Most apartment markets are near the peak -- buyer beware

60 Replies

I'm just posting this as a warning for newbies.  Obviously, no one can predict the future and no one knows what's going to happen next year, the year after, etc.  But most apartment markets are at or near the peak in pricing for this cycle.  The apartment market cycle is not something that is discussed much on this forum, and I've been seeing a lot of posts about buying apartment buildings with little money and then having loans with a balloon payment in 1, 2 or 3 years down the road.  

It's really great that people are taking action and buying, but please please please be running sensitivity analyses on your exit strategy.  Don't assume rents will be higher in 3 years, values will be higher in 3 years, cap rates lower, etc.  Ask yourself, what is my exit strategy to deal with my balloon payment if interest rates are 2% higher and cap rates are as well?  Please understand what that does to the value of your building and plan accordingly.

Not trying to be doom and gloom, and hopefully the market continues to boom and rates stay low, but I'm seeing so many new buyers enter the market with little to no experience, no discussion at all about the cycles and most have these balloon payments.  

Hi Account Closed  ---  Thanks for update;  Are you saying across the board in all areas, across the country or are there certain areas than others you are noticing this?

Great post Sean!  Very insightful and I believe spot on.  I think there are still deals to be found, one just has to look a lot harder.

Thank you for the insight,  I am currently in the market for an apartment complex and will heed your warning moving forward 

@Bill T. While every market is a little bit different, I think most are at or near the peak.  There are a few laggards (Las Vegas, Dayton, Detroit), but even those are getting closer.  My warning is just for people to be careful and understand what happens if you buy at or near the top of an apartment market cycle and then need to refinance or sell in a few years.  We have the added risk currently of potentially higher interest rates and cap rates down the road.  

We are still buying, however, mostly using 10-12 year Fannie/Freddie fixed rate, non-recourse debt.  But it's tough out there and hard to make sense of the pricing.

This information is coming to you from a person that spends his life evaluating potential large multi-family transactions.  If you are an apartment investor, listen up!

Guy, how do you get 10 years non recourse for apartments?

@Jane A.

Typically, Fannie Mae or Freddie Mac loans over $5 million.  They have recently started a "small loan program" for multifamily loans in the $1-3 million range which I believe has non recourse options as well.

i completely agree

@Steve Olafson

thanks for the kind words.

if this pricing keeps going up though, pretty soon the only thing left for me to do will be to host a multifamily underwriting webinar, sell an ebook and become a guru! Haha.

Its always funny how the psychology works. 

Three years ago we were "crazy" to get involved in risky real estate. Now we're "smart" for doing so and the same people want to follow suit any buy. 

When this happens you kinda feel the end is near without even looking at the data... 

I can tell you I have seen many investors make millions and then lose millions because they became overleveraged at the peak of a cycle.

You own all of these properties but when the market goes down you can become upside down or cash flow insolvent.

The time for 100% owner finance, little money down, etc. is when the market cycle is frozen and just starting to recover for an asset class. You get the equity upside and cap compression on the upswing and can refi out with a new loan or sell. You can't do that if a peak has occurred and it drops.

As a commercial broker it's a great time for a seller to sell. The asset classes cycle at different times. So you can 1031 into a different asset class that is at a different stage of recovery. 90% of multifamily I am not a buyer on right now. Too expensive and the numbers do not work. Listing brokers are pushing puke pro-formas with rosy numbers based on a market to keep rising with strong rent growth and low expenses.

Biggest thing I can't stand is from the big apartment listing brokers where they use TBD for pricing. They make buyers go through rounds of bidding over 2 months to try to extract the highest price or play the buyer against themselves even if they want to accept that buyers offer.

Frankly I run across quality commercial brokers and then I run across scummy ones who will do anything to close a deal and give the profession a bad name. My buyer clients if I see TBD etc. we usually will not bid on it. You waste months of time if you are not selected. I go to the brokers instead and say here is our best. If your seller wants it they go with us now in the next week but if not we are not sitting around for 2 months while the seller decides and plays games. Sometimes if it is close to what the seller wants and a strong buyer they will go for it. If it is much below what the seller wants and they are not under a time crunch then the seller will wait 2 to 4 weeks to see what the market will bare from other offers.

Spreads are all relative to what constitutes a deal. Some buyers selling off a 3 cap in California a 7 cap is amazing in a different state for multifamily. A local buyer who has seen it go from a 9 to 7 isn't so happy about the cap.

You make money when you buy. I advise my clients to wait for the right property to purchase. I believe in the long term success of my clients. Some brokers take the short view and sell anyone anything until the investors capital is exhausted to make a quick commission. I want my clients to look back over working with me 5,10,15 years etc. and hopefully point to success with investments.         


I haven't seen rents go up so quickly in 15 years here in San Diego.  

It really ties into the old Warren Buffett quote:

"Be fearful when others are greedy and greedy when others are fearful."

Or, the more colorful Baron Rothschild:

"The time to buy is when there's blood in the streets."

Not much blood right now. I wish I was in my current financial position back in 2008-9.

We only buy what no one else wants.  Distressed physically is scary to most people.  You really have to understand your costs to rehab and plan for more but there is very little competition in this space.

Just like rehabbing a house, just more of it.

Great posts in this thread.  What tools or sources do all of you use to keep an eye on the investment cycle?  Is it mainly from your own observations in the markets you're in or do you have any other tip?  Thanks!

@John O.

The main source, and unfortunately the hardest to duplicate, is simply to be in the trenches day to day.  I've been talking to brokers, underwriting deals, touring properties and making offers on large multifamily deals (150+ units deals) on a daily basis since 2011.  That's how I am able to see cap rate movement, sales pricing rising, seller expectations getting higher and higher, etc.  

I fully understand that it's near impossible to see the things some people that are engaged daily can from the outside.  But there are market reports (CBRE, Axiometrics, Marcus & Millichap, etc) that help.  What I like to do is get the last 5 years of reports and then read them because that way you can see the direction the market is moving.  It's tough to look at a current report and understand where things are if you don't know where they came from.

Personally, I also think good commercial brokers are worth their weight in gold.  They are speaking with sellers everyday, listing properties, putting together BOVs and the good ones are fantastic sources of info.  The rub is obviously it's hard for someone who is not a player in the market to get the time of day from them.  

I am not in the market to buy an apartment building and do not claim to know anything about them, but Fox News ran an article today:

Apartment construction a booming business nationwide

I believe that Sean being an expert and someone in the trenches daily will have a better handle on the market.  How can the author of this article be so far off?

Nice comment @Joel Owens . thanks for the reminder about cycles. As I sit on the side lines waiting a good deal, your post reminds me that this is the smart thing to do.



@Bob B.

 the apartment construction market typically lags the acquisition market.  as the market slowly began to recover in 2010/2011, it was ripe for buying existing apartments, but in most cases rents were not high enough to justify new construction.  as rent growth accelerated in 2012 and 2013 and now a lot into 2014 and 2015 while it is harder and harder to find existing apartment buildings to buy, the last couple of years have been great for apartment developers.  Eventually, they will overbuild and some will be left holding the bag and the entire market will adjust, but that hasn't happened...yet.

@Account Closed -- can you talk a little but more about those market reports? Do they need a paid subscription? I'm going to look into them.

Yes Sean has it right. This is what happened last time. Developers see a boom for pent up demand because nobody was building when the market was frozen. Lenders on construction loans were too uncertain about when the market was going to turn around. 

So developers build their pro-forma's and try to time the exits. If for example they want to build a 300 unit apartment building they might set a timeline for 2 to 3 years from time of zoning to construction to get leased up. In that time span anything can happen with the market. It's a game of musical chairs where you can win big but also fall flat on your face with nothing. The last cycle you could build and get non-recourse with 90% and put down 10. If it didn't work out you could walk. Lenders are wise now and want full recourse in many cases. As a developer you have to really watch the land costs now with recourse against you for what you pay, how much to develop, and how long to bring to market.

You could say instead you would build say a 20 unit complex faster and then could sell and exit the market in months and not years. One issue is what the local authority will charge you for permitting and costs etc. Some are so high that it makes small projects not possible with the numbers.

If you see pent up demand in an area for an asset class then you need to look at upcoming zoning applications, site plans filed, permits applied for etc. So if there is a shortage of 10,000 units for an area but you can already see 20,000 is in the pipeline you might have a problem starting a project. I have found developers switch to holding properties in a down turn or they do value add type buildings or turn around's while the economy improves. I would rather turn around something for value add then build from scratch. Building from scratch there has to be a lot of meat on the bone to justify the risk.

I know people now that are buying for holds only that use to develop because they are tired of the personal guarantees with millions to tens of millions on the line. They want to sleep at night and own properties already performing where they can land non-recourse debt. It's comforting to high net worth people to know the lenders only recourse as long as carve outs are not violated is to the property itself. The lenders tend to also work with the borrower because they have recourse with the property only if something goes wrong. If you have recourse the lender will want to stick it to you and not work things out especially if you have high net worth and liquidity.  

Thanks Sean!  I had actually never heard of AxioMetrics before.  I signed up for their newsletter.

What's everyone's favorite book on the topic of real estate cycles?  Maybe especially apartment cycles?  My current favorite is; Boom Bust: House Prices, Banking and the Depression of 2010, by Fred Harrison.

Wow that was weird, I got on BP to post a question to other MF investors about a peak in the cycle, but the perfect thread was already going!

I went to an event last night where Greg Willett, VP of Research and Analysis with MPF, gave a presentation on the apartment cycle in Dallas Ft Worth.   Google him and you can get a ton of great info on multifamily markets.  Jay Parsons as well, if you're interested...

The first 2/3 of the talk was regarding how great the fundamentals are here.  Wage increases are likely higher than reported, population is booming, apartments are all full, new construction is being absorbed, and rent growth is likely to stay strong for a while longer.  He then turned to some things to worry about, although he prefaced it with "If you are one of those people that just HAS to worry about SOMEthing..."  So basically, everything is great right now, and probably will continue to be for a while longer, but there are some potential headwinds coming, and nobody knows how big an effect they'll have.  Someone asked him, if DFW is at a peak, what markets are not, and would be good places to buy?  He didn't really have any suggestions, for which I don't blame him! 

DFW is one of the top performing MF markets right now, but even here, I think Account Closed I completely agree on the market pricing approach.  Pretty much EVERY deal that comes out now is not priced, and it makes me crazy.  I'm still going through the motions, if for no other reason than to stay up with whats going on, but its pretty tough to compete when I'm using 2% rent growth, and somebody from California has 1031 money, or is looking at a sub 4 cap rate where they live.  Your comment about going through all the work and then having to bid against yourself is dead on too.  I spent the last week analyzing two neighboring 150+ unit properties that look like a fantastic opportunity, and came up with my price.  I spent a day talking to all the nearby properties about the area, rents, tenants, etc, and I may get outbid, but I had the free time so I'm pursuing it.  It also allows me to build relationships with the brokers.  Bottom line is, I'm willing to keep looking, keep making offers, and stick to conservative numbers.  There are a lot of deals coming up for sale, and maybe one of them will work for me. 

Kind of off the subject, but for those of you just starting out,  several brokers were present as well last night, and were asked what it takes to get an offer accepted at this point.  They all said that the buyer pool is so deep, that buyers are really having to be qualified before the seller will think about accepting an offer.  Non-refundable earnest money day one doesn't hurt either. 

Sorry for the long rant, and keep in mind that this was all relating to DFW, but I think its relevant everywhere else as well...

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