Why Your Chance to Land a Big Multifamily Deal Might Be Just Around the Corner

by | BiggerPockets.com

“What goes up must come down.” So said Blood, Sweat & Tears in their 1968 Grammy-nominated hit Spinning Wheel.

I’m guessing a lot of you missed that one. (It was popular about the time that semi-boneless ham sales peaked.) And many of us wish we had missed it.

Did you miss the fact that we’ve been in a multifamily frenzy for the past seven years or so? Or did you miss your chance to get in on it?

If so, you actually may not have missed anything at all because your chance to jump in may be just around the corner.

As you know, everything is cyclical. The pricing and popularity of every asset class rises and falls more than is supported by the cash flow of the underlying asset.

So if you’re convinced of the powerful demographics undergirding the long-term strength of the multifamily housing market—and you’ve been unwilling to overpay for assets these past few years or unable to find deals at all—then you may be perfectly positioned to acquire multifamily assets in the cooling off period that seems to be materializing now.

Why Do I Say the Market is Cooling Off?

Some data is starting to roll in that suggests this. The Wall Street Journal recently reported on an uptick in home ownership rates. At 63.9%, they are far below the 69%+ peak in 2005. The article reports that Millennials are starting to buy homes at a higher rate than expected.

Yardi’s statistics also show that rent growth is starting to decelerate. A Multifamily Executive article says that the average rent nationwide fell by $4 in October, to $1,358. Rent growth slowed to an annual average of 2.3%.

Related: 4 Ways Technology is Shaking Up Commercial Real Estate (& Why Multifamily Will Pull Ahead)

Here is a graph from Yardi Matrix:

What’s Causing This Shift?

Here are a few possible factors.

1. Mortgage lenders are loosening up again.

In my early years of real estate investing, anyone who could fog a mirror could get a 100 percent loan. No documentation. No proof. No problem.

A guy I know who made about $40,000 per year bought a dated $600,000 mansion in a small West Virginia town in 2005—as his second home! He didn’t have it for long until the bank got it.

The financial crisis caused lending standards to retreat back to normal. Buyers actually had to have real income, a better credit score, and—wait for it—a down payment (gasp!).

But mortgage companies are loosening their standards again, and some Millennials are taking advantage of the chance to own rather than buy.

Nevertheless, Millennials as a whole still have a record penchant for renting over buying, and there is no reason to think there will be a large scale shift toward ownership.

2. Some markets are overbuilt.

It always happens. With a rush of capital from the United States and internationally and the press reporting the big move toward multifamily housing, developers have been building at a torrid pace. Recent multifamily construction has continued at about double the historic rate.

Fortunately for most BiggerPockets readers, the majority of this overbuilding is high-end, pricey, luxury construction. Rents for newly constructed apartments are 50% or more above the Class B or C realm that most of us play in.

And as I’ll discuss in a future article, there is an important distinction between catering to “lifestyle tenants” versus “renters-by-necessity.”

3. Rents are crazy high in some markets.

Many of the markets where rent growth is slowing have rents that have reached dizzying heights. They can’t go up at this pace forever.

San Jose rents dropped by 0.7% in the past quarter. Seattle’s dropped by 0.8%. This is really no surprise at all.

4. Nothing’s wrong. It’s just a cycle.

It is widely known that rents flatten in the fall and winter. Many of the stats behind this conversation were measured in the fall, and this could be just that simple.

More likely, it is a pullback in the overheated market that everyone knew would come at some point.

As I said earlier, if you’ve been studying multifamily and believe in its long-term viability, your opportunities to buy or invest could be just around the corner.

how-to-value-multifamily-property

3 Trends to Expect if the Frenzy is Over

1. Expect a lag in sellers coming to reality.

Many multifamily owners have been counting their chickens prior to hatching. Holding on for the top of the market, many will be in denial once they realize they missed the top.

I expect some to go to market quickly in 2018, expecting to get the bloated price they were quoted by eager brokers the past few years. They may still get their price—unless they don’t.

In the event that the buyer community doesn’t see things their way, I expect some failed marketing campaigns in 2018—sellers and buyers not getting together. If you’re a buyer, that’s the time to be patient. Don’t be manipulated by the broker or cajoled into paying last year’s price.

It’s likely that this same seller will go back to the market (perhaps with a different broker) within the year, and if this softening continues, receive even lower offers than the first time.

Eventually, the seller will face reality and either refinance or sell for a more realistic price. Which will be to your benefit, Mr. and Mrs. Buyer.

2. Expect resistance from investors.

It’s funny—when many investors should be cautious, they’re raring to go. And when they should be eager, they’re pulling in the reigns.

Capital has been pouring into the multifamily space from the United States and abroad for quite a few years. As a syndicator, I’m happy for this interest in our investment class.

But let’s be honest. Overall, this has not been the best time to buy. My firm has passed on dozens of opportunities and has been outbid on quite a few more.

Related: 5 Ways to Jump Up to Large-Scale Multifamily Investing

If this softening turns into a multifamily downturn, it is possible that the best buying opportunities are just ahead. And this should get passive investors excited about jumping in.

But history tells us that this will not be the case.

Warren Buffett said, “Be fearful when others are greedy, and greedy when others are fearful.”

You’ll need to show your investor partners why lower prices mean better values. Educate them on cycles in the market, why the best times to buy are when other buyers are wary, and why it pays to invest when sellers are ready to make a deal.

3. If trends really go south, expect a few opportunities to buy distressed assets.

Don’t get your hopes up. There probably won’t be many distressed opportunities—at least in large scale commercial multifamily. But if you know the right people and have the cash and financing at hand, you may be able to step into a real bargain.

It happened in this last recession. I spoke to a few owners who bought multifamily assets for under $20,000 per door. These assets were recently valued at two to three times that much.

Before you get too excited about this, realize that Freddie Mac and Fannie Mae’s mortgage failure rates have been practically zero nationally since the downturn. This reflects on the safety of the multifamily asset class as well as the high standards of these two agencies. They really are the nation’s smartest multifamily investors.

(By the way, if you’re reading this and you’re not yet sold on large-scale multifamily investing, that last paragraph should have got your attention. This asset class has a stunning risk/reward profile, as I’ve written about extensively in my book and in other articles.)

So, What Do We Do Now?

Let’s all watch the numbers. Let’s try to interpret what’s happening in the market nationally—and more importantly for us, in the local markets we track. And let’s watch for opportunities to buy if this market continues to soften.

As far as I’m concerned, I’m not changing my buying and management strategy at all. My firm is staying on course looking for value-add and management play deals and catering to renters-by-necessity in strong and growing class B markets.

We’re not taking any unnecessary risks and not investing in markets with exaggerated appreciation and deprecation trends. You know the ones where people made a fortune, then got crushed in the last downturn.

How about you? What are you seeing in your market? And what do you plan to do differently if the multifamily market softens in the coming year or two?

Comment below!

About Author

Paul Moore

Paul is author of The Perfect Investment – Create Enduring Wealth from the Historic Shift to Multifamily Housing, which you should probably get if you want to learn to invest in multifamily. He leads Wellings Capital, a multifamily investment firm, and hosts the How to Lose Money podcast. Paul was 2-time Finalist for MI Entrepreneur of the Year, has flipped 60 homes and 30 waterfront lots, developed a subdivision, and appeared on HGTV. Paul’s firm invests heavily to fight human trafficking and rescue its victims.

38 Comments

  1. Nate Reed

    Some caution is definitely warranted, based on where we are in the market cycle.

    “exaggerated appreciation and deprecation trends. You know the ones where people made a fortune, then got crushed in the last downturn.”

    I assume you are talking about the West Coast?

    • Paul Moore

      Nick,

      That is a great question, and I wish I had a clear answer. I would just say to look at the projected cash flow and base your decision on that. Treat cash flow as central and appreciation as a bonus. If the cash flow is strong, with a margin of safety, then it could be a deal worth considering.

      • Nick B.

        Thank you for your answer Paul.

        Cash flow may be good in the current high rent environment but what needs to happen for rents to decline significantly and thus bring property values down?
        If the rents and occupancies stay the same there is no reason for the values to drop, or is there?

        • Paul Moore

          Nick,

          Rents and occupancies (less expenses) translate to NOI (Net Operating Income). That is half of the formula for calculating value. The rest is the Cap Rate, which is a subjective measure of the owner’s expectation of unleveraged ROI. So if NOI stays the same, and the Cap Rate expands, values can drop. At this point in history, most people think it is more likely for cap rates to expand then to contract. (But the new tax bill may change that – since this is a subjective measure.)

          I hope that makes sense. Thanks Nick.

        • Nick B.

          Paul,

          It does make sense but what would cause cap rates to expand? Cap rates measure investors demand. More demand means lower cap rates and vise versa. If fundamentals stay the same, why would demand decrease? What other investment vehicle will offer similar or higher returns with comparable risks?

          Thank you
          Nick

        • Paul Moore

          Nick.

          In response to your 12/30 post at 10:30am ET (I can’t seem to find a reply button under that comment). Cap rates could be driven by other factors like interest rate on debt, and the “risk-free rate” which is a treasury bill rate.

          For example, if the interest rate on US treasury debt rose to 5%, then it would make much more sense to buy that debt with “no risk” than to buy an apartment with a 5% return with more risk.

          Or if investors see an increased risk caused by (say) government regulations in a certain city or state, the cap rate may expand. Or on the other hand, if Amazon decides to locate their new headquarters in a certain town, though fundamentals will be the same the next week, the cap rate will dramatically compress.

          That’s my take anyway.

    • Paul Moore

      Alex,

      I’m not sure how to answer that. Can you expand on the question a bit?

      If it is Cash on Cash return you are looking for, most operators are netting in the range of about 6 to 12% right now. And their investors are getting the majority of that. I hope that helps.

  2. Mike Rosso

    Great article Paul! I live in Cleveland, Ohio and hope to be investing in multifamily one day in the future. I just finished my very first deal this year which was a duplex. I have a lot to learn about large MF before I can begin investing in it.

  3. James K.

    Hi Paul,
    I really hope what you are saying will become true. I have passed up on many deals and also knows many sellers who are underwater now based on the operation but does not want to sell hoping to get higher prices. However, I also know that when the market turns, there will something else (black swan) financial blockage that will prevent the buyers to buy. That’s a definition of a true market cycle. Buyers are limited to buy for some reason. It could be the dollar has lost value, people are losing jobs, no debt available, investors has lost hope in real estate etc.We just don’t know.
    I realize the richest guys made money during that downturns but I also realize that most people could not do the same during that cycle.

    • Paul Moore

      James,

      I hope it’s true, too, but I’m starting to wonder if the new tax plan will inject a few more years of life into this bull run. Which will be great for owners/sellers… but make it really tough for us wanting to buy. What do you think?

  4. Good luck, Paul! From your mouth to God’s ears! Here in Denver’s market we’re pretty poised for a soft landing, predicated on 2 variables. … job creation & population increases. On the affordable housing side, strength in those numbers will keep the market vibrant. Goodness, the cash flow is boardering on obscene!! I’m lowering my rents and lengthening my leases. Just don’t want / need the headache associated with the top dollar turnover!!

  5. Jerome Kaidor

    Taxes! I’d like to pull a big loan off one of my properties – I can walk away with $300K cash and no added payment. With added payment, even more. And hang onto that $$ so when the market dips, I’d be able to pick up something.

    HOWEVER, I have to be careful to preserve the tax-deductible status of my interest. I’m told that if you pull money out of a property for personal use, that particular interest is not deductible. You can, however, have a fund for maintenance/capex that you consider part of the business, and your deductibility is preserved. Or so says my tax guy.

    In addition, it would be nice if I could park that $$ somewhere where it could make a few bucks to offset the interest expense AND inflation. I think that dividend-paying stocks will do well in the new tax environment, but who knows?

    • Paul Moore

      Jerome,

      I have literally never heard of this before. So I think you’re saying that if I do a cash-out refinance of any type, and I use the funds for personal use, that I could be taxed on this?? I would love to hear more about this. Actually… maybe I wouldn’t. 🙂

      Can you have your tax person reference any case law or code?

      Thanks for your comment, Jerome.

      • Jerome Kaidor

        from my tax man…

        IRS Reg. 1.163-8T(‘c)(1) “Allocation in accordance with use of proceeds. Debt is allocated to expenditures in accordance with the use of the debt proceeds and, except as provided in paragraph (m) of this section, interest expense accruing on a debt during any period is allocated to expenditures in the same manner as the debt is allocated from time to time during such period. Except as provided in paragraph (m) of this section, debt proceeds and related interest expense are allocated solely by reference to the use of such proceeds, and the allocation is not affected by the use of an interest in any property to secure the repayment of such debt or interest.”

        Exceptions referred to above in paragraph (m) include home mortgages where security of the property actually matters. With most property, as the citation states in unusually blunt terms, security of the loan is irrelevant and interest is only deductible with respect to the use of the loan proceeds.

        • Paul Moore

          Thanks for looking this up, Jerome. As an example, if I do a $1MM cash out refinance on a commercial apartment, and use the proceeds for personal use, is the interest on the new loan not deductible? If so, in a syndication, with each of (say) 50 investors getting a portion (say $20k each), does that mean we have to reallocate expenses to each to account for interest that should not have been deductible?

  6. Nathan G.

    A very timely article. I’m considering larger multi-family in other markets but it seems the ship has sailed. I know there are still deals to be found but that’s tough to do when I’m not boots on the ground.

    I’m trying to decide if I should continue buying SFR until the market changes or save up cash and wait for the big fish.

    • Paul Moore

      Nathan,

      I understand how you feel. But everything is cyclical and your ship will return.

      Another option is for you to partner with (invest with or otherwise) a syndicator w/boots on the ground. Someone with access to the deals you eventually want to do yourself.

  7. Jessie Silva

    Thanks for the article Paul! I agree with your blog post completely.

    Although no one can say exactly when the market is going to turn, it is 100% certain that it will at SOME point. And we are definately overdue on that promise.

    Paul, do you believe it’s going to be on the scale of a full blown recession or depression? Worst or better than the previous?

    This is definately another interesting time in the market cycle.

    I don’t know how hard this baby is going to crash but every smart investor is focusing on; 1.)Cashflow (not betting on appreciation), 2.) Rent affordability, and 3.) Sustainable markets (think about jobs). Last but not least – have plenty of cash on hand for the shopping spree of a lifetime!

    • Paul Moore

      Jessie,

      I strongly agree with your last paragraph. As far as how bad the downturn, I don’t see anything menacing on the horizon. Maybe just a normal market correction. But I’ve been wrong before.

      The tax bill was passed since I penned this article, and in fact I’m wondering if this bull market may have new life in it? Maybe it will be more difficult than I thought in 2018. We will see.

    • Paul Moore

      Jessie,

      I completely agree with your last comment.

      As far as the downturn, I don’t see it as more than a normal correction. But I’ve been wrong before.

      I wrote this article before the new tax overhaul, so maybe I’m going to be wrong on this already. Maybe the MF bull market will continue a few more years. Making it harder for all of us trying to acquire new assets. Time will tell.

  8. Bill Davis

    Actually this is an encouraging article Paul. Thank you for the insights to the Multifamily cycle and where you think it is heading. I have seen 5500+ class A type apartments coming online in 2017 in my area. The frenzy is in full swing. It is a great time to be patient on the buy side. It reminds me of the tech pop in 1996 and the telco bust of 2000-2002. When the taxi cab driver is giving you investment advise, it’s time to either sell or be extra vigilant of those things you are about to invest in.

  9. JL Hut

    Patience is a Virtue, but is difficult to obtain. It pays a stream of dividends your whole life once acquired. Now is the time for patience. What robs us of patience is feeling like you’re going to miss the train that is leaving the station. If you’re patient, you will look at the history of this train and see that it always comes by again and you will have a chance to board if you are prepared. Don’t get distracted, get prepared.

    The key is suppressing your feelings and looking at the facts.

    A wise man once said “There is nothing new under the sun” All the knowledge you need to prepare for the future exists today. Every behavior of man in the future has happened in the past. Learn from history to be prepared for the future.

    • Paul Moore

      JL. I love this post, and I wish everyone could read and believe it. I read it several times.

      As a syndicator, it is tough because we often have a number of investors who are waiting for us to invest. And we feel pressure, because we know they will eventually move on if we don’t acquire something.

      That thought needs to be tempered with yours.

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