Multifamily PEAK coming to fruition?

28 Replies

I have been around long enough to know that one sign of a pending crash is that most people walk blindly into it, which is probably the underlying point of your post. People don't want to miss out on an opportunity. You will hear rationalization such as, "it is different this time." 

I am firm believer that it all comes down to supply and demand. This is localized from the standpoint that demand increases as people move into an area. I think what just happened with oil is great example. As prices drove up, it increased production and new sources. At the same time causing people to reduce consumption. Falling prices hurts those with the highest production costs first. In multifamily, at some point there will be too many apartments and vacancies will increase, eventually causing rents to fall. At around the same time, people unable to pay higher rents will move in with relatives to save money or look to buy a home if they can afford it. Supply and demand will not stay in sync forever and that is when the correction occurs. The problem is predicting exactly when the tipping point will occur. There will be a catalyst - some market factor will push it over the edge. 

Originally posted by @Joel Owens :

I have been saying this for awhile that the market is frothy and that IF you buy larger multifamily you better be using conservative underwriting numbers.

Those placing money into properties with the prediction of above markets numbers continuing indefinitely you are in for a big surprise.

Multifamily Overbuilding

 Are you referring to a National peak or just looking at the specific markets?

yes I think we are peaking.   Too many people trying to make rentals work and they haven't done their homework.  An example is how many folks post to this website asking for help on basic stuff (what should cap rates be, how do I figure out expenses, etc) AFTER they bought the property.  

Sorry, but this smacks of F.U.D.  Fear, Uncertainty and Doubt.  It's good to look ahead, to have plans, but the richest men in history have all been contrarian - - buy when other sell and sell when they're buying.

No fear at all. It's important to spot cycles.

People buying multifamily need to be conservative in numbers. Many parts of the country have experienced 4 to 4.5% rent growth and 3% vacancy but it has been for the past 12 to 18 months.

Historically looking at cycles an data that figure is not sustainable long term. Buyers are salivating at the market and saying "What can go wrong?". A TON can go wrong if you do not buy correctly.

I am seeing people buy stuff on 40% opex, 3% vacancy, and saying rent growth will keep sustaining at over 4%. They are buying at lower caps and using short term debt with a floating rate to eek out cash flow.

Those types of buyers will be in trouble in a few years. I like multifamily just not at what cap rates and what underwriting seller and brokers are pushing. I choose not the drink that koolade...... : )

You make money when you buy so not disagreement there. I am still seeing deals but you have to hunt for them.   

Originally posted by @Joel Owens :

No fear at all. It's important to spot cycles.

People buying multifamily need to be conservative in numbers. Many parts of the country have experienced 4 to 4.5% rent growth and 3% vacancy but it has been for the past 12 to 18 months.

Historically looking at cycles an data that figure is not sustainable long term. Buyers are salivating at the market and saying "What can go wrong?". A TON can go wrong if you do not buy correctly.

I am seeing people buy stuff on 40% opex, 3% vacancy, and saying rent growth will keep sustaining at over 4%. They are buying at lower caps and using short term debt with a floating rate to eek out cash flow.

Those types of buyers will be in trouble in a few years. I like multifamily just not at what cap rates and what underwriting seller and brokers are pushing. I choose not the drink that koolade...... : )

You make money when you buy so not disagreement there. I am still seeing deals but you have to hunt for them.   

 do you think that this is true in smaller multi-families as well? More specifically the crash in larger commercial multi-families bleeding over into (2-4) multifamily markets?

I have seen frothiness all over. There are still deals but you have to stick to your numbers and not deviate. Do not let the herd mentality make you feel like you need to buy something because you will lose out on a hot market etc.

The investors I know who have been doing it for decades and decades are very controlled with their investing strategies.

I had a client years ago who owned 300+ units spread across 10 buildings. Some they bought right and the others were over inflated thinking a market would keep rising so they took on more debt. A downturn happened and now a few properties made them money but they overall were negative for the portfolio because they had to take money to prop up the bad properties.

I did not know them when they purchased and would have counseled against that.

It's better to have quality properties and buy NOTHING more than to buy marginal properties to grow the portfolio or feel like you need to be doing something. Instead if you only bought 1 property a year but it was a great property in 10 years you would likely have an a excellent portfolio. As your network expands you tend to be more exposed to more opportunities. When people know you are a closer you usually get brought the best properties.  

@Eugene Beard , @Joel Owens;

A primitive rule in RE is: Real Estate is cyclic, waxing and waning ever 7-9 years.

Since purchasing our 6unit MFU in '97, that's fully two cycles and approaching the third.

We bought a Class C+ .. B- blue collar property at 305k and rents & net worth are both 2x today.  YES, that's a long term hold, and that's how to keep afloat IMO.

As Alfred E Neuman says, "What - - Me Worry?"

Really, I'm not saying there are no issues on the horizon, BUT good properties in well chosen locations WILL weather through.

[ I'll let you have the last word Joel :) ]

@Joel Owens Couldn't agree more.

Anything today listed by a major brokerage (CBRE, Cushman, Marcus & Millichap) has been bid up to nonsensical pricing.

I don't care what anyone says, if you're buying nearly anything today (heavy value-add somewhat excluded) and you have 65% LTV+ debt that matures in under 7 years you're going to be in some serious trouble. (Leaving aside all the idiots buying with ARMs floating over LIBOR who are just completely screwed.)

I'm under contract on a deal at a 6.8% cap rate in a 5% cap rate market with rents $200 below market. And yet I'm STILL considering wholesaling the deal, taking a 7 figure windfall and waiting for the crash because I doubt things are going to hold up another 18 months.

Even if the Fed doesn't hike rates further (and they've got $19T reasons not to raise rates), the coming inflation in expenses (when they bring in the next round of QE) will not keep pace with rent increases and NOI will suffer, causing serious refinancing problems.

And I know all the reasons I'm "wrong"  but I'm not buying it. This time is NOT different.

My mentor who owns $600mm+ in property in the NYC area told me he bought something like $75 million of property from 2008-2012. He said he's only purchased 2 deals in the past 4 years because of all the silly prices in the market. He's refinancing left and right as we speak in order to sit on cash to scoop up deals in the coming crash.

"I look for the desperate optimism of the invested that occurs at market tops."

Michael Janszen 

Doesn't the above quote sound like all the bulls today saying "we're becoming a renter society", "foreign money is limitless", "no new housing supply is coming online", "construction financing is still tight", etc.?

P.S. People should checkout RealForecasts.com, see how an Austrian Economics trained institutional real estate analyst is predicting the next crisis at the end of 2016.

One commercial mortgage broker friend of mine knows a very wealthy person that floats LIBOR but they own properties at a high cap rate.

They float to generate excess cash and as the hikes start floating close to what you can lock in long term fixed for they start converting some of the portfolio but that is a unique situation where this person is so wealthy they can get way with things like that.

People buying at low caps with floating or even fixed with a 3 year balloon are asking for it. Some 5 year is okay if they are putting so much down a refi and rate hike will still leave them cash flowing plenty.  

I'm no expert on Multifamily, but I could very easily see a viscous downward cycle forming after the extreme run up in prices and financing:

1) Economy does not do as well as it has been.

2)People get laid off and/or have their work hours cut.

3)Economic and physical vacancies go up.

4)"Investors" who bought marginal deals and leveraged too much get into trouble and start to lose their properties.

5)Banks get scared and stop issuing new or refinancing existing commercial loans.

6)Balloon payments hit with nowhere for owners to go to get reasonable refinancing. Meanwhile rates have gone up even if they could refinance.

7)Downward cycle repeats and reinforces itself.

Curious for those that are students of history and multifamily investment class, is this the way it typically goes down when commercial RE hits a rough patch, like in the 1980s S&L crisis? Did I miss anything? How do multifamily investors with balloon payments on their commercial loans but otherwise good investment properties protect themselves from 6 above?

@David Faulkner Investors either pony up more equity or sell the property if they can't refinance. The best way to hedge yourself is using 25 year amortization and taking out 7-10 year loans. Sam Zell said real estate became a much crappier business when you couldn't get 30 year fixed rate loans on apartment buildings like you could in the 1960s, 5 year loans just leave you so exposed to interest rate risk and recession risks.

The S&L crisis was exactly like this (from what I hear, seeing as I was 3 years old when the SHTF). But rarely will you find a time where there's absolutely NO debt available. The real issue is that if rates rise, cap rates rise, property values fall and all of a sudden a 70% LTV loan that should be easy to refinance becomes an 85% LTV loan that can't be refinanced without injecting some equity.

To further compound the problem, when banks are facing defaults they further tighten their lending so even if your property hasn't fallen far in value (maybe your rents rose dramatically like the oil boom times in North Dakota), they may only make loans at 55-65% so either way you need to inject some equity. 

And lastly, if rates rise quickly enough, your NOI may not be able to support a refinancing at the same LTV so you'll have to put EVEN MORE equity in.

@Joel Owens I agree, the guy I know w $600MM in property is borrowing some reckless amts. floating over LIBOR but again like you said, when you're that rich you can get away doing some reckless stuff. I asked him what he would do if rates skyrocketed like the 1970s. He goes "I'll call the banks back and ask them if they want the buildings back." LOL!

It is a truism, if you own the bank $1,000,000 they own you, if you owe the bank $1,000,000,000 you own them.

I still don't get why these guys do what they do. 

When I get to the point I have $500mm in property I'm going to deleverage to 50% LTV, call up Fannie Mae and I'm getting a 15 year full amortizing mortgage.

Contrast this with my mentor who is floating at 1.85% (true story, 75% LTV, non-recourse, 3 year) and then putting some mezz. debt on top to bring it to 90% LTV.

Admittedly it's on a portfolio deal that he bought for $50k/door (disaster property) that's now worth $150k/door but still, I don't know how he sleeps at night.

Originally posted by @Joel Owens :

I guess what I am saying in short is people shouldn't massage debt to make a thin deal barely work. That's a time bomb waiting to go off.

These short term bank loans scare me unless you are doing interest only and creating upside with a turn around value add deal. Make sure no pre-pay is there as well.

 BINGO!  ABSOLUTELY 

Originally posted by @Joel Owens :

A lot of cities and counties are ...

Where I live the government is ...

Depressed areas like to .... 

Hmm; guess we're at odds on lots of subjects and the generalities are loaded with politics, so I will agree to drop out.

Originally posted by @Joel Owens :

I guess what I am saying in short is people shouldn't massage debt to make a thin deal barely work. That's a time bomb waiting to go off.

 I think that's solid advice for ANY Real Estate deal - from a total n00b's perspective it just seems that there are a whole lot more numbers to massage when it comes to the bigger, more complicated deals, and it takes a lot more discipline and knowledge not to get hosed when the market turns.

@Vincent Crane That is likely the case in many areas. There are still many areas that are very depressed and prices could be 1900s ish. Think coal towns, steel towns, depressed parts of cities etc....When I look historically it is mainly the top tier cities you see the tops and sometimes even those have large areas within that real cheapos exist. Prized in demand locations for sure nearest the tops though.

Deals are out there. You have to search constantly. Off market is where I am finding the deals.

The other buyers only know how to look on market so when it comes on there are a lot of eyeballs looking at it and competing for it which drives the cap down and the pricing up.

Sellers often wonder if they have a flaky buyer or the real deal. Many do not like the process of selling and all of that. If you can make it easy on them with a strong buyer where they can avoid the typical marketing and selling process they are more likely to give a deal  for surety of close and less hassle.