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Why Your Chance to Land a Big Multifamily Deal Might Be Just Around the Corner

Why Your Chance to Land a Big Multifamily Deal Might Be Just Around the Corner

5 min read
Paul Moore

Paul Moore is the managing partner of Wellings Capital, a private equit...

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“What goes up must come down.” So said Blood, Sweat & Tears in their 1968 Grammy-nominated hit Spinning Wheel.

I’m guessing a lot of you missed that one. (It was popular about the time that semi-boneless ham sales peaked.) And many of us wish we had missed it.

Did you miss the fact that we’ve been in a multifamily frenzy for the past seven years or so? Or did you miss your chance to get in on it?

If so, you actually may not have missed anything at all because your chance to jump in may be just around the corner.

As you know, everything is cyclical. The pricing and popularity of every asset class rises and falls more than is supported by the cash flow of the underlying asset.

So if you’re convinced of the powerful demographics undergirding the long-term strength of the multifamily housing market—and you’ve been unwilling to overpay for assets these past few years or unable to find deals at all—then you may be perfectly positioned to acquire multifamily assets in the cooling off period that seems to be materializing now.

Why Do I Say the Market is Cooling Off?

Some data is starting to roll in that suggests this. The Wall Street Journal recently reported on an uptick in home ownership rates. At 63.9%, they are far below the 69%+ peak in 2005. The article reports that Millennials are starting to buy homes at a higher rate than expected.

Yardi’s statistics also show that rent growth is starting to decelerate. A Multifamily Executive article says that the average rent nationwide fell by $4 in October, to $1,358. Rent growth slowed to an annual average of 2.3%.

Related: 4 Ways Technology is Shaking Up Commercial Real Estate (& Why Multifamily Will Pull Ahead)

Here is a graph from Yardi Matrix:

Yardi Avg Rents 2017

What’s Causing This Shift?

Here are a few possible factors.

1. Mortgage lenders are loosening up again.

In my early years of real estate investing, anyone who could fog a mirror could get a 100 percent loan. No documentation. No proof. No problem.

A guy I know who made about $40,000 per year bought a dated $600,000 mansion in a small West Virginia town in 2005—as his second home! He didn’t have it for long until the bank got it.

The financial crisis caused lending standards to retreat back to normal. Buyers actually had to have real income, a better credit score, and—wait for it—a down payment (gasp!).

But mortgage companies are loosening their standards again, and some Millennials are taking advantage of the chance to own rather than buy.

Nevertheless, Millennials as a whole still have a record penchant for renting over buying, and there is no reason to think there will be a large scale shift toward ownership.

2. Some markets are overbuilt.

It always happens. With a rush of capital from the United States and internationally and the press reporting the big move toward multifamily housing, developers have been building at a torrid pace. Recent multifamily construction has continued at about double the historic rate.

Fortunately for most BiggerPockets readers, the majority of this overbuilding is high-end, pricey, luxury construction. Rents for newly constructed apartments are 50% or more above the Class B or C realm that most of us play in.

And as I’ll discuss in a future article, there is an important distinction between catering to “lifestyle tenants” versus “renters-by-necessity.”

3. Rents are crazy high in some markets.

Many of the markets where rent growth is slowing have rents that have reached dizzying heights. They can’t go up at this pace forever.

San Jose rents dropped by 0.7% in the past quarter. Seattle’s dropped by 0.8%. This is really no surprise at all.

4. Nothing’s wrong. It’s just a cycle.

It is widely known that rents flatten in the fall and winter. Many of the stats behind this conversation were measured in the fall, and this could be just that simple.

More likely, it is a pullback in the overheated market that everyone knew would come at some point.

As I said earlier, if you’ve been studying multifamily and believe in its long-term viability, your opportunities to buy or invest could be just around the corner.

how-to-value-multifamily-property

3 Trends to Expect if the Frenzy is Over

1. Expect a lag in sellers coming to reality.

Many multifamily owners have been counting their chickens prior to hatching. Holding on for the top of the market, many will be in denial once they realize they missed the top.

I expect some to go to market quickly in 2018, expecting to get the bloated price they were quoted by eager brokers the past few years. They may still get their price—unless they don’t.

In the event that the buyer community doesn’t see things their way, I expect some failed marketing campaigns in 2018—sellers and buyers not getting together. If you’re a buyer, that’s the time to be patient. Don’t be manipulated by the broker or cajoled into paying last year’s price.

It’s likely that this same seller will go back to the market (perhaps with a different broker) within the year, and if this softening continues, receive even lower offers than the first time.

Eventually, the seller will face reality and either refinance or sell for a more realistic price. Which will be to your benefit, Mr. and Mrs. Buyer.

2. Expect resistance from investors.

It’s funny—when many investors should be cautious, they’re raring to go. And when they should be eager, they’re pulling in the reigns.

Capital has been pouring into the multifamily space from the United States and abroad for quite a few years. As a syndicator, I’m happy for this interest in our investment class.

But let’s be honest. Overall, this has not been the best time to buy. My firm has passed on dozens of opportunities and has been outbid on quite a few more.

Related: 5 Ways to Jump Up to Large-Scale Multifamily Investing

If this softening turns into a multifamily downturn, it is possible that the best buying opportunities are just ahead. And this should get passive investors excited about jumping in.

But history tells us that this will not be the case.

Warren Buffett said, “Be fearful when others are greedy, and greedy when others are fearful.”

You’ll need to show your investor partners why lower prices mean better values. Educate them on cycles in the market, why the best times to buy are when other buyers are wary, and why it pays to invest when sellers are ready to make a deal.

3. If trends really go south, expect a few opportunities to buy distressed assets.

Don’t get your hopes up. There probably won’t be many distressed opportunities—at least in large scale commercial multifamily. But if you know the right people and have the cash and financing at hand, you may be able to step into a real bargain.

It happened in this last recession. I spoke to a few owners who bought multifamily assets for under $20,000 per door. These assets were recently valued at two to three times that much.

Before you get too excited about this, realize that Freddie Mac and Fannie Mae’s mortgage failure rates have been practically zero nationally since the downturn. This reflects on the safety of the multifamily asset class as well as the high standards of these two agencies. They really are the nation’s smartest multifamily investors.

(By the way, if you’re reading this and you’re not yet sold on large-scale multifamily investing, that last paragraph should have got your attention. This asset class has a stunning risk/reward profile, as I’ve written about extensively in my book and in other articles.)

So, What Do We Do Now?

Let’s all watch the numbers. Let’s try to interpret what’s happening in the market nationally—and more importantly for us, in the local markets we track. And let’s watch for opportunities to buy if this market continues to soften.

As far as I’m concerned, I’m not changing my buying and management strategy at all. My firm is staying on course looking for value-add and management play deals and catering to renters-by-necessity in strong and growing class B markets.

We’re not taking any unnecessary risks and not investing in markets with exaggerated appreciation and deprecation trends. You know the ones where people made a fortune, then got crushed in the last downturn.

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How about you? What are you seeing in your market? And what do you plan to do differently if the multifamily market softens in the coming year or two?

Comment below!