As soon as we see a few more closed sales transactions in the workforce housing space, I believe what is so clear to me right now will become evident to the greater marketplace – there's a material spread between the top and bottom of the grades from a cap rate perspective. If anyone has heard me speak over the past several years, you might remember the story I've told about SPI trading up in the quality of our assets, as it didn't seem sensible to pay the same, or similar, cap rates for a 40+-year-old asset as you can for one that's brand-new. When SPI purchased its first apartment complexes a decade ago (2013), in DFW, Class-A deals traded for a 5% CAP, Class-B for a 6-6.5% CAP, and Class-C for an 8% CAP. Current CAP rates are "Gapping Out" on the lower end of the grade and are stickier on the top end. In 2024, I expect we'll see cap rates resemble what we had in 2013: a ~300bps spread from the top to the bottom of the quality grade. Class-B deals (1980s-1990s) will trade with a 6%+ CAP rate, and Class-C deals (1960s-1970s) will need to be 7%+ with their marginal locations and/or physically inferior assets (those with aluminum wiring, flat roofs, boilers, and chillers) will likely take an 8%+ CAP to clear the market.
Concurrently, after over a year and a half of pain, it looks as if the Federal Reserve is at or near the end of its interest rate hiking cycle, indicating that the short end of the interest rate curve is likely at or near its peak (although the longer end might have a bit more to go...). In addition, due to recent property tax reform supplemented by an upcoming decrease in values resulting from properties trading at lower prices than the peak of Q1 2022, I feel very confident that 2023 will represent the peak for property taxes in Texas and that 2024 will bring some welcomed relief on that front with lower property tax bills. If, on top of that, insurance premiums soften, we’ll receive a trifecta of support. However, I am less confident that we’ll see relief on the insurance front.
My crystal ball says that it's very probable that, due to a combination of higher cap rates pushing values down, property taxes coming in, and the possibility of a credit or significant job loss event, the Federal Reserve will reverse its course in 2024 and cut interest rates to some extent. If this comes to pass, the combination of lower property values, lower interest rates, and higher NOI due to lower property taxes should allow those with the courage and ability to act to buy stabilized Class-B deals at 75% LTV with an Agency Loan (Fannie/Freddie). If/When that comes to pass, we at SPI Advisory plan on backing the truck up and buying as many well-located deals as possible. History tells me that, if you can qualify for 75% LTV Agency Loans, it is one of the best times to buy. In the meantime, SPI Advisory is hiring several new team members to increase our capacity as a firm so we can best take advantage of the imminent opportunities awaiting in 2024.