I have to admit, this is not an easy article to write.
(After all, I wrote a book where I extolled the virtues of investing in multifamily real estate. And I spoke about multifamily on the BiggerPockets Podcast recently.)
This isn’t easy. But it’s necessary.
My company was formed a few years ago to take advantage of the wonderful demographic shifts underlying the growth in multifamily housing. Apartments have been booming since the middle of the recession, and my partner and I dedicated our lives to making the most of this opportunity and sharing it with others.
Our last multifamily project was oversubscribed with $3.8 million from investors in a matter of days. We love multifamily, and our investors do, too.
But overall, we have failed our investors.
I love talking with investors. I continue to talk with many of them weekly, and one of the questions that I haven’t been able to answer is, “When will you have another deal for us to invest in?”
I have had to say “I don’t know” more times than I can count.
When my partners and I started our company, we made a commitment to ourselves, our families, and our investors that we would never knowingly overpay for an apartment asset just to get a deal.
We are all in our mid-50s, and we’ve made a lot of money in our careers. But we’ve lost money, too. We know what it’s like to be on both sides of the table, as a sponsor and an investor.
Thankfully, we’ve made a lot more than we’ve lost. But we never want to be in a position of apologizing to our investors, our families, and ourselves—for up to a decade—for a deal we overpaid for.
The multifamily sector is overheated and sponsors are overpaying for deals on a regular basis.
Wait—Why Would Anyone Overpay for a Multifamily Deal?
Why are other people buying deals that we are passing up?
We don’t know most of them, but here are some potential reasons:
- They have tax-deferred 1031 exchange funds, and they would rather overpay than pay Uncle Sam.
- They have international investors who will accept a very low return just for the perceived benefit of being in the U.S. dollar rather than their currency.
- Institutional investors are looking at smaller deals and smaller markets, and they are willing to live with much lower steady returns.
- Operators are ignoring low cash flow and counting on appreciation to fix everything. (Didn’t we all learn how well that didn’t work in the Great Recession?)
- Less experienced syndicators with access to funds are mistakenly overpaying.
- Less than scrupulous operators are doing deals to make the acquisition fees.
However, I want to be clear that not everyone who is buying apartments is overpaying, inexperienced, or unscrupulous!
I’m not saying that at all. (Some of them just have better access to off-market deals than us. But I will say that we are looking at off-market deals, too, and most of them are just as overpriced as the marketed deals.)
I am saying that we have looked at over 190 deals since January, and though we’ve made offers, we’ve come up short every time. Some of these deals sell for a few million above what we think is prudent.
So Where is My Company Going from Here?
Like I said, it’s hard for me as a multifamily syndicator to say this.
I’ve been studying Warren Buffett, and I’m writing a book on applying his wisdom to the real estate arena. One of Buffett’s keys to success is investing in great teams. He invests in top teams with a proven product in a growing market.
By fueling them with more equity, Buffett gives them wings to fly.
We still believe in multifamily. But only at the right price.
And I still believe everything I wrote in my book. But multifamily opportunities are few and far between at the time of this writing.
So our company has spent most of this year researching opportunities outside multifamily. Like Buffett, we are looking for great teams with proven track records.
We’ve located a profitable, risk-averse asset class. And we’ve vetted a team that has been operating in this asset class for decades.
We have decided to invest with a leading self-storage operator.
- There are over 53,000 self-storage facilities in the U.S. (about the number of Subways, McDonalds, and Starbucks combined). But unlike professionally-run franchises, about 40,000 of these storage facilities are owned by independent operators. These (often) mom and pop owners rarely have the knowledge or team to maximize income and value. So, there are a significant number of profitable deals available for the right operator.
- Self-storage is somewhat price resistant. If we raise the rent 6% on an $1,000 apartment, a tenant may leave for the $60 increase. But raise the rent 6% on a $100 storage unit, and most tenants will not rent a truck, gather friends, and waste a Saturday to move down the street—to save $6.
- Self-storage did surprisingly well (like apartments) during the recession. When people downsized or lost their homes, many of them rented self-storage units. The relatively small cost to store stuff played a role here as well. Many who planned to store for a few months are still storing their stuff today. The monthly ding on their credit cards is often forgotten.
How Did We Choose an Operator?
There are literally thousands of small operators, and only one operator in the nation (Public Storage) has over 2% of the market (they have 7%). Like I said, very fragmented.
I’ve concluded that it is not that hard to operate a mediocre self-storage facility. But it is very hard and somewhat complex to run a world class one.
We have teamed up with someone who does just that. Here’s what was important to us as we made this decision:
- We were looking for someone with decades of experience and a strong track record.
- We wanted an operator whose team has a lot of depth—a full accounting department, automated processes, great operations, etc.
- The profitability of storage units is very high on average. We wanted a firm with profitability exceeding industry norms using smart leverage, value-add strategies, and online marketing.
- I wanted the opportunity to talk with several investors who have invested with the company for a number of full cycles (buy, operate, refinance, sell).
- I was looking for someone who had an inside track on acquisitions. With the difficulties my company has experienced in this arena, I was looking for someone with a consistent stream of deal flow, someone who knew how to buy right.
- I wanted an operator with a program that took advantage of the various upsides available in this business—adding U-Haul, point-of-sale opportunities (like boxes and locks), selling insurance, and more.
- I was hoping to locate a company with great debt available, in need of equity to grow their portfolio.
- I wanted someone who shared the same values, mindset, and conservative underwriting philosophies that we hold dear.
So, What’s Next for Us?
I’ve made two visits to the CEO of a great company, and I’ve visited another one recently as well. As I write this, I’m on the way to check out a new self-storage acquisition that one of them is doing in a nearby state. (Don’t worry—my wife is driving.)
My firm just partnered with quite a few of our investors to invest almost $3 million in one of their projects
Wait… what about our multifamily investors? And my book? And my reputation?
I know that many of our investors are focused specifically on multifamily, and that’s OK. We are still looking for multifamily deals every week. We’re looking at a multifamily asset now, in fact.
But I feel that self-storage is the next step for our firm and is an intelligent response to the current state of the tight multifamily market.
If you’ve been “storing up cash” for your next investment, you may want to consider checking out self-storage, too.
What about you? I know that some of you are unsuccessfully chasing multifamily. Have you found other viable investment options?
Weigh in with a comment!