Late last summer, optimism ran steady across the multifamily investment sales market. Prior to the Federal Reserve’s initial rate cut in September 2024, interest rates had remained stable throughout the year. The outlook was positive. But that more ebullient market proved temporary.
The Fed’s interest rate cut had a positive effect on the secured overnight financing rate (SOFR), which fell from 5.3 percent on Sept. 18, 2024, to 4.3 percent in early February 2025. The U.S. 10-year Treasury yield rose during the same period. On Sept. 18, 2024, the 10-year yield closed at approximately 3.7 percent, and it stands at 4.5 percent as of Feb. 17.
As a result of these factors, a bid-ask spread between apartment buyers and sellers has re-emerged, and transactions largely continue to follow the lackluster pace emblematic of the market since the cost of capital skyrocketed over a roughly 18-month period beginning in early 2022.
The lack of sales has also suppressed the plans of property investors who want to take advantage of Section 1031 of the U.S. Internal Revenue Code. The provision allows sellers to defer paying capital gains taxes by using the sales proceeds to buy a similar, or “like-kind,” asset. But upon the closing of the sale, the sellers must identify the so-called replacement property in 45 days and complete its purchase in 180 days to qualify for the deferral.
“This has been the most difficult environment I’ve seen in the 12 years since we formed our business,” observes Louis Rogers, founder and co-CEO of Capital Square, a Glen Ellen, Virginia-based sponsor of Delaware Statutory Trusts (DSTs), a property ownership structure that qualifies as a 1031 replacement property. “Many sellers of sought-after residential assets aren’t budging on price, and it’s very difficult to underwrite a new deal.”
New Year, New Market
Rogers is more optimistic about 2025, particularly the second half of the year. That’s when inflation and potential tariff fears under the new Trump administration will subside, he predicts.
Pat Swanson, who recently joined Stream Realty as a managing director to build up the brokerage’s multifamily presence in Southern California, agrees. Blackstone’s $10 billion deal to take Apartment Income REIT Corp. private last year signaled the bottom of the market, he suggests. “I think a lot of people who have been on the sidelines are feeling like it’s time to get back to business,” says Swanson. “So, the sentiment is that 2025 could be a great time to buy.”
One variable fueling that bullish opinion is what Todd Pajonas refers to as “pent-up sellers.” In the hopes of fetching a higher price, many sellers have been waiting months for an interest rate decline that never materialized, says Pajonas, president of Legal 1031 Exchange Services, a qualified intermediary based in New York. Qualified intermediaries are third-party fiduciaries that facilitate a 1031 exchange by holding the proceeds from the sale for purchase of the replacement asset, among other activities.
This year, as a large number of loans reach maturity, many property owners will be forced to refinance their debt at current — and much higher — interest rates, which could force their hands to sell.
“I think there will be a lot more people selling than you would normally see in this type of market,” he says. “A lot of people who could afford to wait have probably waited as long as they can.”
To hear other industry professionals describe it, interest in 1031 deals spiked soon after the election. Call volume into the Strategic 1031 Exchange Advisors, a qualified intermediary, picked up considerably around mid-November, says Ricky Novak, who heads up the practice for the Strategic Group, an Atlanta-based investment firm specializing in tax strategies.
“More investors are now looking ahead to executing a 1031 or have just put their properties under contract,” Novak adds. “They’re working off the assumption that interest rates are probably going to come down in the near future.”
Dwelling on Rates
Whether that happens remains to be seen. As noted, even though the Fed cut the federal funds rate 100 basis points over the last four months of the year, yields for the benchmark 10-Year Treasury and other U.S. bonds climbed to well above 4 percent after spending August and September below the threshold.
Meanwhile, because the Fed wants to drag the annual inflation rate back to 2 percent after it ended 2024 at 2.9 percent, the central bank opted to keep rates steady in January. That clouded expectations that it would make two cuts of 25 basis points in 2025.
Concerns over the U.S.’s heavily leveraged balance sheet and some $7 trillion in U.S. Treasures that will need to be refinanced in 2025 could also keep upward pressure on interest rates as risk-sensitive bond buyers demand higher yields.
According to the St. Louis Fed, nearly $36 trillion in U.S. government debt was 120 percent of gross domestic product (GDP) midway through 2024 — just a hair below the percentage following World War II. Net interest payments of $882 billion in fiscal 2024 surpassed spending on defense and Medicare, according to the Treasury Department.
The U.S. budget deficit for fiscal year 2024 was $1.8 trillion, up from $1.7 trillion in fiscal year 2023 and $1.4 trillion in fiscal year 2022. Such massive budget deficits in non-wartime or crisis situations are considered extremely high and inflationary.
“There’s a lot of risk in the market when you look at those types of things — and how do you fix them?” asks Ray DeWitt, president and co-founder of 1031 DST Group, a Salt Lake City-based firm that provides 1031 investors with access to replacement properties. “Like everyone else, I want interest rates to go down. But I think people may have to get used to where they are.”
If that is indeed the case, some financially healthy apartment owners who need to refinance may end up accepting $100,000 or so in additional interest costs to wait another year or two to sell, says John Rodiles, sales manager of the Mogharebi Group, a multifamily investment advisor based in Costa Mesa, California.
“Whether we like it or not, I don’t think rates are going to come down unless there’s some kind of crazy event where everyone decides to put their money in the dollar again,” adds
Rodiles. “So, buyers need to step up.”
Changing Strategies
Some $146 billion in multifamily assets traded hands in 2024, a year-over-year increase of 22 percent, according to MSCI Real Assets, a New York-based research firm that tracks commercial real estate sales of more than $2.5 million. However, that tepid recovery was still miles behind the $359 billion in apartment sales in 2021, an MCSI Real Assets spokesperson reports.
The challenging market dynamics have fueled a need for alternative solutions among would-be 1031 participants. In some cases, multifamily investors are executing reverse 1031 exchanges — that is, buying replacement properties first and then selling an asset, notes Julie Baird, president of First American Exchange Co., a qualified 1031 intermediary based in Denver. Reverse 1031 deals First American administered were up about 10 percent over the last half of 2024, she points out.
“We would expect that to continue as long as the inventory of assets being marketed for sale remains relatively light,” says Baird. “Investors who can take advantage of distress in the market or be more strategic about the assets they acquire are also using reverse exchanges with a little more frequency.”
In a reverse 1031 exchange, the 45-day period applies to identifying the property an investor wants to sell, versus identifying a property to buy. The 180-day timeframe still applies to complete the transactions.
While Stream Realty’s Swanson acknowledges that 1031 activity remained sluggish in 2024, the brokerage was still involved in several exchanges, he says. In December, it represented the original owner in the sale of a 21-unit apartment complex in Huntington Beach, California. The owner was disposing of the asset due to a family partnership dissolution, and the project received five offers. The ultimate buyer executed a reverse 1031.
“We still see a lot of diverse factors driving the market,” says Swanson. “Every given year, 3 to 5 percent of the market will sell, and some of those sales will result from death, divorce, partnership dissolution and other events.”
New Asset Class on the Horizon
One property category emerging in the ranks of replacement candidates for 1031 exchanges is build-to-rent (BTR) single-family rental communities, says Edward Fernandez, president and CEO of Irvine, California-based 1031 Crowdfunding.
Capital Square, for example, in 2022 began buying BTR communities that it offers to 1031 investors through Delaware Statutory Tursts (DSTs). A DST is a legal trust structure that allows 1031 exchange investors to own a fractional interest in institutional grade real estate while maintaining their eligibility for the exchange’s tax-deferral benefits. See the sidebar for more on DSTs.
The asset class is the latest evolution for the firm, which in its early days focused on value-add multifamily deals and worked its way up to new Class A garden-style apartments, Rogers explains. In December, DST investors poured roughly $20.3 million in equity into Capital Square’s Valley Ridge project, a 129-home BTR community in Rossville, Georgia. Capital Square acquired the asset in October 2024.
“We can buy these communities at a price that works. They’re new properties, and residents have good jobs and plenty of money — just not enough to buy a home,” declares Rogers. “The (DST) broker-dealer sales force also likes and understands them.”
1031 Crowdfunding and Origin Investments plan on venturing into the BTR category in the future, Fernandez and Michael O’Shea, vice president of Origin Exchange, confirm. “BTR communities are a little small — maybe 60 or 70 homes — so it may be a challenge to achieve economy of scale,” says O’Shea. “But they’re managed like apartments and have been a fantastic asset class.”
— By Joe Gose. This article originally appeared in the January/February issues of Multifamily & Affordable Housing Business.