Key Points:

• Multifamily cap rates have plateaued, but fundamentals and credit trends signal gradual declines beginning in 2026.
  
  
• Distress resolution and improving debt flows will boost transactions, tightening spreads and supporting lower cap rates.
  
  
• The temporary forces that have held multifamily cap rates above potential are easing, which will allow fundamentals to reassert themselves.

After bottoming out in 2022, multifamily capitalization ("cap") rates^[1] increased steadily through 2023 and have remained flat at 5.7 percent for seven consecutive quarters – the longest stretch of unchanged multifamily cap rates in 25 years. The key question is whether cap rates will continue to move sideways or begin to edge lower in 2026. Early indicators suggest the latter, as improving fundamentals and easing credit conditions point to modest downward movement ahead.

“Multifamily fundamentals suggest that cap rates are poised to fall next year, though the process will be gradual and uneven.”

The Yield-Price Duality of Cap Rates 

To understand what drives multifamily cap rates lower, it’s helpful to consider their dual nature. A cap rate is both a yield and a valuation signal that reflects what investors are willing to pay for a property’s income stream. For example, an apartment generating $100,000 in net operating income (NOI) and selling for $1 million has a 10 percent cap rate. Another property generating the same income but selling for $2 million – perhaps due to more predictable income – has a 5 percent cap rate. 

Lower cap rates translate to higher prices and signal more predictable income, while higher cap rates suggest more income uncertainty and, therefore, lower valuations. The key takeaway: you pay for uncertainty one way or another. The cap rate ultimately reflects how the market values the reliability of that income stream.

Coming Unstuck, in Time

First American’s Multifamily Potential Cap Rate (PCR) model estimates the market-supported “potential” based on key fundamentals, including multifamily transaction volume (a measure of purchase demand), renter household formation (a measure of leasing demand), and multifamily debt flows (a measure of credit availability). When the multifamily PCR is below the actual multifamily cap rate, as is currently the case, it suggests that market fundamentals support lower cap rates than what we’re observing. 

The chart below compares the actual multifamily cap rate over time to the multifamily PCR. Both actual and potential cap rates rose in 2022–2023 as the market adjusted to higher interest rates and repriced risk, then leveled off. 

Over the past five quarters, the gap between the two measures has widened from 40 to 60 basis points. That divergence suggests that transitory forces – such as rate volatility, labor market uncertainty, mortgage distress, and a highly cautious investment environment – are keeping cap rates higher than fundamentals justify. If these forces ease, multifamily cap rates are likely to trend lower in 2026.

What Will Pull Cap Rates Lower Next Year

Three forces will shape next year’s multifamily cap rate trajectory: distress resolution, easing credit, and steady renter demand.

Distress Resolution

CRE mortgage distress is at its highest level since the aftermath of the Global Financial Crisis (GFC), though it is distributed differently across lender types. This distress is being worked through, and delinquency rates won’t remain elevated indefinitely. As more assets trade at lower prices and operations stabilize, fewer owners will hold out to avoid realizing losses. This shift will increase the share of owners willing to sell at prevailing prices. By the time delinquency rates fall, more owners will be focused on new opportunities in this new cycle than salvaging projects from the last. The net effect will be higher sales volume and, as more capital competes for assets, incremental downward pressure on cap rates. 

Even financially pressured sales will help boost transaction activity. Buyers acquiring properties at steep discounts have a greater margin of error and can underwrite future income more confidently. These transactions establish more realistic price benchmarks, reduce reliance on outdated valuations, and attract additional buyers to the market.

Easing Credit

Distress ties up lender balance sheets and limits capital for new originations. As workouts progress and distressed loans are resolved, lenders free up capital that can return to the market as credit. While multifamily debt flows are still declining, lending activity is recovering, which will also put downward pressure on multifamily cap rates. 

Renter Demand

On the leasing demand side, renter household formation remains robust – up roughly 2.7 percent year over year as of the second quarter of 2025. Strong renter household formation supports leasing demand, NOI growth expectations, and, by extension, valuations. 

A Measured Return to Fundamentals

Multifamily fundamentals suggest that cap rates are poised to fall next year, though the process will be gradual and uneven. The temporary forces that have held multifamily cap rates above potential – such as distress, tight credit, and risk aversion – are showing signs of easing. This will eventually allow traditional fundamentals to reassert themselves and drive cap rates down. 

For multifamily owners and investors, modest downward pressure on cap rates would lift property values in the near to mid-term. Existing owners may see mark-to-market gains and easier refinancing as asset values rise, while new investors with capital that can be quickly deployed could benefit by purchasing a multifamily asset before prices fully adjust. While lower cap rates wouldn’t impact multifamily tenants per se, the strong renter demand and gradual absorption of oversupply contributing to downward cap rate pressure signals tenants can expect greater rental competition, and upward pressure on rents, as 2026 unfolds. 

About the Multifamily Potential Cap Rate Model 

The multifamily Potential Cap Rate (PCR) Model estimates cap rates based on the historical relationship between multifamily transaction volume, annual changes in renter household formation, and multifamily mortgage flows. The multifamily PCR Model uses these metrics to establish a potential cap rate level that is supported by these market fundamentals. When actual multifamily cap rates are significantly above the multifamily PCR, it indicates that market fundamentals supported lower cap rates than were observed. Conversely, when actual cap rates are significantly below the potential cap rate level, market fundamentals supported higher cap rates than were observed. Multifamily cap rates are aggregated nationally, and the PCR Model is updated quarterly.

Third Quarter 2025 Multifamily Potential Cap Rate Model

• The multifamily PCR was 5.1 percent, the same as in the second quarter of 2025. 
  
  
• The multifamily PCR decreased by 0.1 percentage points as compared with one year ago.

Multifamily Cap Rate Outlook Gap

The gap between the actual multifamily cap rate and the multifamily PCR provides insight into the likelihood of shifts in the actual cap rate. If the multifamily PCR is below the actual multifamily cap rate, it indicates that fundamentals supported lower cap rates than were observed. If the multifamily PCR is above the actual multifamily cap rate, it indicates that fundamentals supported higher cap rates than were observed.

• In the third quarter of 2025, the actual multifamily cap rate of 5.7 percent was 0.6 percentage points higher than the multifamily PCR, indicating that market fundamentals supported lower cap rates than were observed.
  
  
• The gap between the multifamily PCR and the actual multifamily cap rate was the same in the third quarter as compared to the second quarter of 2025. 

^{[1] A cap rate is one measure of return on investment provided by a building and is equal to the net operating income (“NOI”) generated by the building divided by the price of the building. For example, a multifamily property purchased for $100,000 that generates income of $10,000 a year has a cap rate of 10 percent. Higher cap rates represent higher rates of return, and vice versa.}