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Markets with a diverse, large, and growing employment base, like Dallas-Fort Worth, are inherently less risky than markets with a declining population, like Pittsburgh, Pennsylvania, or markets with a high concentration of employment within one sector, like the tourism-dependent economy of Las Vegas. While neighborhood location is a component within asset risk, we allocate location risk to the economic health of specific cities or markets. With increasing asset risk from Class A to Class C investments, these cap rates show a 1.11 percent risk premium and support the general theory of a linear relationship between risk and return. transacted at an average cap rate of 4.99 percent, Class B transacted at an average of 5.37 percent, and Class C at an average 6.10 percent. In 2019, commercial real estate brokerage and advisory firm CBRE reported that Class A assets within the U.S. With increasing asset risk from Class A to Class C also comes rising cap rates. “Class C” assets are typically located in less-desirable locations, are often in poor physical condition with respect to age, and have mediocre unit interiors and amenities.
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“Class B” assets are usually located in nondescript areas, are older construction, and have modest unit interiors and amenities. “Class A” assets are typically located in favorable neighborhoods, and are newly constructed or thoroughly renovated with luxurious unit interiors and amenities. To easily compare asset risk, multifamily professionals categorize properties using three asset classes. Cap rates also allow us to test one of the basic tenets of investment theory and answer the question, “Do multifamily investors receive greater returns for greater risk?” Here, we’ll define the historical relationship between risk and return within multifamily through the lens of cap rates and establish expectations for the future of multifamily returns.Īsset risk in multifamily is a function of an individual property’s location within a neighborhood and the physical qualities of that property. As an industry-standard, cap rates allow clear comparisons over time between different geographies and asset types. A cap rate is an important indicator of performance potential because it factors in both the asset’s price and the net income generated by that asset. The capitalization rate, commonly known as a “cap rate,” is the standard measure of expected return within the world of multifamily investment.