Why Multifamily Housing Values Will Continue to Defy Gravity

Question

Decent, short read in the link below. As someone who raises capital for a select few syndications, I often get questions around rising interest rates, inflation, will the market crash, etc?

In my humble opinion, multifamily & self storage remain stable investments, and don't tend to be correlated to the single family market, and its vulnerability to changes in interest rates, which is why investors flock to commercial real estate niches such as these. Our opportunities tend to be oversubscribed within in days. Why? It's a repeatable formula, throughout market cycles (can hold for longer time horizon, if need be) - buy assets that need moderate renovation, in growth markets. Improve management, improve the assets, increase rents inline with market rates, but with tenant retention in mind, as well. Increase vacancies, as tenants like improved units/surrounds. Stabilize cash flows, sell to institutional investors or larger family offices, who are happy to buy these in-built cash flows for their investors.

Why Multifamily Values Will Continue to Defy Gravity (multihousingnews.com)

Elizabeth M Williams · Answer

@Sam Wilson most welcome. I have also heard a lot, and thought a lot, about inflation, as well. Wrote this on the subject last month.

Multifamily Investing in Inflationary Times - 6 Reasons This Will Protect & Grow Your Portfolio

The past few years have proven to be pretty turbulent, to say the least, and from an economic perspective, there is no end of opinions on what's coming next. Data is pointing to increasing inflation, and the stock market continues to be irrational & exuberant, making many investors fearful of a correction.

I know many investors like to be 'all in' in some form of investing, be it equities, real estate, crypto, gold, etc, but personally, I think that diversification is critical to protecting your assets. It's easy to become emotionally involved in our investment decisions, picking a favorite stock, or buying houses to flip in our neighborhood, or trading crypto because it's exciting, yet if we are really honest with ourselves, if we are investing to build wealth, are we really making smart choices? Are we taking on more risk than we should be, or conversely, are we being so conservative (or, refusing to look at data, over our opinions) that we are missing out on superior returns?

As a long time fan of rental properties, I have finally turned the corner, and plan to invest our future real estate allocation into multifamily syndications. But, given the concerns of looming inflation, I'd like to explain why multifamily syndications can help you both protect and grow your wealth -

• 1.Multifamily syndications are not closely correlated to the stock market. Not only that, but commercial real estate, such as multifamily syndications, are even less affected by broader market sentiment than single family homes, further protecting investors from market volatility. If the hot housing market cools down, and if the economy and stock markets experience decline, multifamily syndications are a very attractive alternative, providing stable distributions for years to come.
• 
• 2.Investors are investing in physical assets, which appreciate during inflationary times. Unlike investing in stocks, properties are physical assets, with intrinsic value. Furthermore, the types of multifamily syndications we invest in, as well as offer to our investors, are value add, meaning that our syndicators acquire assets (generally off market) at an attractive valuation, renovate the units & common areas, implement well-reputed property managers, and increase rents to market rates, thereby increasing the properties' valuation on exit.
• 
• 3.Inflation creates further increased costs for construction materials, making newly constructed homes & commercial properties even less affordable (and in less supply) and existing assets more valuable. Not only does this drive housing costs up, but it also makes existing, renovated commercial assets very desirable for investors seeking consistent, stable income streams. REITs, DSTs, funds, institutions, large family investment houses, and high net worth investors are exactly the types of buyers who purchase these stable income streams when syndicators sell their assets.
• 
• 4.Multifamily syndications offer attractive long term income. When inflation sets in, interest rates tend to rise, making the cost of affordable single family homes even greater. But people still need a place to live, so rents often go up, due to increased demand for affordable housing, during times of inflation. 

And should there be any slowing down of the single family market, commercial assets, particularly in sectors such as multifamily, self storage, and mobile home parks,  tend to be less correlated to the market sentiment, thereby further insulating investors from market downturns. 

Through market cycles, investors can enjoy stable income streams, for years to come, vs being exposed to a rehabber trying to flip a property, and getting caught in a downturn. Multifamily syndications offer a way to enjoy income, and syndicators can elect to 'wait it out' for favorable market conditions, if need be.
• 
• 5.Inflation creates greater rental demand, in a non-binary fashion. During times of inflation, increased interest rates & cost of construction are two drivers for an increase in rental demand. But another driver is overall cost-cutting. As Covid stimulus dries up, consumers will be looking to save their dollars, and moving to more affordable housing, in the form of rentals, in more affordable markets. 

As a single family investor, if your tenant decides to move to a more affordable area, you expose yourself to a vacant house, creating a less dependable income stream. Even if there is increased rental demand in your market (more on that in Point 6), if you're in a high rent area, the data is showing that more and more millennials, young families, and young retirees are moving to the suburbs, for a lower cost of living, safer areas, better schools, and job growth. 

By investing in a multifamily syndication, or in a multifamily fund, you are diversifying your investment across hundreds of units, thereby reducing your vacancy risk.
• 
• 6.Inflation can affect different geographical areas differently. To me, this is the most critical factor in your decision on whether or not to invest in multifamily syndications. It's the mantra of real estate - location, location, location!

Not only that, but commercial real estate, such as multifamily syndications, are even less affected by broader market sentiment than single family homes, further protecting investors from market volatility. If the hot housing market cools down, and if the economy and stock markets experience decline, multifamily syndications are a very attractive alternative, providing stable distributions for years to come. 

The trick is to invest in syndications whose rents will rise alongside inflation, while also maintaining high rental demand. Savvy investors will follow the data, and invest in markets expected to continue to grow, regardless of broader market conditions. Savvy, well-established syndicators are already doing this.

Final Thoughts

I'm always an advocate of being diversified. It helps me sleep better at night. Our portfolio is a mix of asset classes, designed to weather out most storms, including inflation. We have invested in syndications, personally, and will continue to do so for years to come. I've written about syndications as a hedge against inflation, but there are a number of other reasons investors love syndications, including tax advantages & the passive income streams, to name a few.

Elizabeth M Williams · Answer

@Raju Balakrishnan have a read through these -Surveying the Apartment Landscape For 2022 | GlobeStInstitutional Investors Shift to Long-Term Hold Apartment Strategy | GlobeSt

Elizabeth M Williams · Answer

@Paul Moore read his comments about that deal, too. Love that he dipped into his own pockets to protect his investors, too. No doubt you tell your investors that all investing carries some form of inherent risk, and the overwhelming majority, if not all, of our investor base have a background in investing already. Part of the process is educating them, answering questions, being transparent about both risks and upsides, which I'm sure you do.

@Daniel Han

When asked about what could go wrong, I mention rents not being paid, poor underlying financials at the outset, unexpected expenses, to name a few.

This is where getting into the right deal, with the right syndicator, can help to mitigate risk at the outset -

- picking the right asset class. Class A properties would be more vulnerable during a downturn, with no ability to add value, and no reserves built up (from renovated units and increased rents prior to a downturn)

- picking the right location - in a downturn, those demographics should go a fair ways towards protecting against losses, or at least significant ones. Markets that are growing in population, jobs, rents, and income - leveraging both demographic and economic fundamentals - all helpful risk mitigation factors

- working with syndicators who've either experienced or witnessed deals go south - syndicators who are savvy enough to be conservative in their projections, set aside reserves, have created realistic sensitivity analyses, have good banking relationships in place - investing with these types of syndicators, with a track record through ups and downs, helps to decrease risk. It's worth noting that the market recovered in 8 quarters during the last recession, and good syndicators will be agile enough to deploy a strategy to ride these troughs out - have a look at this-U.S. Multifamily Lessons from the GFC | CBRE- investing in funds - some syndicators offer a portfolio of assets to invest in, with the same underlying returns structure of a single asset deal. By investing in funds, you can further mitigate downside risk by being diversified across a multitude of geographies and/or assets.

- investing in other assets - loads of other types of syndications to invest in - medical offices, self storage, warehousing, etc. On a personal note, we plan to invest in a self storage fund and a MF fund in 2022, and perhaps one individual deal.

- investing in other asset classes outside of real estate - I know some people put all of their investment into real estate, but I am a believer in diversification, so that your entire investment portfolio isn't at risk during any downturns.

- keeping some cash reserves - downturns mean opportunities for smart investors

Investing carries risk, as does not investing. It's super important to create a well-balanced portfolio, in alignment with your risk appetite. I have clients who I advise to not over invest with me, if they aren't also in other asset classes, particularly after understanding their overall investment goals.

Working with operators who can navigate through a few down years without losing your capital also helps. Personally, I expect I will get a lot more hammered in the stock market (which is heavily manipulated, in comparison) in the coming years than in the syndication space, but none of us has a crystal ball. I also think the single family market will get hit first, and that assets like self storage have managed to hold steady through varying cycles.

Lastly, it's worth noting that stricter lending guidelines have been put in place since the GFC, and investors have become careful to make sure that deals they invest in aren't overleveraged, and that the operator's interests are aligned with theirs.

Paul Moore · Answer

Hey @Daniel Han. Great question. One myth - which is just a way of justification in general - is that people always need a place to live. Believing this myth is like believing the lie that “things are different this time.”

While it is true that people need a place to live, that doesn’t mean they will always pay their rent. And it doesn’t mean they will keep paying the same amount in a big downturn. And it doesn’t mean they won’t move in together or move into their parents’ basement.

@Brian Burke really clarified this for me a number of years ago on my podcast (How to Lose Money).  Brian told the story of buying a deeply discounted Texas apartment asset around 2008. He said occupancy went down by about 25% and about 25% of the others were not paying.  So his economic occupancy was about 50%, and rates were dropping. It was a disaster for him and he showed his shining true colors by the way he dealt with investors through this difficult holding period. None of them lost money.

But I’m guessing other syndications that faced these challenges might not have fared so well. My two cents.

Todd Dexheimer · Answer

I agree that at this time real estate (besides office) looks poised for continued growth. We are continuing to purchase both Senior Housing and Multifamily, but are certainly paying attention to a few factors, especially with Multifamily.

1. Inflation: this could be good, but we need to see income inflation, not just expense inflation

2. Interest Rates: a small fluctuation is fine, but if for some reason interest rates go up 3+ bps, that would certainly change things

3. Government intervention: we are avoiding states that are aggressively going after landlords

Daniel Han · Answer

Let's turn it around and ask what will cause MF syndication to go down in value?

I'm an LP in many syndication deals and I'm really interested in finding out what would cause a downturn in MF other than bad deals and fraudulent operators.

What happened during the GFC? Did many MF deals go belly up? why?

Raju Balakrishnan · Answer

Thank You @Elizabeth M Williams . That is useful. Yes things has been looking good so far. Y-o-Y  stats makes limited sense now as it just says things are looking better than last year, not pre-pandemic. Besides, we are in recovery phase of the pandemic now. The question is really it will go back to where it was before pandemic in a year or so, or there will be a fraction of folks who will decide/able to work remote in industries like tech. This will have an impact on housing in some high price cities at least.   Since pandemic is a black swan, we may have to wait and see.

Raju Balakrishnan · Answer

Beyond inflation, the remote work will have an impact on the Multifamily. Even if 5% of the jobs become fully/partially remote in long term, many will be able to afford a house in suburb/rural areas than renting an apartment. This should take pressure off-of multifamily. Especially significant for current and upcoming tech-hubs including Austin and Phoenix in addition to bay area. Thoughts?

Chris Acosta · Answer

That’s an interesting out look on multi family investing. Are you saying multi family small apartment deals 5-15 units will not be in demand for the years ahead? I’m not understanding what your relating multi family to inflation if you could elaborate more on that?

Inflation should technically decrease leverage, increase rents, increase the value of our investment property. Google triple crown inflation for this theory.

Evan Polaski · Answer

When looking at what can cause prices to drop, I don't believe you can look at anything in a bubble.  Inflation hits and interest rates rise.  As noted a small increase will likely be absorbed with increased demand, but a large increase to stem off systemic inflation will push us into negative leverage.  And let's be honest, real estate returns, on the surface, are not all that great without leverage.

So as rates rise, which will effect all real estate, it will have a larger impact on multifamily than other types of real estate, because the delta between interest and cap rates is typically tightest in multifamily, since it is the "lowest risk" asset class.  This tightening in credit can and will push demand down, as investors continue to chase yield.

Add to that, the strong performance of suburban office, as companies are generally departing the city centers, retail confidence rising and people wanting to spend, and all of this will start moving money back out of multifamily and into office and retail again.  Now, I don't think the institutional and foreign money will be jumping ship next month, but in 3-5 years, I see the confidence in the office sector and retail picking up.  And everyone's memory is short, both retail and institutional investors will be assessing their risk tolerances in a few years and the yields they can create out of multifamily will no look as great.

Then mix in things like crypto, which will either crash and go away (unlikely) or more likely start to stabilize and pull investment allocations away from other asset classes, as investors feel more confident in the long term viability of the asset class.

Why Multifamily Housing Values Will Continue to Defy Gravity

Most Popular Reply