Leverage Is Through the Roof!
Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes
Leverage Is Through the Roof!
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Minneapolis, MN · Member since 2014 · 332 posts · 288 votes
11yI am with @Serge S. on this one. I am little annoyed at how everyone claims to be so smart but they aren't doing deals. I'm not that smart and I've purchased over 3,000 units the past three years on behalf of the fund I work for and every single one of my deals has been a strong performer. Granted, I look at deals in several markets which helps, but please don't tell me it's not possible.
The last slowdown has scarred many people, for good reason. But most "slowdowns" don't look like that. I feel that those sitting on the sidelines and waiting for "massive discounts" may be waiting for a long time. When overbuilding takes effect, obviously there may be some price relief and sure a little better pricing, but with demographic trends the way they are these days, don't expect to see bargain basement pricing on multifamily any time soon.
I work for a fund that is continually buying, buying, buying. Let me see if I can explain the rational.
We offer a 7% preferred return to our investors, as well splits above that amount. Our president is the largest investor in our fund, so we have more skin in the game that any other investor. We believe rents will continue to grow modestly the next couple of years, most likely. @Ben Leybovich you are a smart guy, you understand the delta between cap rate and interest rate is where the money is made. If we buying at 6+ cap rates (and that was usually 7+ the past few years) and financing at 3.5/4% or lower, we are making a lot of money.
Will their be a slowdown? 100% YES. That is a certainty. But, if we are buying deals with 10%+ cash on cash returns in stable secondary and tertiary markets, short of 2007/8 happening again, what's the likely outcome? Things slow down in a couple of years and instead of paying our investors amazing 15% returns, we are then paying a more modest 7-9%. Still keeps people happy and we still are able to raise money. And so we don't make as much as a company. But we've been making money hand over fist since 2011.
We put 10 years loans on most properties. We are getting 2-4 years of interest only with incredible rates on nonrecourse loans.
@Ben Leybovich as an example, I put together a deal in your next of the woods last year. Bought 204 units built in 2004 out of foreclosure just north of Dayton for about 40% less than replacement cost. Put a bank loan on it, stabilized operations and refi'd end of 2014. Appraisal was $2 million higher than purchase price 11 months later. We put a long term loan on the deal and expect 11-12% annual cash on cash returns for the foreseeable future.
Are there risks out there? Of course. And as @Steve Olafson said, it's very metro specific. I totally understand why he's not buying in Phoenix right now. He also doesn't need to buy. He's doing quite well.
If you want to keep growing today, you need to be opening to expanding your target markets a bit, or yes, you might be sitting on the sidelines.
Maybe we will be famously wrong. That is a possibility. But our model has worked for 23 years, built incredible wealth for our founder and he has NEVER missed a mortgage payment on any deal in 23 years. That includes 2007 - 2009 when the world imploded.
My $0.02. But remember, I'm not as smart as most of you.
174 Replies
- Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes11y
Great discussion everyone. A few points:
Fannie and Freddie are obviously seeing something we are not seeing. And a lot of big REITs are of the same opinion. They are seeing growth!
There are 2 models of valuing property. One - capitalized income valuation. Two - valuation based on rebuild cost.
Today, on one hand, income valuation does not support anywhere near the prices that are being paid. On the other hand, these prices constitute 70%-80% of rebuild cost - may be less. Many players are saying - we can't build it for this, and if we can carry it for a few years, the rents will catch up due to end of stagnation of incomes, lower unemployment, and inventory. Besides, if the game is arbitrage of the delta between interest rate and Cap rate, then why not buy at 6 Cap...
I am not saying I agree. In fact, I think that cash in the bank is better than a bad investment. But, this is the rationale I see out there. And perhaps I am wrong and missing out on some money.
Thoughts everyone?
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes11y
I had an e-mail comes across my desk today where a family trust in Socal was looking for 10 to 30 million quality strip centers at I kid you not a 4 cap plus.
There are buyers for whatever reason where they want to buy something at a certain price and to them it works.
I would never buy that way but everyone is different.
Some foreigners want to just place money here in the U.S. to get it out of their country and it almost doesn't even need to cash flow. They just want high quality assets.
Everything cash flows when you pay cash @Joel Owens
We all seem to be jaded by living through the great recession. Remember that those events most likely happen once in a lifetime. Reminds me of the guys who were investing in the late 70s and early 80s who will never forget to remind you that interest rates were 16%+. Those investors will call you insane for choosing an adjustable rate mortgage when you can get 4% fixed. Scars last a long time. We need to keep perspective.
Before the latest crash we had a sustained run up for around 15 full years. Before that we had fairly predictable cycles and recoveries that were driven by macro economic shocks such as the Savings and Loan collapse, dot.com bubble and the oil shocks of the 70s. All of these cycles behaved similarly in that they were generally 1-3 years of no growth to fairly minor stagnation. RE always recovered and grew at its historical averages.
There are many ways to look at the data. Yes cap rates are historically low. But even in multifamily most markets are trading around 2001-2003 levels. Most markets have not surpassed the peaks, although some have. So you can say there was no growth for over 10 years and we are just now starting to get back to the averages. I am certain there will continue to be shocks and they will probably be more frequent. I am also confident that they will not be of the magnitude of 2008. Hoarding cash and gold is likely not the answer. The answer lies in cash flow and asset/location quality as it always has been.
Astute investors will adapt their underwriting model to the times. People are now underwriting sustained rent growth and with that model a quality class A or B building in a prime location does not look so bad at a 5 cap. Guys like @Ben Leybovich may think that is crazy but these are the same people that though 7 caps were crazy in 2012. I find that these guys were not buying in 2009-2011 either when the cap rates were higher because there were far more risks to consider. There is always a reason NOT to buy. Problem is if you don't buy you don't make money. Its a strategy to sit out a cycle. Its not a strategy to sit.
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes11y
Yeah you have to do something with the money or the gov. mint just takes it all. If you let money sit then taxes, inflation, and no write offs will eat you alive. You have to keep it growing each year so it is not devalued.
People think when you have money you have it made. You have to get whole teams to keep the ship running.
Attorneys, accountants, brokers ( me ) lol, PM, etc. You have to work very hard even if you are smart to get ahead.
Right now some asset classes are frothy but others are ripe for the picking. There is always opportunity somewhere at some time you just have to find it and exploit it.
I talk to investors constantly all over the country and everyone has a different take on things and how they want to live now and what retirement means to them.
- Scottsdale, AZ · Member since 2014 · 659 posts · 536 votes11y
Originally posted by @Ben Leybovich:
Great discussion everyone. A few points:
Fannie and Freddie are obviously seeing something we are not seeing. And a lot of big REITs are of the same opinion. They are seeing growth!
Since when has Fannie and Freddie had it right? The lend massively when they should not be and pull back when prices are at their lowest.
Same for the REIT's. My favorite time to buy in a market is when they are selling and vice-versa. How do you think their business models work? Money coming in from investors, money available for loans, time to buy.
- Scottsdale, AZ · Member since 2014 · 659 posts · 536 votes11y
Originally posted by @Jeff S.:
Everything cash flows when you pay cash @Joel Owens
How long does it take to save up enough for a 3M strip center?
- Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes11y
I am seeing some very smart people very bullish on this marketplace. I am forced to play the devils advocate to myself and presume that nothing I know holds true any more...
What is going on out there makes no sense to me - at all. Outperforming the other guy; assuming that you are smarter and better seems to be key today. I am not comfortable with that line of thinking. I may be smarter than the other guy, but I don't buy that way - especially with investor capital on the line. There's no margin for error out there today...
Again - you guys know what I am about. But, as I said, I am questioning myself as I see a ton of activity from very smart people.
WTF?!
- Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes11y
Agreed when have Fannie & Freddie got it right and they don't care if they make a profit, because the taxpayers will bail them out. There's no risk of failure!
- Scottsdale, AZ · Member since 2014 · 659 posts · 536 votes11y
In 2009 to 2011, I did not find higher cap rates. Regardless of what was reported, I was finding most properties were trading at zero cap rates in Phoenix. Those that were making money were holding on to sell.
- Scottsdale, AZ · Member since 2014 · 659 posts · 536 votes11y
Originally posted by @Ben Leybovich:
I am seeing some very smart people very bullish on this marketplace. I am forced to play the devils advocate to myself and presume that nothing I know holds true any more...
I see everything through the focus of my location. Whatever is going on around the rest of the nation is only relevant if it affects me.
I see craziness in the Phoenix market for multi-family. To me it looks like buyers are not making rational decisions. I have sold a property at less than a 4% cap on real numbers. I am in the process of rehabbing another but have it listed at the same time. I fully expect to sell it at well under a 4 cap. The buyers see proforma. I see extreme overbuilding.
@Steve Olafson how long does it take to save up 3 million to pay cash? A long time for you and me and most of our BP friends. But if your net worth is $100,000,000 then $3,000,000 is chump change.
- Real Estate Investor · San Antonio, TX · Member since 2014 · 785 posts · 190 votes11y
Cash all the way. I respect the difference of opinions. I buy 50-65k houses as I can, carry the note and make 12 % ROI. That's what I believe in. I'll thrive through any crash, short of nuclear holocaust.
How to get the cash? Flip, sell real estate. :)
- Homeowner · Westminster, MD · Member since 2014 · 18 posts · 4 votes11y
According to the article Ben referenced, any bubble forming is nothing like the previous one that led to our Great Recession.
As long as the rating companies are giving honest grades and bond buyers are showing discretion in underlying paper, there will be no massive bubble to snowball into a massive crash.
Individual investors beware according to the investing market of your choice.
- Real Estate Investor · San Antonio, TX · Member since 2014 · 785 posts · 190 votes11y
Good points, brian, thank you.
- Scottsdale, AZ · Member since 2014 · 659 posts · 536 votes11y
Originally posted by @Jeff S.:
@Steve Olafson how long does it take to save up 3 million to pay cash? A long time for you and me and most of our BP friends. But if your net worth is $100,000,000 then $3,000,000 is chump change.
Maybe less time for me. I leveraged during the past few years and put together a bit of money.
- Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes11y
Here's what concerns me:
Rents are going up - fine. People are saying that this is because stagnation of the 1990es is over, as @Serge S. mentioned - fine. I'm not seeing it, but I am not going to argue. Let's assume they have better research data and know what's coming - fine...
This doesn't change the delta of home ownership. As @Jeff S. mentioned - at what point have the rents gone too far and changed C+ to B tenants into buyers again. Certainly the FED, FHA, and HUD are doing all that they can to get home-ownership rates up...
For now, there's been a shift in consumer thinking relative to home-ownership. But, at what point does the rental market collapse under its' own strength?
Is this what the proponents of "buy for for the delta between interest rate and cap rate" really mean when they tell us that this bubble has 5 more years in it?
@Brian Burke - wanna jump in here?
- Rental Property Investor · Austin, TX · Member since 2015 · 49 posts · 21 votes11y
Originally posted by @Ben Leybovich:
I am seeing some very smart people very bullish on this marketplace. I am forced to play the devils advocate to myself and presume that nothing I know holds true any more...
What is going on out there makes no sense to me - at all. Outperforming the other guy; assuming that you are smarter and better seems to be key today. I am not comfortable with that line of thinking. I may be smarter than the other guy, but I don't buy that way - especially with investor capital on the line. There's no margin for error out there today...
Again - you guys know what I am about. But, as I said, I am questioning myself as I see a ton of activity from very smart people.
WTF?!
I conpletely hear ya. Emotions mix with finance the same way oil mixes with water. I believe the term is "Social Finance". There are a ton of "investors", "traders", etc out there today who make financial decisions based on what they "feel" or "think" about a financial decision. You see a lot of this in the present day securities market, instead of using the empirical, black&white data to determine and estimate realistic ROI figures. Whats even crazier? These decisions can create market anomalies for better and/or for worse. So counterintuitively, using "social finance" we learn and understand the psychology of the mind making these emotional decisions which drive some of this volatility we see. It's such a strange concept and certainly not a tried and true proven model that I condone. In the end, it truly comes down to the type of investor you are and how risk averse you are. The #1 rule of finance - "With risk comes reward."
- I appreciate your comment as it sparked my thoughts on the whole "social finance" thing that started getting popular around the '08 crash. Also, I like to keep things a bit general to explain my thinking around concepts (not necessarily particular specifics).
Keep this coming! We are all really thinking outside of the box here and it's fantastic!
- Rental Property Investor · Austin, TX · Member since 2015 · 49 posts · 21 votes11y
EDIT: please forgive me! I was stuck on the term "social finance" when I meant "EMOTIONAL FINANCE". My apologies as these two terms are not related. I get so excited here I start getting flustered :-)
Phoenix has been a comparable market to Portland with Phoenix being lots more volatile @Steve Olafson . In past times investors would cash in Portland properties and buy up Phoenix apts for a song. But in hot markets (bubbles?) Phoenix seems to compete price wise and come close to surpassing Portland values. You might check out Portland's market and when you see Phoenix being equal-maybe- just maybe we are talking bubble time. Portland is nice in the summer-look up some locals.
- Minneapolis, MN · Member since 2014 · 332 posts · 288 votes11y
I am with @Serge S. on this one. I am little annoyed at how everyone claims to be so smart but they aren't doing deals. I'm not that smart and I've purchased over 3,000 units the past three years on behalf of the fund I work for and every single one of my deals has been a strong performer. Granted, I look at deals in several markets which helps, but please don't tell me it's not possible.
The last slowdown has scarred many people, for good reason. But most "slowdowns" don't look like that. I feel that those sitting on the sidelines and waiting for "massive discounts" may be waiting for a long time. When overbuilding takes effect, obviously there may be some price relief and sure a little better pricing, but with demographic trends the way they are these days, don't expect to see bargain basement pricing on multifamily any time soon.
I work for a fund that is continually buying, buying, buying. Let me see if I can explain the rational.
We offer a 7% preferred return to our investors, as well splits above that amount. Our president is the largest investor in our fund, so we have more skin in the game that any other investor. We believe rents will continue to grow modestly the next couple of years, most likely. @Ben Leybovich you are a smart guy, you understand the delta between cap rate and interest rate is where the money is made. If we buying at 6+ cap rates (and that was usually 7+ the past few years) and financing at 3.5/4% or lower, we are making a lot of money.
Will their be a slowdown? 100% YES. That is a certainty. But, if we are buying deals with 10%+ cash on cash returns in stable secondary and tertiary markets, short of 2007/8 happening again, what's the likely outcome? Things slow down in a couple of years and instead of paying our investors amazing 15% returns, we are then paying a more modest 7-9%. Still keeps people happy and we still are able to raise money. And so we don't make as much as a company. But we've been making money hand over fist since 2011.
We put 10 years loans on most properties. We are getting 2-4 years of interest only with incredible rates on nonrecourse loans.
@Ben Leybovich as an example, I put together a deal in your next of the woods last year. Bought 204 units built in 2004 out of foreclosure just north of Dayton for about 40% less than replacement cost. Put a bank loan on it, stabilized operations and refi'd end of 2014. Appraisal was $2 million higher than purchase price 11 months later. We put a long term loan on the deal and expect 11-12% annual cash on cash returns for the foreseeable future.
Are there risks out there? Of course. And as @Steve Olafson said, it's very metro specific. I totally understand why he's not buying in Phoenix right now. He also doesn't need to buy. He's doing quite well.
If you want to keep growing today, you need to be opening to expanding your target markets a bit, or yes, you might be sitting on the sidelines.
Maybe we will be famously wrong. That is a possibility. But our model has worked for 23 years, built incredible wealth for our founder and he has NEVER missed a mortgage payment on any deal in 23 years. That includes 2007 - 2009 when the world imploded.
My $0.02. But remember, I'm not as smart as most of you.
- Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes11y
@Account Closed - I know this is where you stand. And I understand the rationale. For me, it is the question of figuring out whether the cost of staying out is higher than the risk of coming in. I am conservative as all hell with investor capital :(
- Minneapolis, MN · Member since 2014 · 332 posts · 288 votes11yBen Leybovich understood. And trust me, I understand that us having the scale we do makes a huge difference. I also understand 100% about having to have your first, or first few, syndications go extremely well. Otherwise you don't get to do it again. I think you are being thoughtful and appropriately cautious. I guess I'm just pushing you to either to look a little harder or expand your markets a little or if nothing else, come to terms with sitting on the sidelines. Just don't tell me about it every day :)
- Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes11y
Haha - tou-che @Account Closed ! This coin has 2 sides in that I may be inappropriately cautious, or you might be inappropriately aggressive. Tomorrow will tell... :)
Originally posted by @Account Closed:
I guess I'm just pushing you to either to look a little harder or expand your markets a little or if nothing else, come to terms with sitting on the sidelines. Just don't tell me about it every day :)Well said. Its so easy to call anyone buying an "idiot." I will not call someone with the ability to raise millions of dollars let alone a bank account with millions of dollars a blind idiot. On the contrary, we should dig deeper and see if there is a sustainable model and if we can replicate success. Some people will indeed lose money. I know people that bought very bad assets in 2010 and lost money. There will always be losers. The biggest losers though are the ones that have the inability to adjust underwriting models to the times. I can sit and brag about how smart I was to buy something 5 years ago. That doesn't make me smart today.
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