Metro Phoenix Multifamily flashing red
Phoenix multifamily can't lose right? We have been purchasing based on three primary inputs:
1. Perpetual rising rents.
2. Perpetually low interest rates/ability to refinance.
3, High occupancy/low economic vacancy.
Unfortunately, none of these 3 pillars are holding up. Take a look at the exit cap rate on deals from 2021 into peak Q1 2022. Try not to cry. Yes those are 3.5-4% projected exit cap rates. Now revalue your exit price at 5%, 5.5%, etc etc whatever you think that rates can and will get to.
At least those rents are still rising right? Nope, most submarkets decreased. AZ Rent price drop
Now look at that investment prospectus and change the topline growth to decreasing and/or concessions over any time period of your choice (I am underwriting 3 years rent concessions and NO growth and and minimum 15% economic vacancy).
The interest rate picture is a disaster and I don't have a clue in the world how anyone can sleep at night knowing a 3 year bridge time bomb is ticking. I am very long on this market and have assets in play, but the smart money is on the sidelines right now. We are in the 1st inning of a long term devaluation of multifamily.
Interesting read. Why do you think rent prices are down? I understand value decreases on sales, in correlation to interest rates, but I can’t peg how that would immediately affect rents. Is it as simple as people are sick of rent hikes?
#5 Investor Mindset Contributor
- Investor
- Greenville, SC
Let's hope the Fed sees it before it takes the 6-12 months for it to be picked up in the CPI calculation.
There's a lot of chatter on the forums that interest rates don't matter and that 7+% for residential and 6+% for commercial is "normal". That ignores the other side of the equation...inflation adjusted prices doubled over the past 10+ years after staying flat for 40 years from 1970 to 2010. Rates matter...a lot. We have a debtism economic system, not capitalism. A DSC ratio for a commercial loan that used to generate an 80+% LTV now results in a 50-60% LTV....similar for DTIs in residential. What does that mean? Limited real estate activity until price and/or rates come down. Plus, banks are tightening big time.
Inflation is hitting the lower income segment hard, particularly in the smile states with high growth. Rents, groceries, utilities, and fuel is up a lot more than 8%. Loan delinquencies and charge-offs are above pre-pandemic levels at the publicly traded nonprime consumer finance companies. Households are consolidating and that will hold rents down and vacancy up.
@Mike Dymski has it right. I am going back and looking at some of the deals done in the last 12 months and the assumptions used. Pretty much all inputs are wrong in a very material way but just the exit cap rate alone will sink every one of these deals. On a deal underwritten at a 4 cap exit getting revalued to a 6 cap cuts no less than HALF the value of the asset. Now combine that with the 3 year bridge time bomb AND concessions AND bad debt. People will regret ignoring cash flow or discounting it as insignificant. @Brian Burke
Well I don't know. I just GP invested in a deal in Tuscon. 80 Unit building. rents are below comps of buildings nearby. The apartments have not been upgraded but the structure/mechanicals are all sounds. We bought at a 5.2 cap rate. We are projecting a 5.5 cap rate conservatively in 2 years with fairly good upside in rent. So I think it's based on the property and fundamentals.
@Daniel Green you will be just fine. That Tucson market is very supply constrained and there is in place cash flow before the renovations.
Quote from @Serge S.:There is a lot of new multi family construction in that area that is effecting the supply and demand curve. We are seeing some banks hesitant to lend on MF in the area because of this construction.
@Daniel Green you will be just fine. That Tucson market is very supply constrained and there is in place cash flow before the renovations.
One of the main rules of investing....never say never.
This is also why we like secondary markets with strong fundamentals (like high job growth and lower rent-to-income ratios) vs markets that may have seen massive run-ups in the last few years. We have been diversifying our multifamily portfolio from primary cities to these secondary markets for the past 3-4 years and have been seeing great results. The exit caps for properties in these markets can be reasonable and generate a decent profit.
We do believe the capital market situation will create some opportunities for those who are well-positioned and are just about to launch a $50mm fund focusing on multifamily opportunities in high growth secondary markets.
@Serge S.
Agree with your points especially about the syndicators. I have sat through a lot of presentations over the last year where they were projecting 8-10% rent growth over the next 2-3 years and then down to 6% in perpetuity. They estimated record low interest rates and CAP rates. I am waiting to see what happens over the next 6-12 months b/c like you I assume when these bridge loans come due, they will not be able to refinance to permanent debt. Like @Daniel Green I bought a property 18months ago, only a 14-unit, in Phoenix and ran my numbers very conservative, about $200 under market, and I got a construction loan that rolls into perm financing. Even though there were better financing options I took this b/c economic data has looked terrible for the last 2years.
Unfortunately, I think a lot of RE investors do not follow Macro and just believe headline numbers. Great example is on Friday the jobs numbers came out and showed a "great" number adding 260k jobs. People do not realize those numbers are skewed b/c it is run through logarithms to smooth the data out. If you look at the Household Survey #s, which is raw data, it was the 5th time in 7 months that there was a loss of FT jobs and increase in PT. This last month was a loss of 490k of FT jobs!! BP over the last 2-3 years has been caught up in this craze telling people just buy property it doesn't matter if it CF just buy it. RE is an inflation hedge. Now we are seeing housing slow down dramatically and we have not even started the fall out of AirBnB, syndicators, etc. When you have a monthly expense for those rentals, long and short term, it can create massive damage to your personal balance sheet. Throw in if you are one of the white collared workers who are on the chopping block this can get ugly quick. Too much speculation.
@Percy N. Same thoughts here, do you have any good secondary markets for MF?
Quote from @Vincent Chen:
@Percy N. Same thoughts here, do you have any good secondary markets for MF?
We evaluate various public and proprietary data sources every quarter and track 5-6 markets that meet our research team's criteria.
There is a lot of time, effort and expense that goes into this so we share this research with the investors in our fund.
Quote from @Serge S.:
Phoenix multifamily can't lose right? We have been purchasing based on three primary inputs:
1. Perpetual rising rents.
2. Perpetually low interest rates/ability to refinance.
3, High occupancy/low economic vacancy.
Unfortunately, none of these 3 pillars are holding up. Take a look at the exit cap rate on deals from 2021 into peak Q1 2022. Try not to cry. Yes those are 3.5-4% projected exit cap rates. Now revalue your exit price at 5%, 5.5%, etc etc whatever you think that rates can and will get to.
At least those rents are still rising right? Nope, most submarkets decreased. AZ Rent price drop
Now look at that investment prospectus and change the topline growth to decreasing and/or concessions over any time period of your choice (I am underwriting 3 years rent concessions and NO growth and and minimum 15% economic vacancy).The interest rate picture is a disaster and I don't have a clue in the world how anyone can sleep at night knowing a 3 year bridge time bomb is ticking. I am very long on this market and have assets in play, but the smart money is on the sidelines right now. We are in the 1st inning of a long term devaluation of multifamily.
Hi Serge,
What kind of concessions are you projecting (???)
Depending on how low we go (and for how long) consessions may be no last month's rent, and looking the way while renters on the lease double up secretly with freinds and family in the units (when they go uemployed) Don't rock the boat, just collect the monthly. And with the added occpant load...beware of cutting security and extra load on entry gate mechanisms and overflowing dumpsters unless you increase them or increase pickups.
Good Luck!
And remember this song...and make sure you make Whitefish Bay when the gales of November come calling: https://www.youtube.com/watch?v=lE2LOhs5jaE