Now that the Manhattan multifamily market is in a slump, investors and other market participants have been asking me to compare current conditions to various points in previous cycles in the past 25 years. They want to know what the market looked like in the 1980s, when we were booming, and in the early 1990s when we almost went bust. What were the peak-to-trough comparisons then? How long did the recovery take? They have the same questions about what happened before and after the recession of the early 2000s. Above all, they want to know how low the market is going to dip this time, from its high point in 2007.
Looking at the market from 1984 (the year I started selling buildings) to the present, we notice cyclical patterns that indicate that to some extent, history repeats itself. However, it has never been easy to anticipate the peaks and the valleys.
The most effective way to analyze Manhattan’s multifamily market over the past generation or so is to compare capitalization rates and gross rent multipliers (GRMs) during that period.
The “cap rate” is the ratio of a property’s net operating income, and either its original price or current market value. In other words, if you paid $1 million for a building that nets $60,000 in a year, the building’s cap rate is 6%. This is a way of determining how soon a property will pay for itself. By dividing a property’s cash flow by its cap rate, you can estimate the property’s market value. The GRM is simply the ratio of a property’s price to its annual rental income before expenses. The multiplier is the number of years it would take a property to pay for itself in gross received rent.
While GRM analysis is useful—particularly in a regulated environment such as we have in New York City—cap rates are stronger indicators of the relationship between a property’s risk and its cash flow growth potential. The price of a higher-risk property should be justified by a higher cap rate, while a property with a low cap rate should show greater upside potential in its cash flow.
By itself, a building’s cap rate doesn’t mean much. You have to compare that rate with those of similar properties, and observe how the building’s cap rate has changed over time. You also have to compare it to changes in commercial mortgage rates and 10-year Treasury bill rates.
Graph A shows the 25-year trend in cap rates for both walkup properties and those with elevators. The average cap rates for that period have been 8.40% for walkups and 7.68% for elevator buildings—but you can see that in the mid-1980s, average cap rates for both walkups and elevator buildings were in the double digits, and that in the mid-2000s they’re much lower.
Click here to read full article and for further graphs analyzing Cap Rate vs. GRM
Agents: Robert Knakal