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Positive demographic trends, low interest rates and Boston’s stable economy inspired a surge of investments in the New England multifamily market. Last year, multifamily transaction volume neared $1.2 billion across the region, roughly 70 percent of the $1.6 billion peak we experienced in 2007. Transaction volume has increased every year since 2008, fueling competition for product and driving down cap rates.
Investors pursuing deals in Greater Boston’s inner ring are accustomed to cap rates in the low 4s and sometimes below. While low cap rates have been great for sellers, they are causing some investors to widen their investment parameters. Many groups are finding Boston’s economic momentum resonates beyond the 128 beltway, allowing for rental increases and limited vacancies previously unrealized.
ARA has tracked sales from Rhode Island to New Hampshire and has seen an influx of foreign equity, mainly from Asia, the Middle East and Australia. This trend represents a change from the last cycle when Europeans, mostly Germany and Ireland, were the largest foreign capital source in the region. In recent years, the majority of investments targeted by these foreign players have been in the city of Boston and the immediate suburbs; however, ARA has tracked recent sales ranging from Connecticut to New Hampshire involving foreign equity.
There is no questioning the trends that have caused investors to focus on these locations. Rents in Boston have increased anywhere from 5 to 8 percent in the city and 9 to 13 percent in the inner suburbs over the last few years. Occupancy has been immune to rent increases due partly to the lack of new supply, but also as a result of the demographics within Boston, which is driven by a booming education- and life science-based economy.
As a result, we are seeing winning buyers underwriting cash-on-cash returns of 5 to 7 percent and IRRs of 10 to 14 percent. However, these yields are causing some investors to pursue alternative methods for creating returns.
The number of cranes around Boston and Cambridge are evidence that a large number of players are pursuing development as a means to increase their returns. This trend has catapulted land values and fueled growth in areas such as the Seaport, Fenway, South Boston and Downtown Crossing. ARA has also seen equity players choose to pursue well-located properties where they can add value through unit or amenity renovations and upgrades.
Aside from these two strategies, we are also seeing an increasing interest in properties in New Hampshire, Connecticut, Rhode Island and Maine. These submarkets have not experienced a drop in cap rates of the same magnitude as Boston. However, even in Boston, the spread between investment cap rates and 10-year Treasuries remains 150 to 200 basis points wider than it was during the run-up from 2005 to 2007.
As we look ahead, it remains to be seen if the run-up in transaction volume will continue at the same pace. Although it is certain Boston is and will remain one of the premier real estate investment markets in the country, it will be interesting to see what strategies equity players choose to create value in an environment tolerant of a little additional risk in the search for higher yields. For some investors this could mean turning their focus from core to value-add properties. For others, it could mean looking further out to the suburbs and to our second-tier cities. And for others, it could mean a return to more creative developments.
— Richard Robinson, principal for ARA