Key Takeaways

• Supply and demand fundamentals point to tepid near-term rent growth, but a positive outlook on the 2–5-year mid-term horizon
• Investments today should not expect to benefit from cap-rate compression
• Investment returns will be driven by net operating income growth
• Distressed sellers facing limits to loan extensions may provide buying opportunities
• Discount to replacement cost will remain central investment thesis

Where Are We in the Multifamily Cycle?

Rent growth surged during and immediately after the pandemic, fueled by demand for housing and limited supply. Many developers chased the booming rent growth, starting new projects using then-low-cost debt capital. This triggered the largest boost to apartment supply in over 40 years.

Seeking to reduce post-pandemic inflation, the Federal Reserve raised interest rates seven times in 2022 and four times in 2023, bringing the federal funds rate to a 23-year high of 5.50%. This resulted in the end of a ten-plus-year expansion period of commercial real estate values. In the two and a half years that followed, property values fell as cap rates rebalanced to the new elevated interest rate environment. Simultaneously, operating income growth stalled or decreased as new supply flattened rent growth and expenses rose.

Year-to-date, national rent growth has remained tepid, even during the typically active summer months, as the market continues to grapple with new supply. CBRE expects the national vacancy rate to end 2025 near equilibrium at 4.9%. Encouragingly, apartment starts have been declining since 2023 and the fall-off in deliveries is finally materializing. Growth rates for labor and material cost may slow, but are unlikely to decline. Should short-term rates fall, that would be a tailwind for development, but a moderate reduction would not serve as a panacea to development economics. As such, the outlook for new market-rate construction will likely remain challenged.

Against the backdrop of falling supply and a market reaching equilibrium, the demand from apartment renters is as strong as ever. Household income growth continues to outpace rent growth (31 months and counting, as of Q2 2025). This has translated to increased affordability as the median rent-to-income level has fallen to Pre-COVID levels. The demand for rental housing is further supported positive demographic trends by include delayed marriage, delayed childbirth, and preferences for flexibility, mobility, and amenities.

Additionally, the feasibility of becoming of a first-time homebuyer is increasingly untenable for many Americans. As of mid-2025, the monthly cost cap to own a (median priced) home is over $1,200 more expensive than the average monthly cost to rent – 10x higher than in 2015 when the delta was $111. The ongoing costs of homeownership have also been rising. Insurance, property tax, and maintenance costs have all increased significantly in recent years and render owning a home that much less attractive.

Expectations for Multifamily Investment Returns

Over the next 2-5 years, demand for rental housing should steadily outpace supply and translate to above-average rent growth, particularly in the business-friendly, low-cost-of-living markets targeted by Timberland Partners. Apartment investing has entered a period of normalization with a renewed focus on investment returns driven by operating fundamentals and net operating income growth rather than cap rate compression.

In the two decades leading up to 2022, owners of apartments and other commercial real estate benefited from both operating income growth and a tailwind of cap rate compression – largely a product of steadily declining interest rates. Properties could generally be refinanced or sold at a lower cap rate (which moves inversely to property values) than at which it was acquired. This boosted returns and it was not uncommon to see net returns in the 15%-20% range.

Today, global investor appetite for apartments remains strong, due in large part to the previously discussed secular trends and supply/demand fundamentals. This investor demand has (and should continue to) put downward pressure on cap rates. Meanwhile, the cost of long-term debt financing has risen commensurately with short term rates, creating a “neutral” leverage environment where the cost of debt is equal to, or in some cases higher, than the un-levered return of the asset. This means that equity returns are no longer initially amplified by the use of leverage.

Investors today utilize neutral leverage, and without underwriting cap rate compression on a sale, returns must once again be derived fundamentally through operating income growth at the properties. It is our belief that the net returns generated from this scenario will likely fall in the range of 12%-14%.

Transaction volume is increasing as interest rates have settled. After a period of pricing discovery, the bid-ask spread between buyers and sellers is narrowing. Values are down approximately 20% from the peak and often represent a 15%-20% discount to replacement cost. Earlier this year, Timberland Partners purchased Elwood, a 288-unit 2024-build suburban apartment community at approximately 20% below replacement cost. The seller was an institutional developer motivated to sell and recycle capital on an accelerated timeline.

Separately, some sellers are facing distress. Over the past few years, many lenders have granted extensions to over-leveraged borrowers who purchased properties at the peak of the market and subsequently experienced occupancy and cash flow disruptions. With credit conditions tightening, lenders are less likely to continue extending in hopes of workouts. This distress, however, represents a small fraction of all maturing loans. Distressed private sellers may be more likely to transact than those able to extend, but this should not be expected to drive the majority of transactions nor will it translate to “bargain” prices due to the volume of undeployed capital pursuing distressed deals.

We believe that in the near term, returns from apartments will prove some of the most attractive investment opportunities across both the private alternative markets and the traditional public markets. Fixed income yields should continue to decline with any reductions in the Fed Funds Rate, and should long-term rates fall as well, cap rates will likely follow and valuations will increase. We view this as a more likely scenario than the alternative (i.e. rising interest rates and cap rates), though investment success is not predicated on this falling-rate scenario.

In the public equity markets, the S&P is currently trading at over a 30x price-to-earnings multiple (P/E ratio), over twice the long-term median of 15x, and nearly double the long-term average. It’s anyone’s guess where the market goes from here, but it is hard to suggest by any metric that stocks are “cheap” today.

Our acquisition activity has intentionally slowed since the beginning of this cycle reset, but we believe now, in the early days of the new cycle, there are promising buying opportunities ahead, and it is time to get active.

Onward and upward.