Multifamily Getting Frothy - The end is near.

13 Replies

MULTIFAMILY FROTHY

So I have been saying this for years now. The cap rates multifamily is trading at is crazy.

Lot's of sellers pushing the idea of never ending above historical market rent growth and little to no vacancy levels.

The stronger than normal rent growth and little vacancy is a cycle mini bubble that will not last. Buyers over leveraging with short term debt planning on strong rents over the long term to push the property to an acceptable cap rate will be in possible danger of a default.

Now there is the going in cap rate and then the realized cap rate after value add strategies such as cutting property taxes, offloading utilities to the tenant, raising rents in a way under market property. In this way cap can be improved.

I am seeing however lots of sellers and listing brokers where the property for that value has already been extracted. They say then that current market rents are still under by 50 dollars a unit which is more value to the investor. Pro-forma 2% vacancy and rent growth at 4 to 5% each year which is BS long term. Basically they are trying to dangle a little meat in front of the buyer when it really is a bone and nothing else.

If my clients want to buy it multifamily than longer term debt makes sense and the LTV not going to high. Forecast 10% vacancy in the coming years ( under 5 from now ) as new supply outpaces demand and rents soften to rent increases of 0 to 2% a year.

Of course nobody has a crystal ball and can say for sure 100% what will happen. The headwinds are not looking good seeing the metrics as a whole.

In some respects building new all in for a 9 cap might possibility give some security in the market.

For example I would not want to own the quote ( rehabbed ) old apartment buildings in Atlanta built in the 70's etc. at compressed caps. Just build new product in a great dirt location for an all in high cap. When it's done sell in a low cap market for a great spread or hold with long term debt if the cycle changes.

There is a ton of new construction multi-family going in Detroit right now in burgeoning areas. I have looked at numerous deals (cheap dirt) and going in cap is around 10 percent for new build. Most of the exit options assume some sort of cap rate compression in the coming years which I don't see happening. The pro formas are so sensitive to cap rates if the market moves sideways the next five years you are left holding the bag. After a year of bird dogging I decided I didn't have the stomach for the risk in this hot asset class.

Hi Mark,

You can lock permanent long term financing ahead of time from the construction loan. The interest rate is slightly higher but you build in future volatility protection.

Building all in for a 10 cap is good if the right area. You could sell even if cap rates moved from 5's to 7's.

I still see multifamily selling. A lot to uneducated foreign investors on the local markets. Some just want to park money here. It's all perception as to what is a deal and the risks involved.

When my clients put down millions for a down payment everything has to be analyzed for sure with exit strategies.

What you do not want to be is the last person building on a development cycle and then be stuck.       

@Joel Owens

Frothy --- you'd have a hard time pouring a pint with more head! 

Multifamily properties here have been listing at their "Potential Values" for some time now.  I have had conversations with several vendors in the past year where we've agreed on the potential of the business, but they could not articulate a logical argument to explain why I should pay them for the potential when I would be the one doing the work to realize it.

Sadly, in many instances someone - or some company - has come along and paid the owner for the 1 - 2 years of work they will need to carry out to reposition the property.

I don't get it and my slide rule is telling me this game of buy high with plans to sell higher is a dangerous one to be playing.  I certainly would not want to be the one left standing when the music stops.

@Joel Owens I would ordinarily agree with the majority of your assessment from what I've seen in past cycles. However, I think today's market is different.

Why? Because the real estate consumer has changed.

As you read through industry publications, supply/demand reports, and prognostications from segment industry insiders the one caviot many are reporting is the changing dynamic of today's consumer as their habits relate to real estate.

The bulk of renters today are composed of Millenials who have a desire to live a fluid lifestyle where movement and change is easier to incorporate into their lives due in large part because of their frequency in changing jobs. Renting their living accommodations helps them to maintain this fluidity. In addition, it is reported this generations mindset is set more towards living an experiential life as opposed to one of consumption of possessions, unlike that of the next large group of renters. 

One of the largest segments of renters also happens to be the largest possessions consumption group the Baby Boomer generation. They too are choosing to rent for various reasons from enhancing lifestyle to relocating closer to offspring or other family. With the tail end of this generation just turning 50 there are decades left where this generation may choose to convert from an owner to a renter.

We've seen how these renters are changing the for rent landscape in market across the nation. To further my point as to why I believe today is different I offer that for the first time in history national and large regional home builders will begin to build SFR to accommodate the growing wants, desires, and needs of an ever growing consortium of renters.

This is according to John Burns Associates a leading consultancy to the national and large regional residential housing builders. They are reporting builders intend to incorporate into their projects a for rent component to either sell to institutional investors (see my comment below) or manage themselves.

I'll also add anecdotally, I'm of the opinion that many of the hedge funds who built portfolios of SFRs  during the not so great recession and still have them on their balance sheet today will seek ways to continue to participate in this asset class by creating ownership vehicles that they can either retain, participate, or manage instead of exiting.

In Atlanta right now, the recovery is over and the expansion phase is well under way. Huge apartment complexes and condo's are going up EVERYWHERE, it's literally unbelievable. In the next 2-3 years it'll hit hyper supply, and then 2 years after that, a sharp drop in prices and the crash occurs. I'd say around 2020 we'll see most markets take a decent drop in prices. Most places are in the expansion phase right now, some are further along than others, but we're certainly seeing an unreasonable amount of new building for multi's. And on top of this, prices are right back to where they were. Townhomes in Atlanta in Vinings, which is 20 mins away from the actual city (midtown/downtown/buckhead) are going for $800k-$900k. It's literally insane what's happening here. Everyone is talking about how good of an investment real estate is and how their house is double what it was worth 3 years ago... It's looking a lot like 2009, or in Atlanta's case, 2011.

@Joel Owens

So what you seem to be saying is that we are approaching the peak of the bubble in multifamily, so now is not the time to buy. Supply is greatly increasing, and occupancy will decrease as a result. The cap rates that properties are selling are based upon growth in rental income that is unsustainable. 

The question I have is should we hold off on buying for a few years?

The other side to the millennial argument is the following.

3 to 4 years ago lot's of foreclosures and short sales of houses were occurring. If the value of the house was currently 90k and they owed 150k with a high payment they sold it off.

They then went to rent an apartment unit for much less money. Fast forward to today with rental increases and the inverse is happening in a lot of markets.

The rent they pay is now more expensive than what they could buy a house for. So a lot of people who had a foreclosure or short sale on the credit the lenders now will look at giving them a loan again on a house etc.

So the projections are for home ownership levels to go up and not detract.

There is macro and micro markets that are local so it will vary by area how much product is being developed versus the demographic and population levels that can absorb it. On new projects the timing is everything especially the larger projects as they take longer from start to finish.

If you have a 250 unit complex at an absorption of 10 a month that is a little over 2 years to get fully stabilized. That Is not counting from the time of purchasing the raw land. Developers will generally build the apartment buildings in stages starting upfront so that not to much capital and risk it outlaid. If the market changes they can then hold off on the rest and do in small sections at a time.

I am not saying there are not opportunities out there. I review about 500 properties a week for clients. 4 to 5 years ago maybe 6 in 20 were deals. Now maybe one in a couple hundred on MF works and the rest is overpriced junk.

So buy MF but only when it makes sense to do so. Interest rates are low so now is a good time to lock something in long term if the conservative projections work. I would rather be conservative and be wrong about a better outcome then be overly optimistic and a worse than expected future reality takes me under etc.    

Here is a counter info article to Millennials . The research shows they are tending to stay with family and live in the houses.

My brokerage in process of starting an internal invest agent group to go 

after some of the local commercial properties. I believe it might be due 

to some of the local investor agents / property managements are tired

of chasing and performing due diligences while some clients hardly 

do anything besides cutting a check.  Worse case it will keep surrounding

myself around additional investor mind individuals.

Originally posted by @Joel Owens :

MULTIFAMILY FROTHY

So I have been saying this for years now. The cap rates multifamily is trading at is crazy.

Lot's of sellers pushing the idea of never ending above historical market rent growth and little to no vacancy levels.

The stronger than normal rent growth and little vacancy is a cycle mini bubble that will not last. Buyers over leveraging with short term debt planning on strong rents over the long term to push the property to an acceptable cap rate will be in possible danger of a default.

Now there is the going in cap rate and then the realized cap rate after value add strategies such as cutting property taxes, offloading utilities to the tenant, raising rents in a way under market property. In this way cap can be improved.

I am seeing however lots of sellers and listing brokers where the property for that value has already been extracted. They say then that current market rents are still under by 50 dollars a unit which is more value to the investor. Pro-forma 2% vacancy and rent growth at 4 to 5% each year which is BS long term. Basically they are trying to dangle a little meat in front of the buyer when it really is a bone and nothing else.

If my clients want to buy it multifamily than longer term debt makes sense and the LTV not going to high. Forecast 10% vacancy in the coming years ( under 5 from now ) as new supply outpaces demand and rents soften to rent increases of 0 to 2% a year.

Of course nobody has a crystal ball and can say for sure 100% what will happen. The headwinds are not looking good seeing the metrics as a whole.

In some respects building new all in for a 9 cap might possibility give some security in the market.

For example I would not want to own the quote ( rehabbed ) old apartment buildings in Atlanta built in the 70's etc. at compressed caps. Just build new product in a great dirt location for an all in high cap. When it's done sell in a low cap market for a great spread or hold with long term debt if the cycle changes.

Come to NYC and you'll see brokers pitch MF buildings with cap rates at parity with 10 yr treasuries. Hah. What happened to risk premiums? Sure, the interest rate card gets thrown around a lot but even if it creeps up slowly, cap rates will rise - this is market economics. A lot of silliness is going on, although from what I see, senior lenders are taking a bit more caution which should diminish the chaos. I think equity investors will experience the brunt of the pullback this time. 

At the same time you have secondary markets which have not reached previous peaks...solid markets with sound fundamentals and growth metrics, i.e Phoenix. Leads me to believe there is still some room to run...

Bottom line, I have no idea where the market will go... but it sure as hell does not seem sustainable. 

I am completely and utterly un-researched in this area, and only know from Bigger Pockets posts and Marketplace radio pieces what the official word is, BUT -- I look around the IP - "inside-the-perimeter" area of Atlanta at all the ginormous apartment complexes going up, 4 within a square mile of the Decatur town square alone -- and I think I'll stick with the fringe area SFRs with yards, and allow pets.  Those are rentals that won't be overbuilt in the next 2-4 years.

Christopher many of my clients are from New York or Cali. They are looking at 3 caps. So they are selling their inventory there to purchase 7.5 to 8 caps here. 

Originally posted by @Joel Owens :

Christopher many of my clients are from New York or Cali. They are looking at 3 caps. So they are selling their inventory there to purchase 7.5 to 8 caps here. 

Our firm is backed by ultra HNW family and because of this, we rarely sell - we focus on tax-efficient strategies. We are currently building a portfolio across the river in Hudson County, NJ full of amenities and tailored towards young professionals, as they continue to get priced out of Manhattan. 7.5 to 8 caps do sound enticing, however, deals like that can still be made up here. They are less frequent and require more work. We are close to breaking ground on an 80 unit project that will stabilize at around ~7.2 cap, based on our other completed projects in the area. 20 minute commute to Manhattan. 

To put a shovel in the ground in Georgia (I know nothing about the market), I would expect higher caps? 

The pattern you are describing will be common trend over the next few years. Watching secondary and tertiary market cap compression is a great indicator of the U.S market as a whole.

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