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.
US population now: 327 million.
US population estimates for 2050: Range from 380 million to 420 million depending on the number of migrants allowed to move to the US within calculations.
Taking this one simple idea into consideration all these additional people need places to live and multifamily properties are the most affordable solution to the problem of growth. Cycles with happen with cap rates, interest rates being one of the big drivers in that discussion. But the fundamental problem of people needing a place to live doesnt change.
Absolutely agreed and I am the biggest advocate and benefited from investing in multifamily. I have nothing to gain from any correction and sincerely hope we continue this run. If the market tanks I'll probably go down with it. But when I'm sitting on 50% LTV, 1.5 DSCR and cash reserves then falling rents and high vacancy means I'll have a bad year on that investment. Maybe 2-3 bad years with the nice side effect of new buying opportunities. A little different than the guy whos bridge loan is called in the year NOI is half of where it needs to be.
I wish I could give you 100 votes for this post.
@Serge S.
What suggestions might you have for someone like my husband and I (husband finishing grad school in May) who want Multifamily to be their retirement plan and ultimately their wealth building tool?
I know you asked Serge, but here is my advice. You are young and there is no rush. Time is your friend in real estate but you still need to buy in the right part of the cycle.
My advice is wait until you start hearing horror stories on BP about people losing money, and about how terrible MF is, and how it’s rigged against the little guy. When you start hearing about foreclosures and blood in the streets. That will be the time to buy, and if you are patient enough to wait until then you will do very well. Save your pennies for that day.
If you cannot wait for some reason then you must be extremely cautious. Learn how to underwrite deals and then scenario plan them to see how far down your vacancy can go before you cannot make your debt service payments. Plan for the absolute worst to happen a year or two into your hold period. Only if the deal still works under the worst case scenario should you even consider moving forward.
Also, at this point in the cycle, you want to buy the best located properties, where people will always want to rent no matter how bad the economy is. Buying marginal properties in marginal markets, as so many people are doing right now, is a really bad idea.
And a word on markets. There are a lot of markets that look cheap because they are marginal. Lots of people are investing in these places because they think they are finding bargains. But they are still overpaying and don’t even realize it because you should never compare markets laterally. Only compare them to themselves. These marginal markets will always be cheaper than the good markets and when a downturn hits and the good markets get cheaper, the marginal markets will get even cheaper and people who invested there at the top will lose money.
@Jonathan Twombly @Serge S. your advice is sound and this whole thread has done two things for me. 1) Instilled fear 2) Instilled fear. Which I honestly don't mind at all. I like most others on BP are just starting out. By that I mean I’ve flipped one house and read a handful of books but have no rentals as we speak. If I had a dozen I would still consider myself a newbie. There are very few seasoned investors on here in my opinion so when investors like you two jump in I feel fortunate to soak up the knowledge shared.
I recently formed a partnership for flipping homes here in Houston and we successfully flipped our first home that sold/closed last month. It was a great learning experience and the margin wasn't what we had hoped but we still made money. Initially, I had zero interest in flipping homes when I was approached by my partner but I figured it would be a good way for me to build up cash reserves so that I could acquire more and more rentals so I said yes. I have always wanted the long term buy and hold approach that so many of us newbie investors are after. I started with looking into SFH, and then moved onto 2-4 unit properties and now looking into MFH. All the while not having a single rental. It's surprisingly hard to pick one niche in real estate and truly dig in and plow ahead. I find myself stuck in this cycle of which type of REI I should hone in on.
I also have a friend of mine who has spoken to me about helping him syndicate for some apartments. He has successfully purchased a few apartments within the last 18 months or so but I cannot tell you whether or not the figures within those deals are contingent upon value add and increase rents or if the deal was structured in a way that it would survive a worst case scenario vacancy / market crash.
Now I am confused more than ever on what to do.
@David Olson congratulations on getting into it!
Re: your number 1 - flippers can get in trouble if the market hits a rough patch as well. If you can't move your properties and lenders come knocking that can lead to cascading foreclosures.
Tough call on your options. Except for #4, don't do that.
@Serge S.
What suggestions might you have for someone like my husband and I (husband finishing grad school in May) who want Multifamily to be their retirement plan and ultimately their wealth building tool?
I know you asked Serge, but here is my advice. You are young and there is no rush. Time is your friend in real estate but you still need to buy in the right part of the cycle.
My advice is wait until you start hearing horror stories on BP about people losing money, and about how terrible MF is, and how it’s rigged against the little guy. When you start hearing about foreclosures and blood in the streets. That will be the time to buy, and if you are patient enough to wait until then you will do very well. Save your pennies for that day.
If you cannot wait for some reason then you must be extremely cautious. Learn how to underwrite deals and then scenario plan them to see how far down your vacancy can go before you cannot make your debt service payments. Plan for the absolute worst to happen a year or two into your hold period. Only if the deal still works under the worst case scenario should you even consider moving forward.
Also, at this point in the cycle, you want to buy the best located properties, where people will always want to rent no matter how bad the economy is. Buying marginal properties in marginal markets, as so many people are doing right now, is a really bad idea.
And a word on markets. There are a lot of markets that look cheap because they are marginal. Lots of people are investing in these places because they think they are finding bargains. But they are still overpaying and don’t even realize it because you should never compare markets laterally. Only compare them to themselves. These marginal markets will always be cheaper than the good markets and when a downturn hits and the good markets get cheaper, the marginal markets will get even cheaper and people who invested there at the top will lose money.
Jonathon,
I applaud your advice to this young family. I am new to RE investing, but have significant experience in equity investing. You are right...cycles matter. If you bought the S&P 500 in 2007 you got hammered to the tune of -37% the proceeding year. Although the magnitude of that financial calamity was much more severe than most the lesson is the same. The signs are everywhere. Three of my friends are getting their RE license to invest “on the side”. These are people with no real financial acumen much less a background in RE. I think your advice was honest, practical and came from experience. If your wrong? They lose out on an opportunity. Big deal.
Warren Buffett’s rules of investing:
#1 Don’t lose money
#2 Always observe rule #1
Anyway, personally, appreciated your honesty and sage advice. Good luck in all you do.
Dave
@Jonathan Twombly
Thank you for the advice. That is what my line of thinking was. Especially where we have some serious student loans to hack away at. I am, however, contemplating a smaller multifamily to live in while we tackle our debt. What are some things to consider in this part of the market cycle? We are in Asheville, NC.
@Jonathan Twombly
Thank you for the advice. That is what my line of thinking was. Especially where we have some serious student loans to hack away at. I am, however, contemplating a smaller multifamily to live in while we tackle our debt. What are some things to consider in this part of the market cycle? We are in Asheville, NC.
Take advantage of the difficult time to study your chosen market, find target properties you’d buy if the price were right, and start saving. In other words, get prepared so you can pounce when the moment is right.
@Serge S., Thank you as well for the feedback. Most of what I know about DSTs and installment sales are from reading online or in books. So, from that perspective, a DST has always seemed to me something to consider more towards retirement, or when I'm truly tired of active RE management. You're making me think it deserves another look, though. Can you mention some big reasons NOT to do a DST when exiting? It does sound awfully good on paper.
Not to bring the conversation over to opportunity zones, since there are tons of threads on the topic now, but based on my research, it seems like there are a number of tricky uncertainties there like:
1.) How to pick a fund to invest in? Seems like there are endless managers who are great at raising money right now, but it's hard to tell which ones know how to operate on the ground (even more so than traditional syndications since it's so new).
2.) If investing individually, a lot of the good locations are as competitive as ever with prices already on the rise, and the property has to be ripe for extensive rehabilitation or development.
3.) I heard that different states are adopting variations of the opportunity zones tax law, which brings me to another point that there's so much hype and information being spread about opportunity zones right now that it's hard to figure out what's accurate or worth pursuing.
Definitely some interesting topics to think about. I'm a guy who's hyper-localized in my investments, and while I think that has served me well, I also think it's become a barrier to pursuing certain other opportunities.
@Jonathan Twombly
Well that’s exactly what I’m doing right now. So I will just keep on keepin on! Thank you again.
@Robert C. there are some drawbacks to DST primarily fees. They want 2-3% of the cash (cap gains) brought into the trust. Then .5-1% annually AND a fund management fee for every investment you purchase. And thats if its a "preferred" investment that they pitch. Its a partnership between investor, trustee and investment manager. You can invest in what you want but then the yearly fee spikes to over 1%. All these fees add up. But you can invest in what you like and write the note as you prefer.
Regarding the opportunity zones, again plenty of ways to skin it. There is a lot of flexibility. You can cash out of RE $1M then open a bank account called Opportunity Zone Fund and now you are the fund. Put the $1M there and its deferred 10 years plus stepped up basis in whatever you subsequently buy. You have time to buy as well so your deferring in the year of the cap gain event and purchasing the following year. Big problem is that you need to spend the equivalent amount in improvements as your initial purchase so this works best for land or some inner city revitalization where your buying a shell, otherwise can be difficult to pull off. Or you can give it to a "fund" and hope your not getting interviewed 2 years later on an episode of "American Greed." The RE run up has made everyone look smart and there are a ton of operators out right now rolling the dice with other peoples money.
End of the day 1031 is the best option but finding a replacement property, different story.
First off, thank you @Serge S. and @Jonathan Twombly for this incredible thread. Some of the best content I've read on BP.
I'm glad to hear there are other experienced investors with the same view of the market I have. I have the ultimate goal of getting into MF investment but I'm still relatively young and have time.
To those out there that are in my same boat, I'll tell you what I'm doing:
1. Learning my market as best I can
2. Underwriting every single deal that comes across and learning as much as I can about larger properties
3. Networking as much as I can in my market to put myself in a good position
4. Since I have some capital, I am investing in some deals with sponsors that have a serious track record, specifically having been doing this prior to the recession not just post-recession. Among other criteria, debt has to be long term agency from the get go. These deals are few and far between. Most deals I see from sponsors are similar to what everyone has been discussing above
5. I'm also looking at 2-4 unit multifamily. They must have strong cash flow and be in good parts of town, not marginal. I can do these deals by myself. The worst think I could do is kill my reputation with potential investors by losing their capital before the real buying opportunities come along.
@Scott Runyan sounds like you are on the right path. I love the dual track of investing with sponsors while looking/purchasing small multifamily. Everything you learn with the 2-4 unit will be applicable to your larger multifamily purchase and watching the sponsors over time will fill in the rest of the gaps. There will be a time of distress and you will be ready.
I am transitioning from active to more passive and diversifying through LP syndication investments. I'm enjoying reviewing and comparing notes as to what these guys are doing (sorry to any women in this game but I haven't run across a female sponsor yet). What I've learned is that not all sponsors are created equal. There are marginal sponsors that are learning on your dime and there are pros that have been in the game. I'm not sure how a dentist from CA figures out one from another.
@Ivan Barratt
Exactly. I had the same thought given the yield curve inverted today. I just posed the question in a new post.
Serendipity!!