Apartment Investing – Resetting Investor Expectations but Delivering
I had a conversation recently with a multifamily operator partner with whom I have worked on plenty of syndication deals together and who owns 20+ large MF apartments. The challenge is continuing to find deals that have the same return characteristics as our past deals without changing one's criteria. Of course, cap rates are continuing to compress as demand for these assets seem unabated.
More players than ever are in the space due to the long-term performance and stability of value-add apartments, including international buying groups. The U.S. still is seen as a safe haven in the world with one of the strongest economies. I read an article recently that said of family offices (High Net Worth families with professional money managers), apartments are by far the favored real estate investment play.
There are not a lot of commercial real estate niches where the winds are still favorable, and current cash flow with upside can be realistically achieved and out-looked while risk is minimal with the right ingredients (good market, conservative deal and experienced team). Let’s look at the data.
Apartment assets have outperformed the stock market by 2x for the past 25 years with far less risk. Very few folks really know this. I highlight data like this in my recent eBook, Riches in Niches. From 1993 thru 2007 apartments returned 13.32% and stocks returned 7.54%. As important to investors especially in a market that has been robust for awhile now, is that apartment assets do admirably in a downturn as well. During the 2007 – 2009 period when the markets were imploding, the S&P 500 stock index lost 22% while apartments fell 6%. One would have to think that this data includes all apartments. If you selectively removed for some of these types of properties, areas or operators below, the risk would have been almost nil.
- New constructed apartments get hit the hardest during downturns (we only focus on value-add which is far less risky since new apartments are more prone to having to provide rent concessions).
- Risky markets (think Vegas, Phoenix and Miami that were over heated, even speculative) or bad areas of any town where jobs and people are not moving too but fleeing from.
- Bad operators (those with no experience, no business plans, little cash reserves, poorly maintained or managed properties, over-inflated forecasts, wrong loan structures, and so on, that may have been forced to sell at low prices or lost to banks due to inability to pay their debt.
- Small apartments that lack scale versus larger apartments (200 units +) where the cost per unit of a manager or maintenance person for example is much lower.
The data shown on slide 28 by clicking on this link of this Housing Finance Policy Center report included the good, bad and ugly. During 2009, the worst year of the crash period, only 1 in 200 apartment owners were delinquent in paying their debt (0.5% nationwide). Compare that to most folks who own a single-family home, the mortgage default rate was (4.5% nationwide). About 10x riskier to own a single family property vs owning an apartment.
So, getting back to my conversation, my operator partner models to a 8% preferred return, a Cash on Cash (COC) of 8% range, and average annual returns over a 5-year target hold of 18 to 22% returns. Those characteristics have been consistent over the past 3 years I’ve been working with them on the GP side. They hit 8% in year 1 on CoC basis. They pay out monthly so investors get enamored with the consistency and frequency of payouts. They have successfully exited and exceeded expectations on several deals by a wide margin.
This came up because if they are struggling to find deals in this range, if we lower our return expectations and as a result reset expectation with our investors, it would open up more opportunities for investors. I encouraged them, since I’m close to the investors who are interested in their deals and sometimes allocations are limited to our investors which get shut out of their deals, to still buy in quality markets, quality assets that need renovating and improved operations (value add strategy) but our investors would accept slightly lower returns.
If we educated investors and shared quality deals (still offering up a 8% preferred return that is cumulative) where CoC returns are say 5% yr 1, 7% yr 2 and maybe 8-9% yr 3 thru 5 with 15% to 17% annualized returns that with their track record and consistency investors would still jump on board. Even going out further say 7 years versus 5 years hold period would be tolerable.
They agreed so a slight re-set of expectations is at hand in an extended market like this but it does not mean we can’t find good high-quality deals that investors can do well, its just that we need to educate investors and help them understand that these types of returns are still admirable and open up more opportunities for them to participate. Re-setting expectations would be healthy.
When the bank is paying 2% on one-year CDs that lock your money up, 1% on savings accounts and with a stock market that Vanguard (largest mutual fund company in the world) says will only deliver a 5% return over the next decade, its not even a question that value-add apartment investing with slightly lower return expectations can still be a powerful, reliable motor to get your financial boat to the best and safest beaches with less rocking along the way.