It’s no secret that apartments have become the apple of institutional investor’s eyes. For good reason – the sector has held up well in the (supposedly over) recession and has continued to provide stable and reliable cash flows.

It this point, however, I think we are looking at the beginnings of a bubble. Here is the cash flow from a 250 unit apartment complex called Del Boca Vista in Miami Florida:

Net Operating Income:    $  1,430,000

Capitalization Rate:                  5.72%      (Average Rate per PwC/Korpacz 4th Quarter 2012 Investor Survey)

Sale Price:                           $25,000,000

Equity:                                 $  5,000,000 (20%)

Debt:                                    $20,000,000 (80%)

Interest Rate:                             4.40%

Annual Debt Service:        $ 1,320,412    (Rate, LTV and Amortization (25 Years) per

Cash Flow:                           $    109,588

Cash on Cash Return:        2.19%

Of course I made this up. Del Boca Vista is a condominium complex. The Seinfeld’s live there.

The capitalization rate and the interest rate are published averages. My buddy in this business tells me that they like wider spreads, which clearly makes the numbers work better. But boy, deals like this are riskier than porcupine sex. In the same survey, PwC/Korpacz notes that average overall capitalization rates for apartments are back to the historic lows hit in the 2nd Quarter of 2008 after spiking at 8.0% in the 4th Quarter of 2009.

For fun, I stress-tested this deal (yes, this is what I do for fun). The cash flow goes negative with an 80 basis point (0.08%) increase in interest rates. And that assumes that nothing else goes wrong. Does it feel hot in here, or is it just me?

Look, the pros know what they are doing, and they will do just fine. I just get concerned when the mom and pop investors get taken in by the cocktail party chatter about a “sure thing” and invest their life savings in a six unit hell hole in the scary part of town. And I get really nervous when the banker standing next to them holding a canape starts nodding his head.