All Forum Posts by: Matthew Drouin

The latest report out of Costar on Multifamily was quite an interesting read.  I decided to do a deep dive analysis on our market in particular; see how it stacks up against these; and how our own multifamily portfolio stacks up with local trends.

Rochester may not be a sexy high growth market but, if you buy in the right location, have a great business plan and execute that plan, you can enjoy great cash flow and steady, double digit appreciation in your equity position!

In this report, you will learn:

- What rent growth and vacancy trends we have experienced over the last three years.
- How that compares to the overall Rochester market.
- What we are selling right now.
- How we are positioning our company for future opportunities.

Don't let the headlines fool you on the fundamentals of your own market. The most recent multifamily reports that you'll see is a significant pull back in rent growth, even some recently high flying markets have had negative rent growth, like Tampa, Phoenix, Austin, and Atlanta, some as high as a negative rent growth of 24% from 4th Quarter 2021 to 2nd Quarter 2023!

The pull back in these markets is due to a confluence of many factors, but it started with these environmental factors:

1. Low interest rates and easy financing for new projects.
2. Structurally high rent growth on existing inventory.
3. High wage growth and high job growth.
4. Very low vacancy.

These factors led to floods of institutional capital coming to these markets to snap up existing multifamily inventory and build new supply to meet demand.

For these markets, the last 5 years have been a seemingly never ending party!

But now, they are dealing with a hangover.

But not Rochester, NY!

We've maintained our status as the "steady eddy" of real estate. In a nut shell, rent growth has remained elevated but not sky high. So the low interest rate environment dovetailed with "good but not great" demand has kept new inventory low and absorption of any new product very healthy.

Turns out Rochester is not the only market in the US that has not fallen victim to the headline numbers. "Midwest and Northeast markets remain the most stable given their more modest construction pipelines and are projected to see rent growth in the 2% to 3% range into 2024."

As a region, our relatively anemic rent growth and job growth has prevented developers from appreciably adding to new supply of multifamily housing.

According to Costar (a real estate analytics firm):
"Vacancy in the Rochester multi-family market is 3.7% and has increased by 0.6% over the past 12 months. During this period, 540 units have delivered, and 180 units have been absorbed.... Rents are around $1,330/month, which is a 4.6% increase from where they were a year ago.... About 1,000 units are under construction, representing a 1.8% expansion of inventory. There have been 22 sales over the past year. Sales have averaged $85,330/unit.... Over the past three years, there have been 122 sales, which have traded for approximately $277 million. The market cap rate for Rochester is 7.1%, slightly above its trailing three-year average of 6.9%...."

However, sales transaction volume is down considerably. This is primarily due to high interest rates and a very wide bid-ask spread between what sellers want for their property (the ask) and what buyers can conceivably pay (the bid) while being able to meet their return requirements for their lenders and investors. We've seen it first hand. Not only do we have to pay a lower price for a property, just to meet the Debt Service Coverage Ratio our banks require, but also we need to be more competitive in the annual returns that we offer our investment partners. Just a few years ago, it was easy to raise capital for deals while offering a 7% fixed annual rate of return to our investors when 10 year treasuries were paying 0.55% to investors. Now 10 year treasuries are paying closer to 4% and FDIC insured money market accounts are paying 5%. All of these factors have to be considered when calculating the net present value on any asset we purchase. However, property owners haven't come back down to reality, because they don't HAVE to sell. So it's resulting in sales volume of multifamily assets plummeting to almost 50% of the 5 year average.

According to Costar:
"Rochester recorded just 22 market-rate trades over the past 12 months, which was near the bottom of its peer group. That translated to the lowest number of sales over a 12-month period in five years, as investors appeared to dial back purchasing activity. Annual sales volume has averaged $101 million over the past five years, and the 12-month high in investment volume hit $207 million over that stretch. In the past 12 months specifically, $51.9 million worth of multifamily assets sold."

We own a fair amount of multifamily in the Rochester market. So are these statistics mirroring what we are seeing across our assets?

The short answer is "yes"

As a company, we've been able to maintain strong occupancy at 97% while achieving organic rent increases of 5.2% across our residential portfolio over the the past 12 months and been able to achieve rent increases on average of 5% while maintaining occupancy of 97% for the year prior to that as well in 2021.

In regard to the new acquisitions, our experience has been consistent with the stats as well. Many more opportunities are coming our way through commercial real estate brokers and our work on off market deals direct to seller, but the pricing expectations are not in line with the reality of interest rates and our investment return requirements given the current state of what our investment partners are now demanding given how high returns have been driven in "risk free" assets like MMA (Money Market Accounts) and other fixed income products. This has been primarily the result of the Federal Reserve's monetary policy to help curb inflation.

So that's a snap shot of local multifamily. What about the local economic fundamentals in Rochester?

As you will see, the underlying fundamentals in our region remain steady. Although there are no foreseeable catalysts in turbocharging household incomes or population growth, there are no foreseeable cataclysmic events that should shake that up. Rochester has gone through it's changes. We no longer have the corporate behemoths of Kodak, Bausch And Lomb, or Xerox. But out of their ashes, we've risen, possessing a diversified economy of a constellation of companies largely made up of recession resistant sectors like education and healthcare.
Some key stats:

• Employment rate across all sectors is up 1.54% which is well above the 10 year average of just 0.15% according to Oxford Economics.
• Also median household income is up 3.3% over the last 12 months which will continue to undergird rent price stability. That dovetailed with extremely high construction costs and stable but not explosive rent growth will keep new supply constrained.

So the bottom line:

If you are a multifamily investor, be patient. It's going to take some time for bid ask spreads to narrow and create buying opportunities for operators.
As inventory starts to tick up, and deals start to stay on the market for longer, some sellers will come to grips with reality.
That being said, now is the time to keep prospecting for opportunities and maintain top of mind in your sector as an active buyer.
If you own small multifamily 2-4 unit, the market is still red hot. We are jumping on the opportunity and strategically selling off some of our smaller assets that have considerably appreciated in value.

We are not a fan of doing 1031 Exchanges right now because of the constrained market on the buy side. Instead we are selling some assets and then performing a cost segregation analysis on some of our larger deals to help defray or eliminate capital gains taxes, and just sticking the cash on our balance sheet to better position ourselves for a potential market shift.

@Jake Andronico thanks.  There's a lot of text on these forums so I figured I'd mix it up with a gratuitous check selfie lol

Where you at on your real estate journey?

@Johnny Munoz

Congrats! And thanks for the kind words. And let me know if you need any other details!

@Alexa Ghyzel

It’s awesome you’re taking the first step and becoming obsessed!

I’m an active investor in Rochester. I’m president of our local Real Estate Investors Association, Freedom First.

Getting in the same physical room with people is going to help tremendously! Our community is a non profit and is dedicated to helping people build generational wealth in real estate, so check out our calendar, our next general meeting is on Sept 14th at Eagle Vale in Fairport.

You may be surprised to learn that you may be able to skip the fix and flip and go right to buy and hold if that’s your goal. A lot of people who start in fix and flip believe that the only way to buy long term investments is by using the profits from flips to use as down payments on investment properties.

To buy a flip that’s going to make money, you’ll need to buy it with equity built in. However if you buy a property with substantial equity from day one, then you could do it as a long term hold using little to none of your own cash and create long term cash flow.

Just a thought.

Either way, for a successful real estate deal you need three things:

1.) An Opportunity

2.) Money

3.) Experience

If you don’t have all three of these, that’s ok. But you do need one. So if you find an opportunity, off market, then you can find someone who has 2 and 3 and joint venture with them and take an active role in the project to get the invaluable experience!

Hope this helps! Reach out if you have any questions or need help!

I know this check says $176k but I held $25k in escrow, paid $10,800 to the buyers agent, and had a $8k in a holdback that was released after I fixed a furnace at the property.

This was a duplex that I bought in 2017 for $146k.  I recently sold it for $360k.  I raised the acquisition cost in hard money and rented both units out pretty quickly after buying.  I refinanced it in less than 12 months, took my hard money out and got my capital back that I put into the reno.

Why did I sell it?

I sold it because, even after I stabilized it, it only cash flowed about $5k a year.  I figured it would sell for around $350k+.  My loan balance was $138k.  My return on equity was around 2.25%.  Return on equity is calculated by dividing the cash flow by your equity position.  I have a portfolio policy that if my return on equity drops below 11% consistently, I will either sell or refinance (strap on more debt and cash out.)  In this case, I couldn't refinance because it wouldn't meet the Debt Service Coverage Ratio covenant with my bank.  So I sold.

What am I going to do with the cash?

I would have done a 1031 exchange but the market is so overheated that I didn't want to have the 1031 gun against my head and be forced into a bad or mediocre deal.  I believe the market is inflated.  I have been focusing on larger commercial acquisitions over the past several years.  With the interest rate environment, the cost of capital increase for both the banks and our investors has not come in line with seller expectations.  That being said, I'm taking the cash out and taking the tax hit.  Why would I pay $300k more for a property just to save $50k in taxes? (which is the worst case scenario if I don't have net loss carry forwards, which I do have.)  I am working with my accountant on getting cost segregation on one of my larger properties to defray the tax liability but it appears to be zero sum in the grand scheme of things.  So I am going to add to my stock portfolio of mostly total stock market index funds and increasing my securities based line of credit so I can use that line to fund future opportunities.

Incidentally, one of my biggest lessons learned was "search everywhere for deals and leave no stone unturned." This was an MLS listed property in a tertiary market (Rochester NY). I've bought deals "on market" and "off market". I've bought great deals and duds utilizing both.

Cheers and if you have any questions or thoughts, let me know!

@Nate Carlson

First off, congrats on being on the position to do that!

Finding an investment that pays you a risk free 6.5% rate of return is going to be awfully hard.

So for me in your situation it would be a no brainer to pay the house off, especially since you’ll have rainy day funds left over as well.

Then I would get a home equity line of credit so you have a flexible credit facility to pull on when you find opportunities.

I used my HELOC to explode my real estate portfolio where I'd buy small multifamily, fix them up, rent them and refinance and pay the line back down to zero. It's how I went from unit 4 to unit 76 during my first 13 years of investing.

@Nick Libert

Cheap and investment are two words that should not be used together!

Rochester is a great place to invest for cash flow and stable appreciation.

Buuut there are a lot of traps in our market. 3/4 of our city lives in crushingly brutal poverty stricken areas. You can find cheap properties there but no one who would want to live there that will pay you the rent and not destroy the place.

There are pockets of very desirable areas in the city where I invest where I am able to achieve returns on my equity of between 11%-15% and internal rates of return above 25% per year.

The suburbs are great, but since Rochester was so wealthy back in its heyday there was not a lot of multifamily housing that was built in the burbs but you can find single family rentals.

Either way, you aren’t going to be buying “cheap” properties, so why not invest in your own market and owner occupy a multifamily?

@Haylee Moore

To echo what @Chris Seveney said. You will need to check with zoning.

And very important here, check with building code.

Zoning might allow it. They might not. If they don’t they you’d have to obtain a variance, which involves a public process.

Let’s assume that it is zoned as of right…

Now Let’s consider building code. When you change use or build new, it usually triggers you to bring the new building or what is being converted to be brought up to current building code. In some towns they change the code every year.

I’ve found in my experience that even if something is zoned for the proposed project, the building code requirements can make it cost prohibitive: think sprinklers, ADA requirements etc.

The one thing that would make it less cost prohibited if it was an extremely high demand, high barrier to entry, low supply market.

I own property in Rochester NY and I considered adding an additional unit to a 4 family I own. The cost of that additional unit was going to be $200k. Well I can buy a preexisting TWO family for $200k in my market so it was relatively cost prohibitive.

But, if you can build an 2 bd ADU for $200k and units in your area go for $350k and the cash flow from the additional unit gives you well above 20% above your debt service, it might be worth looking into further!

Hope this helps. I’m no Florida expert but I’m a developer so feel free to reach out if you have any other questions.

@Justin Li

By the way, congrats on your 5th property! Most people out there don’t even do their first!

Getting your credit pulled upon inquiry is going to hit your score regardless. And I don’t know any institutional lender who doesn’t pull your credit when you apply for a loan.

However, it's getting them financed under your personal name is what kills you. And regardless of your DTI, the credit bureaus don't give a hoot about you income, only about the nature of your debt. And subsequently, your score will drop as you start to look riskier and riskier. Remember, most people don't own rental property and the credit reporting companies has a one size fits all model for analyzing a borrowers risk!

Community and regional banks will lend to your LLC and keep the debt off your balance sheet.

What I’ve done in the past is I would accumulate 5 properties with a hard money lender and then refinance them with a community bank.

Hope this helps, feel free to reach out have any other questions!

@Russell Sherman

The good news is, you expectations and goals are VERY realistic. I think you might be able to exceed those goals without taking on risk to your capital preservation goals.

I had a client in exactly the same situation you are in a few years ago.  They needed long term predictable income post sale and did not want to lose their principal.

A couple of scenarios:

1.)  You could sell the property and hold the mortgage and customize the terms of that mortgage to whatever your goals were.  You could even negotiate no prepayment to lock in the terms for longer and defer your capital gains.  If you were to seller finance, it would be considered an installment sale and you would only pay gain taxes on the principal payments.  Of you course you would pay income tax on the interest payments.  I have no idea how the owner occupant gains exclusion would work in this scenario so check with a CPA.  The problem is you tie up 2/3 of your wealth into this mortgage.

2.) 1031 Exchange DST. Now, check with your CPA to see if this is even possible based upon what you have claimed as residency to see if a 1031 was possible on some place that you may have claimed as your primary residence. Assuming you can do a 1031, you do have the option of rolling your sale proceeds into a Delaware Statutory Trust. These are usually sold by RIAs (Registered Investment Advisors). They present a fractional ownership interest in a large investment property. They are usually designed for income. Usually fully stabilized, institutional class, in core markets, with very low leverage. You have the option of directing your sale proceeds through your Qualified Intermediary into several different DSTs so as to diversify. DSTs are a little thick with fees. Usually higher than typical real estate syndications so don't be surprised at that when you start reviewing prospectus'. Again, the problem with this scenario is you CAN diversify but 2/3 of your wealth is going to be tied up in real estate DSTs. They are designed to product income but are not very liquid. The standard DST terms are five years, so when the sponsors sell the property, you will have to either take the gain or roll it into another DST(s).

3.) The third and last scenario is to completely cash out, take the hit with your gain. This option will allow you to take your time to really architect your plan that is in line with your long term goals and short term needs. Hell, you could put your money into an FDIC insured money market account and get 5% on your money in this environment. This option gives you the greatest optionality in picking your asset allocation based upon your risk tolerances and goals not based upon what you need to do to beat back the tax man. Also if you have most of your wealth in securities that are liquid and considered cash and cash equivalents, you can convert them to cash very quickly and reallocate or even get a line of credit against those securities so that you can fund passive investments in other real estate deals or private lend or whatever.