Valuations, interest rates slow multifamily apartment market

Northern Nevada’s multifamily apartment market has seen few sales transactions in 2023 as investors balk at taking out high-interest-rate loans and sellers eschew some significant price valuations for their properties.

Multifamily buyers in today’s market conditions often either have ample equity to put into a property, or they need a replacement property to complete their 1031 exchanges, regional commercial brokers told NNBW.

Daniel Winrod, multifamily associate with the Reno office of Marcus & Millichap, told NNBW last week that deal flow is expected to remain limited based on spiking interest rates and other key market factors.

“It’s been a challenge,” Winrod said. “Values are always based on metrics of return, and as interest rates have gone up it requires a lot more equity to do the same deals at the same price. A lot of buyers aren’t willing to pay more and get less returns, and sellers are having a hard time understanding why they need to decrease their values to meet buyer expectations.”

It’s not like Northern Nevada’s multifamily market fundamentals have radically shifted. According to the Johnson Perkins Griffin quarterly apartment survey, the average apartment vacancy in the first quarter of 2023 was a mere 2.66 percent. Average rents across all property types and classes, meanwhile, stood at $1,644, off slightly from last year’s record high of $1,680.

High interest rates aside, multifamily developers remain bullish on Northern Nevada with more than 5,000 apartment units currently under construction in the Truckee Meadows and surrounding communities.

Ken Blomsterberg, senior managing director of investments with Marcus & Millichap, told NNBW that the dearth of multifamily sales differs from the Great Recession, when landlords were defaulting on their loans because their debt load outweighed their cash flow. Today’s potential sellers, he said, simply aren’t motivated to divest and instead are sitting on the sidelines waiting for the Federal Reserve to cool off on the ongoing interest rate hikes.

“Sellers are not willing to take a big haircut on price and are instead keeping their properties full of tenants for a good occupancy rate. They are keeping a keen eye on their expenses as they wait for the market to turn,” Blomsterberg said. “It is difficult to get a seller today that is willing to take that reduction in values.”

If property owners did sell, they likely would have to trade up in value by completing a 1031 exchange in order to defer paying capital gains taxes, especially landlords with long-term holdings that have realized significant asset appreciation. The problem is that there just aren’t any comparable trades.

“Many of them say, ‘Where would I go that has a better runway than Reno,’” Blomsterberg said. “I don’t think buyer interest has waned – we still have buyers looking to get into this market. But the underwriting is different today because everyone is looking for yield and they can’t pay a 3.5 (percent) cap rate when debt is like 5.5 percent. There aren’t many buyers looking at negative leverage just to get into this market.”

Ben Galles, executive vice president with Logic Commercial Real Estate, said the late May purchase of the 100-unit Fairway Park Manor apartment complex on Berrum Lane in Reno was done to complete a 1031 exchange. Feymann Real Estate Holdings LLC of Glenbrook purchased Fairway Park Manor, which was built in 1969 and sold for $16.5 million.

“It boils down to motivation, and it’s a market completely lacking motivation,” Galles said. “But the longer the rates stay elevated the more pressure it puts on sellers — but there’s still a pretty big gap between what buyers want to buy at and what sellers want to sell at.”

An example of how interest rates have changed property values: Blomsterberg highlighted a property owner who received an unsolicited letter of intent about a year-and-a-half ago but declined to sell. That same owner currently is in contract to dispose of the same property, but for approximately a 21 percent reduction in price.

Reno has long been considered a tertiary apartment market, adds Ryan Rife, first vice president of investments with the Reno office of Marcus & Millichap. However, over the past few years Reno’s incredibly strong multifamily market fundamentals, coupled with its high job and population growth, have fueled unparalleled investor demand akin to what’s seen in larger primary markets.

“Every multifamily buyer nationwide was looking at this market and wanted to invest (in Reno) due to the market fundamentals,” Rife said. “But we are still a levered return-buying market. We have to offer a yield profile that is better than in core markets.”

Sales volume on smaller apartment complexes under 100 units is likely to be a bit more brisk, Rife added. Additionally, there could be a few more sales as developers’ construction loans come due and they need to seek more permanent financing solutions. That was the case with Westlook Resort Living on West Fourth Street in Reno. The 192-unit property changed hands without broker representation in a $68.3 million sale.

“What we have really seen is the spread between buyer and seller expectation has just been wide of each other for quite a while,” Rife added. “But the interest rate environment is the biggest hurdle we haven’t been able to bridge. I still think we will get a handful of deals done this year. We aren’t going to see 15 or 20, but we will see two or three more.”