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Suburbs Narrow Pricing Gap as Urban Appreciation Stalls

Suburbs Narrow Pricing Gap as Urban Appreciation Stalls

In making an investment decision for a long-term hold, there is generally more confidence to deploy capital in the urban core, as these are perceived as the stable economic anchors in the local economy. However, that thinking is changing as the current cycle wears on, as apartment investors are turning their attention to suburban assets.

Apartment transaction data from Real Capital Analytics® shows that increased investment in the suburbs is causing prices for those assets to rise and cap rates to fall. Meanwhile, investors are finding the volume of urban core assets available for purchase more scarce, both from an availability and pricing standpoint. In turn, appreciation in the urban core has essentially stalled, and cap rates have remained at low levels. Those trends have resulted in prices and cap rates narrowing among urban and suburban areas.

Among the top 50 U.S. markets, excluding New York City, appreciation for all apartment assets has picked up significantly since mid-2014. In total, the average price per unit bought and sold over that time has risen 45.6%, landing at $160,000 as of mid-2018. At the same time, cap rates have decreased 60 basis points, to 5.4%.

These overall trends mirror movements seen in suburban areas. The average price per unit in the suburbs has risen 48.4% since mid-2014, compared to an overall increase of 22.1% for urban assets. Likewise, cap rates have decreased 70 basis points (bps) in the suburbs and only 20 bps in urban areas.

Lesser price appreciation in urban areas reflects that prices for those assets have essentially plateaued over the past four years. The average price per door has remained around $235,000 to $255,000 over that time, with relatively little upward momentum.

With these trends, the suburbs are making up ground in terms of pricing. An average suburban asset sold for $148,000 per door in mid-2018, roughly 75% less than an urban asset. While that’s still a large gap, it’s well under the difference seen in mid-2014, when urban units were more than double that of the suburbs. On average, urban units have garnered roughly $116,000 more per unit since mid-2014.

Urban properties maintaining such a price premium over their suburban counterparts reflects that investors remain confident in these areas over the long term. These areas remain employment hubs in most markets, and are attractive to high-income young adults. For these and other reasons, urban areas generally command higher rents. In 2nd quarter 2018, an apartment located in the urban core had an average effective rent of $1,862, while suburban rents were considerably lower at $1,262 in the top 50 markets studied.

Some of that thinking has extended in recent years to suburbs with healthy employment growth and favorable demographics. However, performance across suburbs is varied, with high-performers and laggards among them. In short, not all suburbs offer equal investment opportunities, so transaction activity varies by location.

Apartment pricing and performance trends in both urban and suburban areas have influenced cap rates. In urban areas, cap rates, like pricing, haven’t moved much over the past four years, remaining around 5%. Cap rates for urban assets landed at 4.9% in mid-2018. Meanwhile, suburban cap rates landed at 5.4% in mid-2018, just 50 bps higher than in the urban core.

That spread is one of the lowest since the cycle began in 2010. The spread narrowed to just 20 bps in mid-2012, as cap rates registered 5.9% in the suburbs and 5.7% in the urban core. But in the quarters soon after, divergence occurred, as cap rates in urban areas began to compress, but suburban cap rates didn’t budge. In the suburbs, it wasn’t until the end of 2014 when significant movement occurred in suburban areas and cap rates there fell.

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