may get rough.


In summary, Class A in A locations - expect their cap rates to increase 25 to 50 basis points and Class C in challenging markets may reach 130 basis points higher.