https://www.forbes.com/sites/forbesrealestatecouncil/2019/02/21/multifamily-outlook-and-the-interest-rate-conundrum-in-2019/amp/
Interesting article regarding Multifamily into 2019. Sounds bullish on Sunbelt Multifamily in particular though it feels like this article could have been written in 2006.
@Ethan Smith I really wish that was the case but history says that Is not true and Multifamily is very tied to economic swings. Funny thing is that if you polled investors 2 yrs ago probably 60-70% would have been predicting pending recession. Today 2 years further into the cycle you can’t find a nay sayer.
Serge, you and I are in full agreement on this.
When you purchase a REIS report on a property, it shows market vacancy statistics going back 5 years. So, when I first started downloading them, back in 2013, the vacancy stats included the GFC (Great Financial Crisis) and its aftermath. And, for the markets I was looking at, in SC, the stats were shocking - market vacancy rates in the teens during the worst of it.
But in the aftermath of the recession, a lot of conflated and selective memory - and gurus with stuff to sell - resulted in a false narrative about apartments and recessions.
Let me unpack what happened.
Before the GFC, during the peak of the housing bubble, two related things happened. First, government policy, loose money, and human psychology combined to push the home ownership rate to nearly 70% - nearly 5% higher than the "natural" rate of home ownership in the US - about 65% over the long term.
Second, there was a related spike in vacancy at apartments. That 5% of home owners who never should have owned homes came from somewhere, and that somewhere was apartments.
So, when investors purchased MFRE during the bubble, they were paying inflated prices in the form of low cap rates, but this was mitigated by the fact that vacancy rates were higher, so NOI was lower. The lower cap rates created less of an inflation in asset values because NOI was lower too.
When the GFC hit, unemployment went to about 11% nationally. This caused physical and economic vacancy in apartments to rise. Many owners without enough cushion went into default.
However, as the foreclosure crisis, which many people conflate with the GFC, took hold, apartments were well-positioned to benefit. As people were forced out of their homes or walked away, they had to go somewhere, and that was rentals. And, as lending standards were made stricter, all those would-be homeowners also had to go somewhere, and that was rentals.
What is VERY important to note here is that vacancy ROSE before it fell. It rose as the recession took hold, and people lost jobs, and then it fell when economic growth returned, but the foreclosure crisis continued.
What causes a lot of confusion is that, even after the GFC ended and growth returned, unemployment remained high, and the economy still FELT terrible. So, colloquially, people talked about still being in a recession, even though we were not. Times were tough, and unemployment was still very high, to be sure, but economic growth had returned.
Because of the confusion between what actually happened during the recession (vacancy ROSE) and what happened after the recession, when the economy still felt terrible and people were still struggling but the foreclosure crisis pushed people into renting (vacancy FELL), it became a popular thing to say that MFRE does well in a recession. And, of course, this narrative was pushed heavily by the new crop of syndicators and real estate mentors that rose as multifamily rose over the last few years.
Multifamily asset values actually dropped more than 30% during the GFC. However, because pretty much every other real estate asset class fell more, it was commonly and correctly stated that MFRE is more resilient during recessions than other real estate asset classes. However, doing less bad is not the same thing as doing "well" or being "recession proof." Again, sloppiness with words and analysis led to a self-serving narrative that apartments are "recession proof."
Furthermore, anecdotes abound about individual owners who did just fine during the recession, and no doubt many of them will chime in to deny all the evidence because "I did just fine" in the recession. What is also important to remember is that, nationally unemployment went to nearly 11%. Among four-year college grads, unemployment peaked at less than 4%, meaning that it was much higher than 11% for everyone else. And individual markets did better than others. If your market was a state capital or dominated by a big public university, unemployment did not go much above 6%. That means there were many markets where it was worse than 11%.
This state of affairs has led to a very dangerous complacency among real estate investors. Many are paying record high prices, with the current good economic news baked in and forecast to continue forever, and justifying these prices on the basis that "rentals are recession-proof." Many of them also seem to be convinced that, in the next recession, there will be another foreclosure crisis that will save MFRE again. However, the foreclosure crisis was a one-time event caused by the preceding one-time event of 5% of the population, which never should have owned homes, being pushed into homeownership during the bubble. Since then, lending standards have been made more strict, and history is not going to repeat itself.
The level of investor complacency you mention is a sign of being very late in the cycle. It's just when people start to be lulled into a false sense of security that crashes generally happen. Bubbles take a long time to form and an instant to break. When they do, the trip down is fast. We will soon have another chance to test the hypothesis that "rentals do well in recessions."
By the way, a couple of years ago, even I was starting to internalize the "MFRE does well in recessions" narrative, and I felt the need to get some outside perspective. So, I reached out to my property manager, a man who runs a management company that manages institutional quality assets and serves on the national board of the NAA, who has been in property management for more than 30 years. I asked him what happens to MFRE during a recession. He said, "vacancy goes up." Then we shared a good laugh over people talking about how vacancy goes down in recessions.
It's hard to imagine that multifamily can keep on the tear it's been on for the last seven odd years. But then again, I was saying that two years ago, so who knows.
@Andrew Syrios it’s been quite a run that’s for sure. I was looking back recently at OMs that I had been considering in 2014-2105. I could have purchased any of them and made millions. None of those deals were good enough for me. I’m glad I did get in the game though I’m confident that 2019 is the year to sell rather than buy.
What makes you so confident "...that 2019 is the year to sell rather than buy..." ?!
What makes you so confident "...that 2019 is the year to sell rather than buy..." ?!
It’s not so much confidence; rather I have projects that have reached the end of the value add cycle. I have Multifamily purchased in 2014 and feel as though the majority of the value add has been achieved. Time to lock in gains and move on.
I love Multifamily but these valuations In my market Are not sustainable in my opinion. Dropping $1M+ to turnover units over 2 yrs to get a significant rent bump is certainly a tried and true strategy but at this stage of the cycle I believe this to be the riskiest of all strategies. Not all value add has to be done one way. I also think there ate better markets than AZ.
What makes you so confident "...that 2019 is the year to sell rather than buy..." ?!
It’s not so much confidence; rather I have projects that have reached the end of the value add cycle. I have Multifamily purchased in 2014 and feel as though the majority of the value add has been achieved. Time to lock in gains and move on.
I love Multifamily but these valuations In my market Are not sustainable in my opinion. Dropping $1M+ to turnover units over 2 yrs to get a significant rent bump is certainly a tried and true strategy but at this stage of the cycle I believe this to be the riskiest of all strategies. Not all value add has to be done one way. I also think there ate better markets than AZ.
Absolutely Not...mobile home parks yes!
@Andrew Syrios it’s been quite a run that’s for sure. I was looking back recently at OMs that I had been considering in 2014-2105. I could have purchased any of them and made millions. None of those deals were good enough for me. I’m glad I did get in the game though I’m confident that 2019 is the year to sell rather than buy.
I think you're right, but I'm by no means 100% sure. I've seen a few economists predicting 2019 will be OK but 2020 will be a bit sketchy. We'll see...
It's hard to imagine that multifamily can keep on the tear it's been on for the last seven odd years. But then again, I was saying that two years ago, so who knows.
I agree with this. It's very hard to argue that there is a lot more upside in this market, yet very easy to envision scenarios with a lot of downside risk. I think the best case scenario is for things to just stay the same for a while. But when a market is teetering on the edge like that, any number of things might happen to cause a crash. Some may argue there will be a flight to safety, and that includes MF assets, but I think that will only include MF markets in what are seen to be the safest, blue-chip markets.
It's for this reason that I recently sold my entire $26,000,000 portfolio. I thought there was little way that the market could continue to go up much more than this, and lot of opportunity for it to go down. So I locked in returns and my investors are very happy with the performance. Now, if the market would only correct so we can do it all over again . . .
@Andrew Syrios it’s been quite a run that’s for sure. I was looking back recently at OMs that I had been considering in 2014-2105. I could have purchased any of them and made millions. None of those deals were good enough for me. I’m glad I did get in the game though I’m confident that 2019 is the year to sell rather than buy.
That's what I did: sell.
It's hard to imagine that multifamily can keep on the tear it's been on for the last seven odd years. But then again, I was saying that two years ago, so who knows.
I agree with this. It's very hard to argue that there is a lot more upside in this market, yet very easy to envision scenarios with a lot of downside risk. I think the best case scenario is for things to just stay the same for a while. But when a market is teetering on the edge like that, any number of things might happen to cause a crash. Some may argue there will be a flight to safety, and that includes MF assets, but I think that will only include MF markets in what are seen to be the safest, blue-chip markets.
It's for this reason that I recently sold my entire $26,000,000 portfolio. I thought there was little way that the market could continue to go up much more than this, and lot of opportunity for it to go down. So I locked in returns and my investors are very happy with the performance. Now, if the market would only correct so we can do it all over again . . .
That's probably not a bad idea. I would certainly be much, much more cautious with any acquisitions right now.
@Jonathan Twombly Congrats on your sale. I agree with your sentiment, best case scenario is flatline but a whole lot of scenarios where multifamily gets hurt. Safety and locking in gains, I'm right behind you, slowly liquidating at this end of the cycle. I don't particularly want to be sitting on 500 units in 2021 when Bernie Biden abolishes 1031 exchanges, interest rates are 7% and agency debt requires 65% LTV and investors begin to clamor for 7% cap in markets not in CA or NY. I understand that there is no money to be made waiting on the sidelines and a syndication needs to buy to keep the lights on so its pretty easy to be bullish in that scenario. I am also not in the Robert Kiosaki camp predicting global meltdown for the last 7 years straight! I am just uncomfortable projecting 3/5/10 years out and am even more uncomfortable being tied to A Class rents. Many markets are getting saturated and overbuilt on a promise of never ending rent and population growth. Syndications have never been more popular.
I had a 24 yo kid call me asking for advice on AZ multifamily. His experience consisted of a few flips and he is raising $2.5M to syndicate a 60 unit in PHX after attending a seminar. He had no problem raising money. I know the property well and this deal was a POS in 2014 and an even bigger POS today and I told him so. He closed last week. If your sponsor was in diapers during the last recession or sitting on the sidelines waiting for prices to fall further then please move on to the next. I want someone battle tested and scarred managing my cash not some Putz rolling the dice with my money.
@Jonathan Twombly Congrats on your sale. I agree with your sentiment, best case scenario is flatline but a whole lot of scenarios where multifamily gets hurt. Safety and locking in gains, I'm right behind you, slowly liquidating at this end of the cycle. I don't particularly want to be sitting on 500 units in 2021 when Bernie Biden abolishes 1031 exchanges, interest rates are 7% and agency debt requires 65% LTV and investors begin to clamor for 7% cap in markets not in CA or NY. I understand that there is no money to be made waiting on the sidelines and a syndication needs to buy to keep the lights on so its pretty easy to be bullish in that scenario. I am also not in the Robert Kiosaki camp predicting global meltdown for the last 7 years straight! I am just uncomfortable projecting 3/5/10 years out and am even more uncomfortable being tied to A Class rents. Many markets are getting saturated and overbuilt on a promise of never ending rent and population growth. Syndications have never been more popular.
I had a 24 yo kid call me asking for advice on AZ multifamily. His experience consisted of a few flips and he is raising $2.5M to syndicate a 60 unit in PHX after attending a seminar. He had no problem raising money. I know the property well and this deal was a POS in 2014 and an even bigger POS today and I told him so. He closed last week. If your sponsor was in diapers during the last recession or sitting on the sidelines waiting for prices to fall further then please move on to the next. I want someone battle tested and scarred managing my cash not some Putz rolling the dice with my money.
That’s your “Joe Kennedy” moment right there. When inexperienced 24 year olds have no problem raising $2.5 million (and getting a credit partner too), you know it’s time to get out.
I shudder to think what happens to you when you buy a bad property at the top of the market. I bought one near the bottom of the market and it made my life a living hell. But I was able to sell it at the top for a price that makes my investors quite happy. But if I had purchased that property now, where the market couldn’t rescue me from my mistake? ...
I think you'll start to see evidence of a slow down in primary HCOL markets. There are already some weakness in individual markets and submarkets (Denver), but I believe that the overall multifamily market remains healthy. Cap rates are compressing despite rates rising Treasury rates and could continue that trend. Most multifamily economists expect 2019 to be another strong (albeit worse than 2018) year for the multifamily industry. Homeownership affordability constraints and consumer trends will continue to drive demand, while strong rent growth will support property price growth.
No matter what, stress testing and highly conservative underwriting will be taken on all of my acquisitions.
@Serge S. Thank you for beginning a productive conversation on the state of the market. I think more open conversations like this benefit all. I agree with @Jonathan Twombly assessment regarding monitoring who is entering the market and at what level. I am not as familiar with the MF on the national level, but regionally here in the Chicago market, I definitely agree it is at the peak. CAP rates are at the lowest, and yet buyers are still trading on speculation verses cash flow. It reminds me of the 2008 pre-crash market for SF.
When evaluating the market, we have been studying both MF and SF. SF is definitely slowing down, with respect to velocity as well as pricing. We are seeing pricing similar to 10 years ago. Migration is a major factor to the overall market, which is why other regions may be doing better than here.
We also sold our MF portfolio, and have been focusing on self storage.
So is now a good time to focus on buy and holds and cash flow?
There are many apartment offerings on the market where rents HAVE to increase with the value add; otherwise, the property will have a tough time supporting the short-term, bridge financing. Will most of these in good locations do just fine? Yes. Is there more risk than most investors realize? Absolutely. With current market pricing, many of them have an 'Opportunistic' risk profile (with value add returns) rather than a typical 'Value Add' risk profile.
I have been finding better opportunities outside of multifamily but I still find a lower risk MF here and there. They are not the sexiest opportunities but they have in place cash flow, growing markets, safe debt, easy value add, and excellent management.
Article after article you see the positives of multi-family investing. Everyone seems to be wanting to invest in it and for good reason. Multi-family will be one of the best investments into the future that you can make. With that said, there will be a downturn, likely within the next 5-10 years or less, so it's buyer beware.
For me it's all about buying with solid cash flow, being very well capitalized and having strong debt in place (or no debt).
@Serge S. I fully agree with @Todd Dexheimer there are always deals to be had. Yes, they are hard to come by and you have to sort through the junk to get to them. If you buy for cash flow, have proper debt, and are well capitalized, there is a good chance you perform and make it through a downturn if you do hit one while holding the asset.
Experienced operators buy at the bottom, middle, and top. That's what separates them from the guy who is only educated enough to buy at the bottom. If you can figure out the thought process and principals that experienced operators have, then you will have a better opportunity to invest and dispose at all times in a cycle.
There are many apartment offerings on the market where rents HAVE to increase with the value add; otherwise, the property will have a tough time supporting the short-term, bridge financing. Will most of these in good locations do just fine? Yes. Is there more risk than most investors realize? Absolutely. With current market pricing, many of them have an 'Opportunistic' risk profile (with value add returns) rather than a typical 'Value Add' risk profile.
I have been finding better opportunities outside of multifamily but I still find a lower risk MF here and there. They are not the sexiest opportunities but they have in place cash flow, growing markets, safe debt, easy value add, and excellent management.
Mike hit the nail on the head here. Sure there are opportunities out there but when IRR is 100% driven by rents having to rise and a cooperating market ...
What the savvy investor/syndicator understands is that not all markets are at equal points in the cycle. Astute investors that intimately know a submarket and have been through a cycle in that specific submarket can spot this. The last deal I did was a 128 unit in a submarket where average rents, unit prices, job growth etc were still 25-40% off peak. Now there are reasons for this and not all markets recover but I was in that market already and knew the numbers did not tell the whole story. The seller was a group that operated in a different region and struggled with management and had no other assets in the sumbarket. As such average rents were literally recession era which translates to 1985 rents. They simply were not following the comps and were satisfied with the returns based on their low basis. In less than 12 months of ownership I have raised the rents 3 times and am sitting on a T12 cap rate well over 10%+ year 1 with a cash on cash over 20%. Is that sustainable? Maybe, maybe not but I did not have remodel every unit, double NOI or add $300 in rents per unit. I have a traditional portfolio bank loan 80% LTV 1.3 DSCR going in and 1.5 now. I can decrease rents 10% and operate at 85% occupancy and service my debt. Whats my projected IRR at exit? I have a decent idea but honestly don't care much. Deals like this come along a few times a year and I make sure to be ready. I can still renovate every unit and push rents another $100 and I have the funds in reserve with the bank to do so. Multiple levels of safety. I have neutralized many of the risks associated with a plan that requires huge rent and NOI swings. I've been in the market 10+ years and watch the economic signals carefully. I have flexibility to hold through an adverse cycle. I have been through full value add cycles from purchase to sale and know exactly what happens to inputs such as vacancy, bad debt, concessions, etc when I begin to push rents to the top of market. Safety in cash flow. When I purchase $400k NOI for $4.2M with $500k NOI year 2 and $600k year 3 WITHOUT major unit capex I immune myself to many (not all) market risk.
Now compare this to a typical PHX/Vegas/Denver syndicated deal. Syndicator buys the same $400k NOI for $9M at a 4% cap on a 3 yr balloon bridge loan and a 1:1 DSCR. Justification is that the last owner was an idiot without resources to upgrade units (even though the seller purchased the same asset for $2M just 4 years ago and just made $7M without doing any heavy lifting). Promise is for 15% IRR but its not cash flow driving that number its a "projected" future sale based on a projected cap rate off a projected doubling of NOI. Now how is that possible? Simple he will say. Just spend $1.5M renovating every single unit over 12 months (a laughable timeframe) and boom population growth and gentrification takes care of the rest. This is a great strategy in 2010-2015 when rents were well below historical mean. The bet was continued growth and reverting to equilibrium combined with a low and stable interest rate environment. But for this strategy to work today EVERYTHING must go right. What if that $300 rent bump across 100+ units leads to doubling of the velocity of turnover? What if it doubles bad debt? What if class A gets overbuilt (already happening) ? And how long does it take to address loss to lease recapture? A spreadsheet says one thing but how did your sponsor address these questions and issues with the deals he has successfully repositioned across multiple cycles? If your sponsor was jerking it waiting for prices to fall further during the last recession or just getting his drivers license then maybe its not a good idea to invest $100k in a spreadsheet and a podcast. I'm feeling great watching on the sidelines and I'll be ready to swoop up the foreclosed asset in 2022-2025 when that bridge comes due just as I was ready in 2010.
@Serge S. I fully agree with @Todd Dexheimer there are always deals to be had. Yes, they are hard to come by and you have to sort through the junk to get to them. If you buy for cash flow, have proper debt, and are well capitalized, there is a good chance you perform and make it through a downturn if you do hit one while holding the asset.
Experienced operators buy at the bottom, middle, and top. That's what separates them from the guy who is only educated enough to buy at the bottom. If you can figure out the thought process and principals that experienced operators have, then you will have a better opportunity to invest and dispose at all times in a cycle.
Agreed! I'm watching very intently at what I deem the "smart" money buying. Its multifamily its markets that still have legs. Its alternative asset classes. Operators that account for and know how to mitigate risk. Responsible debt, sustainable cashflow, decoupled from Class A, etc. I was fortunate enough to co-sponsor a syndication together with a guy I consider the smartest, savviest and most ethical operator in the country. Believe me, I am taking notes as we now reach the tail end of the disposition process. I still invest differently than his group and for my own goals but comparing tried and true best practices with some of the deals I see being pitched by new operators is shocking.
Real Estate is HYPER local! So... it depends. In short; I'm bullish there will continue to be opportunities and an abundance of capital to fund them. At the same time there's pain coming for the new and uninitiated.
A wise man once said, "In commercial real estate; somebody somewhere is screwing it up!"
Seek alpha by reducing the risk on a lower IRR, late stage section of the cycle. :)
Aside from real estate being very local, some general principles I follow that serve in any economy :
1- Follow proper underwriting principles based on my specific investment style ( value add etc..)
2- Use leverage to my advantage but never over leverage my position.
3- Keep proper cash reserves.
4- Educate oneself in the economy of the market I’m investing in, including jobs, changing demographics, historical cycles etc...
5- Surround myself with the proper team members who will cover the areas I am weak at and are real experts in their niche.
6- Knowing when to cut my losses.
7- I use real estate investing as a way to achieve more important milestones In life including family, health etc... this keeps me focused on the big picture and adds more objectivity to the process.
8- The bigger the portfolio, the more risk one gets exposed to in a turning market and the harder it gets to change direction. A 100 unit operator may have other needs and goals than a 10,000 unit operator. This goes back to #1 about knowing my investment style and Following proper underwriting principles.
These rules have allowed me to not worry much about being bullish or bearish and focus more on what I love doing.
As normal, all of this is market specific.
Nationally i think 2019 will see similar upward trends of interest, prices, competition on a national scale etc. But i have not seen any supporting information that we will see any tremendous differences, at least this year.
Multi-family continues to be one of the most lucrative out investments and will continue to beat other commercial real estate opportunities this year. Aside from perhaps industrial.
Multifamily is recession proof.
@Ethan Smith I really wish that was the case but history says that Is not true and Multifamily is very tied to economic swings. Funny thing is that if you polled investors 2 yrs ago probably 60-70% would have been predicting pending recession. Today 2 years further into the cycle you can’t find a nay sayer.