If You’re Overpaying for Multifamily, Ignoring Traditional Investing Advice… Stop It!

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Are you old enough to remember Bob Newhart? Yes, he was Will Ferrell’s father in the Christmas classic Elf, but long before that, he was a TV psychiatrist in the ’70s sitcom bearing his name.

I always viewed Newhart as a kind, understanding therapist, someone I’d visit if in the need arose. Someone I could talk to about my apparent obsession with semi-boneless ham, for example.

But I saw a different side of Newhart in the viral comedy video affectionately referred to as “Stop It!”

The video shows Newhart as a psychiatrist who apparently has a single solution to every human problem. In his five-minute therapy sessions, he repeatedly shouts, “Stop it!” in response to every neurotic condition described by his patients.

Now, I doubt that you’re afraid of being buried alive in a box, like Newhart’s phobic client. But if you’re a BiggerPockets reader, you are probably investing in real estate. And if you’re doing that, you may be buying or planning to buy apartments.

Related: I’ll Never Buy Another Multifamily Without This $75,000 Tool That Added $1.3M Value in Less Than 12 Months

After all, it’s a common progression for those who are trying to scale up from single family rentals and other investments. I write about this extensively in my multifamily book.

As multifamily syndicators in the post-recession era, however, our company along with others has become increasingly alarmed at the prices that are being paid for apartments these days.

When the Perfect Investment Isn’t Perfect at All

I still believe everything I wrote in my book. The demographic trends and regulatory faux pas of the past two decades point to a long, healthy investment opportunity in multifamily real estate. I hope you own some, and I hope you have the opportunity to purchase more.

But the perfect investment is not perfect if you can’t find deals that make financial sense.

The world is running after multifamily. And prices are over the top. This is not just true in major cities like New York and L.A., but in the smallest of towns across the fruited plain.

I live in the Blue Ridge Mountains of Central Virginia, and nearby towns like Roanoke, Lynchburg, Charlottesville, and Blacksburg are experiencing unprecedented pricing on multifamily.

From duplexes to 200+ units, sellers are getting cap rates in the 5 and 6% range. Brokers are even surprised when their initial (usually inflated) pricing is blown away in the final bidding round.

My firm recently bid on an ’80s multifamily asset in a small city near Knoxville. The seller had privately approved the sale at any price of $6 million or more. They probably couldn’t imagine it hitting $7 million, though the broker said it was likely.

It actually sold for almost $8 million with a non-refundable deposit up front—before due diligence.

My friends, this should not be happening. This is a recipe for future failure. Don’t pay these inflated prices.

Stop It!

 

• If you’re counting on a continual compression of cap rates, ignoring the marginal cash flow, and counting on ever-increasing appreciation to make your deal work… stop it!
• If you’re banking on interest rates to level off now and drop back to 4% by the time you have to refinance your bridge loan… stop it!
• If you feel sure the economy will keep chugging along as it is and that rent increases will continue at 3 to 5% or more every year forever… stop it!
• If you expect to upgrade a class C or D building and get $100+ rent bumps without hurting occupancy like you can in a class B apartment asset because “multifamily is just so hot now,” then… stop it!
• If you reason that inflation doesn’t equally impact your rent increases and your operating costs, that rents will rise by 5% while you hold operating costs steady… stop it!
• If you assume you’ll always have a ready pool of overpaying buyers due to the influence of international money, IRAs, 1031 exchanges, and irrationality, then remember that syndicators, banks, and investors were running headlong the other way when deals were half-off in the last recession. So stop it!
• If you are lying to yourself and promising your investors a cash-on-cash return from operations of 9 to 12% and a total annual return of 18 to 22% on a deal you bought on-market or on Loopnet… then please stop it!
• If you believe you got a great off-market deal from a broker you barely know and you chalk it up to your intelligence, good looks, or the broker being unaware of the true value, ask yourself why any seller would take much less for their property than they could… then stop it!
• If you’re bending your principles, fudging a few numbers, assuming your ghetto is about to gentrify, or believing the tooth fairy will rescue your marginal deal because after all, everyone knows that multifamily is unstoppable… then stop it!
• If you’re willing to overpay for any reason at the top of the market, ignoring investing greats like Warren Buffett and Howard Marks who were gobbling up financial assets while the knife was falling in 2008 and 2009 and historic multifamily gurus like Sam Zell who has sold off tens of thousands of apartment units and you’re telling yourself and your investors, “This time is different,” then go read the book This Time is Different: Eight Centuries of Financial Folly… then stop it!

Wait. Why on earth would anyone overpay for multifamily or anything else? I tackle this question in a recent BiggerPockets post. This post also explains why my firm is pivoting to add self-storage and mobile home parks to our investment portfolio.

Related: Multifamily vs. Single-Family Real Estate: Which is the Superior Investment?

You Stop It, Paul!

You may say, “You stop it, Paul! I am finding great off-market deals, and my investors really are getting the returns you mocked above! What of that?”

I will readily admit that there are exceptions to the situation I’ve outlined in this post. There are syndicators and investors who are getting great deals. Some are doing better at acquisitions than my firm. There are off-market situations that are profitable and will make investors even more than 20% annually.

Like the badly mismanaged 400-unit Atlanta apartment complex that needs to be completely overhauled and leased up from scratch (way too much risk for me!).

Or the Charlotte-area apartment that had just come out of rent control and was sold for $7 million based on the prior government-prescribed rental income. We missed that one, and I’ve regretted it ever since. The buyer made several million in a few years, more than doubling his equity.

What I am saying is that these deals are few and far between, and they are mostly being scooped up by professionals—usually apartment syndicators who have been around for a decade or more and have survived one or more recessions.

Like you and I and Buffett, these expert operators can’t time the next market cycle. But they know exactly how to behave appropriately in the moment.

Many of these smart guys and gals are hoarding cash, waiting for that next downturn, ready to scoop up apartments and other commercial assets for half-price.

Will you—or worse yet, your lender—be the seller of these fire-sale assets? I’m writing to urge you not to be that guy. And if you’re tempted to do it anyway, then do yourself a favor and just…

STOP IT!

Are you finding solid multifamily deals in your market?

Weigh in with a comment!

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.