{"id":154178,"date":"2023-06-19T17:27:36","date_gmt":"2023-06-19T23:27:36","guid":{"rendered":"https:\/\/www.biggerpockets.com\/blog\/?p=154178"},"modified":"2023-08-01T12:36:39","modified_gmt":"2023-08-01T18:36:39","slug":"analyzing-the-multifamily-meltdown","status":"publish","type":"post","link":"https:\/\/www.biggerpockets.com\/blog\/analyzing-the-multifamily-meltdown","title":{"rendered":"What Happened? An Analysis of the Multifamily Meltdown"},"content":{"rendered":"\n\n      <iframe loading=\"lazy\" frameborder=\"0\" height=\"200\" scrolling=\"no\" src=\"https:\/\/playlist.megaphone.fm\/?e=BIGPOC5188884569\" width=\"100%\"><\/iframe>\r\n  \n\n\n\n\n<p><span data-preserver-spaces=\"true\">We all hate market meltdowns, and this one was bound to happen.&nbsp;We just didn\u2019t know when, exactly how, or how bad things would get.&nbsp;But we now know the answer to the first two of these three questions.&nbsp;<\/span><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><strong><span data-preserver-spaces=\"true\">When<\/span><\/strong><span data-preserver-spaces=\"true\">? Currently underway.<\/span><\/li>\n\n\n\n<li><strong><span data-preserver-spaces=\"true\">How<\/span><\/strong><span data-preserver-spaces=\"true\">? See below.<\/span><\/li>\n\n\n\n<li><strong><span data-preserver-spaces=\"true\">How bad<\/span><\/strong><span data-preserver-spaces=\"true\">?<\/span><strong><span data-preserver-spaces=\"true\">&nbsp;<\/span><\/strong><span data-preserver-spaces=\"true\">No one knows.<\/span><\/li>\n<\/ul>\n\n\n\n<p><span data-preserver-spaces=\"true\">The purpose of this article is to explore what led up to the unfolding meltdown of what is happening now. Then, based on the 10 items I consider below, investors can draw conclusions about what may happen next and how bad this could get.&nbsp;&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Recently, the Wall Street Journal&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.wsj.com\/articles\/a-housing-bust-comes-for-thousands-of-small-time-investors-3934beb3\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">reported<\/span><\/a><span data-preserver-spaces=\"true\">&nbsp;that thousands of investors lost millions of dollars in a series of multifamily deals.<\/span> <span data-preserver-spaces=\"true\">The article highlights a mid-level Dallas IT worker who built a 7,000-unit multifamily portfolio in just four years. Unfortunately, he lost 3,200 units to his lender in Q1, defaulting on $229 million in debt and losing a boatload of syndicated investor capital.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">I\u2019ll comment briefly about what happened here, what\u2019s happening to many syndications right now, and why this failure will certainly not be the last one. Then I will tell you one critical thing you need to do now before you invest again.&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">The Newru Effect<\/span><\/h2>\n\n\n\n<p><a class=\"editor-rtfLink\" href=\"https:\/\/www.biggerpockets.com\/blog\/contributors\/paulmoore\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">I\u2019ve often discussed<\/span><\/a><span data-preserver-spaces=\"true\">&nbsp;the dangers of investing with newrus. \u201cNewru\u201d is my tongue-in-cheek label for promoters who were not in real estate until recently but are now promoting themselves as experts who syndicate deals and raise millions of dollars from thousands of investors.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Newru = Newbie Gurus<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">The term hasn\u2019t caught on yet, but I\u2019m counting on your help.&nbsp;To be clear, nothing is wrong with being new to investing and getting into syndications.&nbsp;What can be wrong is when some of these folks tell others, \u201cIt\u2019s different this time.\u201d They often take colossal risks and convince others to follow in their footsteps.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Newrus have risen to prominence in the past decade through a variety of converging factors. These include:&nbsp;<\/span><\/p>\n\n\n\n<ol class=\"wp-block-list\">\n<li><span data-preserver-spaces=\"true\">Enhanced syndicator capital-raising opportunities resulting from the 2012 JOBS (Jumpstart Our Business Startups) Act.&nbsp;&nbsp;<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">The broad popularization of real estate investing due to trendy HGTV and other network shows.&nbsp;&nbsp;<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Self-promotion opportunities afforded by ubiquitous social media and other online advertising platforms.&nbsp;<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">A movement away from Wall Street\u2019s casinos toward alternative assets.&nbsp;<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">A record (time and growth) bull market in commercial real estate coupled with increasingly fading memories of the 2008 disaster.<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Significant growth in wealth and investable capital among millions of Americans.&nbsp; &nbsp;<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">An influx of investments from the three I\u2019s: institutional, international, and (self-directed) IRA investors.&nbsp;<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">The popularity of coaches who promise freedom from the daily grind and great riches by becoming a syndicator (\u201cno experience needed, and yes, you can try this at home\u201d).&nbsp;<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">A late 2017 tax law change that provided a massive boost to commercial real estate investors.&nbsp;<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">A common realization by HGTV watchers (see #2) is that they love and believe in real estate but don\u2019t like dealing with toilets, tenants, and trash. Investing in a syndication is a natural next step.&nbsp;<\/span><\/li>\n<\/ol>\n\n\n\n<p><span data-preserver-spaces=\"true\">Don\u2019t get me wrong. I am not generally critical of most of the factors that gave rise to this problem. Wellings Capital and many of you have benefitted from this environment.&nbsp;&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">I am critical of how these factors converged to produce a new breed of inexperienced, unqualified, and sometimes unscrupulous operators. Syndicators who collected hundreds of millions of dollars of investor capital to gamble on multifamily assets that, acquired and managed properly, should have produced reliable investor returns.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">This house of cards was bound to tumble, and most of the issues were predictable. But there was one issue I failed to predict in my numerous articles and videos warning of the outcome we\u2019re experiencing now. I\u2019ll get to that in a moment.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">If you have been in Texas, especially these past few years, you might have heard radio ads enticing listeners to join one of several multifamily training programs. Thousands paid the fee and took the plunge in Texas and nationwide.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">These gurus enticed would-be syndicators with the chance to profit from acquisition fees, asset management fees, and other fees paid independent of the deal\u2019s success or failure\u2014an easy path to riches.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Jay Gajavelli is the subject of the WSJ article. He is a Texas IT guy turned student turned syndicator who lost 3,200 multifamily units and tens of millions of investor dollars. Quoting from the article:<\/span><\/p>\n\n\n\n<p><em><span data-preserver-spaces=\"true\">\u201cAfter finishing one exhausting workweek, he said, he was struck by a thought that changed his life: \u2018I\u2019m sick and tired of working for my money.\u2019 That was when he decided to become a landlord, he said. In time, \u2018I was able to replace my IT income,\u2019 he told prospective investors last year in a webinar. \u2018I live on my own terms.\u2019<\/span><\/em><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">He was also quoted on an investor webinar saying: \u201cI never worry about [the] economy now.\u201d \u201cEven if [the] economy goes down, still I make money.\u201d<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">These programs tend to be heavy on raising capital and finding deals but light on asset management. I heard one of the teachers say that getting the money and the deals are the hard part. But managing the deal is pretty simple with a good property manager.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Uh-huh.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Even programs that taught asset and property management couldn\u2019t create the experience that only comes from years in the trenches.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Here\u2019s another quote from the WSJ article highlighting Gajavelli\u2019s lack of asset management skills and financial woes:<\/span><\/p>\n\n\n\n<p><em><span data-preserver-spaces=\"true\">\u201cA video for prospective Applesway investors that was posted in December 2021 featured the 704-unit Houston apartment complex called Timber Ridge. Applesway, Gajavelli\u2019s company, bought the complex that month for $56.7 million with plans to more than double investor returns by raising rents and adding tenant fees for washing machines and covered carports.<\/span><\/em><\/p>\n\n\n\n<p><em><span data-preserver-spaces=\"true\">The investor video showed a tidy complex of apartments arranged around a shimmering swimming pool. By summer 2022, the pool water had turned a sickly green. High piles of trash littered the parking lot. Tenants complained to city officials about rats, mold, illegal evictions and the failure of management to properly maintain the buildings.\u201d<\/span><\/em><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">So these programs churned out thousands of inexperienced students into a market ripe for tribulation (see list above). And these students began competing, outbidding one another in a race to the bottom.&nbsp;&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">And the continual CRE and general economic boom served as a rising tide to lift almost every boat. Even newru boats.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Millions were made. New students signed up. The market got even frothier. And successful investors and their friends tripped over each other to invest in the next soon-to-be-sold-out deal.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">The glitziest capital raisers often rose to the top. But the best promoters are often not the best asset managers. Yet few people seemed to care as they collected quarterly payments and went into debt to invest even more.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">With hundreds of syndicators competing for every deal, something had to give. Syndicators had to:&nbsp;<\/span><\/p>\n\n\n\n<ol class=\"wp-block-list\">\n<li><span data-preserver-spaces=\"true\">Significantly overpay for assets.<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Cut costs by financing with short-term, floating-rate debt.&nbsp;<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Employ more aggressive growth assumptions to convince willing underwriters and unsuspecting investors of the deal\u2019s merits.&nbsp;<\/span><\/li>\n<\/ol>\n\n\n\n<p><span data-preserver-spaces=\"true\">But here\u2019s what actually happened:<\/span><\/p>\n\n\n\n<ol class=\"wp-block-list\">\n<li><span data-preserver-spaces=\"true\">Interest rates rose at an unexpected pace, doubling debt service costs in some cases.&nbsp;<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Rent growth grounded to a halt and even retreated in some cases.&nbsp;<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Operating expenses continued to rise with inflation. For many, insurance and property taxes increased by 50% to 75% or more in the past year. Some Texas and Florida assets saw insurance&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.bloomberg.com\/news\/articles\/2023-05-25\/apartment-landlords-bleeding-cash-imperil-47-billion-of-loans?utm_source=newsletter.credaily.com&amp;utm_medium=newsletter&amp;utm_campaign=cash-crunch-threatens-apartment-landlords-47b-loans&amp;leadSource=uverify%20wall\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">double or triple<\/span><\/a><span data-preserver-spaces=\"true\">.&nbsp;&nbsp;<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">Short-term debt faces refinancing, but the math no longer works.&nbsp;<\/span><\/li>\n\n\n\n<li><span data-preserver-spaces=\"true\">With refinances looming, banks are lending less and stiffening terms.&nbsp;<\/span><\/li>\n<\/ol>\n\n\n\n<p><span data-preserver-spaces=\"true\">This wasn\u2019t a surprise to many of us. But here\u2019s what I didn\u2019t see coming.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Many syndicators with floating rate debt paid for an interest rate cap. Good for them. These caps are temporary and must be renewed, often long before the loan comes due. Lenders have a contractual right to demand that syndicators reserve cash for upcoming rate cap renewals. And they\u2019re doing that.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">These interest rate cap reserves are crushing many syndicators.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">I\u2019ve heard firsthand reports of syndicators setting aside a few thousand dollars monthly into a reserve account for their next interest rate cap. Their lenders increased this mandated monthly reserve to tens of thousands of dollars. Sometimes increasing required reserves by 50x or more (you read that right).&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Last week I heard about a successful syndicator who made $60 million over his career. He is now facing complete ruin due to this convergence of financial problems topped off by this interest rate cap reserve issue.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">So newrus, who expected to keep raising capital and sailing through \u201ceasy\u201d acquisition-to-sale cycles, hit a horrifying roadblock. Now we\u2019re hearing about suspended distributions, capital calls, and a handful of foreclosures. As I write this,&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/newsletter.credaily.com\/p\/cash-crunch-threatens-apartment-landlords-47b-loans\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">today\u2019s CRE Daily<\/span><\/a><span data-preserver-spaces=\"true\">&nbsp;states:&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">\u201cMultifamily asset values are still above pre-pandemic levels, but some owners who opted for riskier loans and are looking to sell quickly are finding a desert where they expected at least a trickle of buyers. The multifamily market saw lenders eagerly issue highly leveraged bridge loans to meet demand in years past, but many investors are now struggling to cover these debts, and headline-making defaults may fall like dominoes in short order.\u201d&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">What to Expect From Here&nbsp;<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">I sincerely wish none of you were on the investing end of any of these deals. But I know many of you are.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">While getting from 9% to under 5% inflation was less painful than expected for most employees and consumers, I believe that getting from here to the Fed\u2019s target 2% inflation rate could be excruciating for America.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">In the meantime, we expect many more apartment projects to return to lenders. This will cause thousands of investors more pain.<\/span> <span data-preserver-spaces=\"true\">This situation will also provide opportunities for syndicators and funds with the cash and conviction to step in and acquire these assets. Though we hate to see the pain this is causing, we are watching the market for opportunities.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">The&nbsp;<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/www.multihousingnews.com\/4-3-million-new-apartments-needed-by-2035\/#:~:text=A%20new%20study%20commissioned%20by,address%20demand%2C%20deficit%20and%20affordability.\" target=\"_blank\" rel=\"noopener\"><span data-preserver-spaces=\"true\">strength of housing demand<\/span><\/a><span data-preserver-spaces=\"true\">&nbsp;is not at all in question. And it is likely that this downturn will put the brakes on new supply, resulting in a better opportunity for syndicators and developers when the time is right.&nbsp;&nbsp;<\/span><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span data-preserver-spaces=\"true\">A Singular Takeaway<\/span><\/h2>\n\n\n\n<p><span data-preserver-spaces=\"true\">I have one takeaway from this rather depressing commentary. The two most essential words in passive investing, both for our team and for all investors: due diligence.<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">I highly recommend you get Brian Burke\u2019s thorough treatise on performing due diligence for passive commercial real estate investments. BiggerPockets published&nbsp;<\/span><em><span data-preserver-spaces=\"true\">The Hands-Off Investor<\/span><\/em><span data-preserver-spaces=\"true\">&nbsp;in 2020, and you can get some great bonuses by ordering it&nbsp;<a href=\"https:\/\/store.biggerpockets.com\/products\/the-hands-off-investor\" target=\"_blank\" rel=\"noreferrer noopener\">here at the BiggerPockets Bookstore<\/a>.&nbsp;<\/span><\/p>\n\n\n\n<p><span data-preserver-spaces=\"true\">Some of the greatest fortunes were amassed while blood ran in the streets. We\u2019re not there yet, but that day could come soon. Will you be ready?<\/span><\/p>\n\n\n\n<div id=\"hero-block_62ee867235a1c\" class=\"first:mt-0 hero-block py-4    has-background has-slate-300-background-color has-text-color has-slate-800-color\">\n    <div\n        class=\"gap-10 lg:gap-20 flex flex-wrap lg:flex-nowrap max-w-screen-xl mx-auto px-4 relative lg:items-center \">\n\n        <div class=\"relative z-30 lg:w-2\/3 \">\n            <main class=\"py-4\">\n                \n\n<p class=\"has-theme-slate-color has-text-color has-large-font-size\"><strong><\/strong><strong><\/strong><strong><\/strong><strong>Invest passively with syndications<\/strong><\/p>\n\n\n\n<p class=\"my-3 md:my-5 lg:my-8 has-theme-slate-color has-text-color\" style=\"font-size:16px\">Want to invest in real estate but don\u2019t have the time? No matter your level of experience, real estate syndications provide an avenue to invest in real estate without tenants, toilets, or trash\u2014and this comprehensive guide will teach you how to invest in these opportunities the right way.<\/p>\n\n\n\n<div id=button-custom-event-block_641384b1eb1d8 class='button-custom-event'>\n      <a href=\"https:\/\/store.biggerpockets.com\/products\/the-hands-off-investor?utm_source=blog&#038;utm_medium=marketing_block\" x-on:click=\"window.analytics.track(&#039;Blog Block | Publishing: HandsOff Investor&#039;, {\n      referrer: &#039;https:\/\/www.biggerpockets.com\/blog\/analyzing-the-multifamily-meltdown&#039;,\n    });\" class=\" btn-shape inline-block no-underline has-background has-theme-gold-background-color has-text-color has-white-color\" target=\"_blank\">Get Yours Now<\/a>\n  <\/div>\n\n            <\/main>\n        <\/div>\n\n                <div class=\"lg:w-1\/3 first:mt-0 relative h-full lg:flex lg:items-center\">\n            <img decoding=\"async\" class=\"object-cover w-full relative z-20 my-0  rounded-md hidden lg:block\" src=\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2023\/04\/IMG_0669-scaled.jpeg\" alt=\"\" title=\"\">\n        <\/div>\n            <\/div>\n<\/div>","protected":false},"excerpt":{"rendered":"<p>We all hate market meltdowns, and this one was bound to happen.&nbsp;We just didn\u2019t know when, exactly how, or how bad things would get.&nbsp;But we now know the answer to [&hellip;]<\/p>\n","protected":false},"author":214608,"featured_media":153848,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[4433,7119,7357],"tags":[],"class_list":["post-154178","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-opinion","category-biggerpockets-daily","category-multifamily-real-estate-investing"],"acf":[],"comment_count":0,"_links":{"self":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/154178","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/users\/214608"}],"replies":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/comments?post=154178"}],"version-history":[{"count":0,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/154178\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media\/153848"}],"wp:attachment":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media?parent=154178"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/categories?post=154178"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/tags?post=154178"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}