Negative Leverage - Who The FUCK Is Buying??

For those buying, are you assuming some massive under-rented lease vacates in 1st year to MTM rents back to a higher cap rate? Are sellers having to accept re-trades and "lowballs" offers now?

Whats the deal.. what's everyone seeing in their markets right now  

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Comments (113)

May 18, 2022 - 11:08am
Ozymandia, what's your opinion? Comment below:

Our business plan revolves around something other than buying the arbitrage between cap rates and debt rates.  Anyone who doesn't have that mindset was never buying real estate, they were buying cheap debt, and will get punished accordingly.

  • Associate 1 in IB - Gen
May 18, 2022 - 11:21am
Ozymandia

Our business plan revolves around something other than buying the arbitrage between cap rates and debt rates.  Anyone who doesn't have that mindset was never buying real estate, they were buying cheap debt, and will get punished accordingly.

Fair but literally everyone says that 

May 18, 2022 - 11:30am
Ozymandia, what's your opinion? Comment below:
Ozymandia

Our business plan revolves around something other than buying the arbitrage between cap rates and debt rates.  Anyone who doesn't have that mindset was never buying real estate, they were buying cheap debt, and will get punished accordingly.

Fair but literally everyone says that 

True.  And we're about to see who was being honest about having an actual, honest-to-god business plan, and who was talking out their ass and pretending that putting in new countertops and saying that was a justification for raising rents 20%.

The Class B MF market, especially in hot markets in the South/Southwest, has been a game of musical chairs for the better part of a decade now, the way the "deregulating rent stabilized units" business plan in NYC was a game of musical chairs in the mid 2010s.  Cheap debt and its corollary of lots of equity looking for a home has kept a lot of people afloat, but now the music has stopped and a lot of people aren't going to be hitting their d/s coverage.  Which is good.  There needs to be some blood, to weed out the people who keep bidding these markets up because they're doing little more than putting their money on black and hoping the roulette gods reward them

May 19, 2022 - 10:36am
Ozymandia, what's your opinion? Comment below:
Sun Wukong

How do you win deals? Do you just find dumb sellers?

I don't understand the question.  How does anyone win deals?  By offering better terms to than competitors.

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May 20, 2022 - 1:03pm
Sun Wukong, what's your opinion? Comment below:

It's funny that you talked about how you don't rely on the low rates but your winning strategy is essential pay a higher price than everyone else? What is your unlevered return and what cap rate expansion do you underwrite. Hard to see how the math works.

May 20, 2022 - 4:38pm
Ozymandia, what's your opinion? Comment below:
Sun Wukong

It's funny that you talked about how you don't rely on the low rates but your winning strategy is essential pay a higher price than everyone else? What is your unlevered return and what cap rate expansion do you underwrite. Hard to see how the math works.

So, my guess is you're what, 19?  Never had a job in this industry?  Because "paying a higher price" is basically the only winning strategy.  The first person who comes on here and proves that their firm is making money because they offer Sellers less money on less competitive terms and still winning deals, I'll give them every penny I have at the most insane terms they can think of, because someone who gets a signature on a PSA by offering less than their competitors is a literal magician.

Low rates help, it's impossible for them not to, but the core of our business plan is tax arbitrage.  

And my cap rate expansion and my unlevered returns vary from deal to deal.  You know that every asset is unique, right?  Something I buy in Dallas tomorrow isn't going to throw off the same returns down to the fifth decimal point as what I bought in Philadelphia yesterday.

I'd suggest you learn a little bit about how this business works, more than regurgitating whatever terms you just looked up on Investopedia, and then come back and join the discussion.  You are embarrassing yourself.

May 20, 2022 - 11:26pm
Sun Wukong, what's your opinion? Comment below:

You don't know what you are talking about. Every deal is different lol. You sound like an amateur. Of course every deal is different, but you don't have the ability to tell me how your deals typically pencil out without me asking for a specific deal?

I thought you were gonna talk about how you find deals off market or how you swap properties or some other creative ways, in which cases offering the highest price isn't necessarily the only winning strategy.

It's funny that you cannot quantify anything while in a industry that's all about numbers.

May 22, 2022 - 8:25pm
CRESF, what's your opinion? Comment below:

Can we take the temp down on these discussions? Not sure why it has to get so personal so quickly. It's a bad look. Let's have a discussion and learn something. 

  • 5
May 23, 2022 - 11:12am
Ozymandia, what's your opinion? Comment below:
Sun Wukong

You don't know what you are talking about. Every deal is different lol. You sound like an amateur. Of course every deal is different, but you don't have the ability to tell me how your deals typically pencil out without me asking for a specific deal?

Because giving you the numbers on a typical deal doesn't help you or anyone else in any way.  How does knowing what my exact IRR is help you understand a business model?  How does that give you any sense of how to replicate it yourself?  Why do you even care, and why should I care to inform you?  I gave you the information you were looking for, which is "what is our business strategy".  If you don't believe that we can make that work, then why in the world would you believe a bunch of numbers you have no way of verifying?  Again, the sheer thoughtlessness and lack of critical thinking just piles up, one post after another.

I thought you were gonna talk about how you find deals off market or how you swap properties or some other creative ways, in which cases offering the highest price isn't necessarily the only winning strategy.

Finding an off market deal still means paying the highest price; you just are the only one offering.  If you don't offer enough, Sellers take their chances with a full marketing effort and an IS team.  So yes, highest price wins.

Swapping properties, in the sense of a 1031 exchange, still involves paying the highest price, it's just that your tax deferral means you juice returns.  If there is some other property swap I'm not aware of, I'd be interested to hear about it.

The only way you get around offering the highest price is by offering attractive deal terms - no diligence, high deposits with no escrow, short closings, no contingencies, etc.  I didn't think it necessary to mention any of this because anyone who has been in the real estate industry for longer than a week understands those.

At the end of the day, you don't "find" property, you convince an owner to sell.  So you have to offer them more than anyone else.  

It's funny that you cannot quantify anything while in a industry that's all about numbers.

I mean... it isn't all about numbers.  If you think that, you either (a) aren't in this industry at all (as I rather suspect) or (b) are really bad at your job and won't be in this industry for long.

I gave you a perfectly acceptable answer, one which you should be taking note of as a way to actually make money in this industry beyond the tried and true "cross my fingers and clench my ass tight and hop that macro economic factors and monetary policy conspire to keep driving the market up" - the fact that you've repeatedly skipped over it to demand a series of numbers that, without context, will be meaningless and useless shows me that you're little more than an excel jockey who doesn't understand that the underwriting doesn't actually drive value, it at best reflects value or allows you to better explore how value can be unlocked.

May 23, 2022 - 12:34pm
Sun Wukong, what's your opinion? Comment below:

Bro, I'm just trying to figure out what kind of deals you are buying and how you make them work. Very simple. You typed an essay without deliverying the answer. I'm baffled by your communication skills that at this point I don't care whatever you are buying becuase I'm not sure whatever spins out of your mouth is accurate lol.

May 23, 2022 - 1:01pm
Sun Wukong, what's your opinion? Comment below:

Yeah he types essays to launch personal attacks but when it comes to the core discussion, he is not willing to type more than 2 words. I was just curious how his deals work becuase it seems to be different from a lot of the deals the guys here do, but it went all downhill when I asked for more info lol

Most Helpful
May 23, 2022 - 2:16pm
CRESEA, what's your opinion? Comment below:

Damn. Why is everyone hating on @Ozymandia? He is largely not wrong here and being a bullshit weaver is not necessarily a bad trait to have in front office finance. Basically means the man has sales skills or chooses to practice them. 

My 2 cents on this topic is that multifamily is mostly a commodity. There are a finite number of ways to "get an edge" over the competition. The CAPM model actually has a degree of application in CRE and each individual asset's performance is correlated with the market ("market" should be defined as National, MSA, County, City and Neighborhood). Hospitality, Multifamily and Self Storage are what you would consider high "beta" property types while property types such as Office, Retail and Industrial are slightly less correlated with the overall market given the longer term leases, specific tenant requirements etc.

Examples of ways get a competitive advantage in multifamily involve making better bets on localized market trends (identifying future areas of growth and being able to identify product demand), sponsorship level advantages (access to more accretive financing, tax arbitrage, etc.), business plan execution (ties into sponsorship; being able to efficiently manage the property while limiting expenses, taking advantage of economies of scale, finding cheaper materials and labor for renovations, experienced asset management on hand that know how to make a property standout).

May 31, 2022 - 9:51am
Ozymandia, what's your opinion? Comment below:

T30Alumnus

He is a bullshit weaver. He also had a thread on how section 8 housing and tenants actually improve a neighborhood's real estate value and schools. 

Lol.  I encourage other people to go on that thread.  Not only is that not what I said, our friend here was also the one saying that he wouldn't put his kids in a school with minorities.  If you're taking any kind of advice from an avowed bigot, you deserve whatever bad end comes from it.

EDIT: Because intelligent, liberal people are usually more secure in the facts than their bigoted conservative counterparts, who rely on projection and lying since they don't actually have a defensible or logical argument, I figured I'd spend the 30 seconds and actually find that thread so anyone who thinks T30Alumnus is anything but the smallest minded bigot imaginable (and a pretty pathetic liar to boot, I'd add) can read it for themselves and see the truly disgusting degree to which he's created an obvious straw man argument to mock, in order to distract from the fact that pretty much all he's got going on in that pea brain of his is "black people bad, white people good"

https://www.wallstreetoasis.com/forum/real-estate/sfr-strategy-utilizing-section-8-vouchers-exclusively#comment-2789904

May 31, 2022 - 9:50am
Ozymandia, what's your opinion? Comment below:
Sun Wukong

Yeah he types essays to launch personal attacks but when it comes to the core discussion, he is not willing to type more than 2 words. I was just curious how his deals work becuase it seems to be different from a lot of the deals the guys here do, but it went all downhill when I asked for more info lol

Why would I type more than two words when that's all it takes to explain our strategy?  On the other hand, just two words doesn't cut it when trying to accurately describe the depth and breadth of your thoughtlessness and stupidity.

Tax arbitrage.

Numbers don't help because numbers don't mean jack shit without context, and in any case it wouldn't matter because you can't verify whether I'm accurately calculating my returns.

May 31, 2022 - 4:10pm
Ozymandia, what's your opinion? Comment below:

dude, he mentioned tax arbitrage. Instead of asking more about it, you are the one who glossed over it (or does not really understand the nuances when it comes to tax arbitrage) and instead is just going around in circles. 

[Sun Wukong]

Again, read the room.

May 23, 2022 - 2:41pm
Ozymandia, what's your opinion? Comment below:
Sun Wukong

Bro, I'm just trying to figure out what kind of deals you are buying and how you make them work. Very simple. You typed an essay without deliverying the answer. I'm baffled by your communication skills that at this point I don't care whatever you are buying becuase I'm not sure whatever spins out of your mouth is accurate lol.

No, that isn't what you are trying to figure out, and if it is, I've never seen someone go about it this poorly.

We buy affordable multifamily.  Our value add is tax arbitrage.  All of which is upthread from this very post; so either you weren't reading or you're just now realizing how stupid you've looked and are backtracking.  Again, what the exact returns are don't matter because every deal is different, every market is different, every asset is different.  

You asked "how do you win deals" as if the answer to that isn't exactly the same for every operator in the real estate world.  You asked "how the math works" when I could have quoted you anything, as if you could verify it.  And when I gave you the answer for the question you should have asked, which was "why can you afford to pay more?" you skipped right over it to argue some more about how if only you knew exactly what my unlevered and levered returns were, everything would all magically make sense!

If it matters to you, we shoot for a mid-to-high teens levered return.  Call it a 16% threshold, and maybe 10-15 bps of cap rate expansion a year on a five year hold, though we've never sold an asset we had operational control over.  I assume that the sun has now risen and you know my business backwards and forwards on the basis of those two numbers.  You don't?  Holy shit, imagine that!  It's almost like hearing that in a vacuum, with no context about why we think we can get there, is completely useless and should never have been asked in the first place!?!?

As I said before, we create value not through gambling on a continuing rise in rents (though that helps, of course), but by engaging local municipalities and finding tax savings through those negotiations.  So no, we don't find "dumb sellers" because such a thing is exceptionally rare in his day and age - your entire question assumed that there is no way to generate value except through a low acquisition basis or greater-than-expected rental growth.  As with many people who don't understand this business, you aren't understanding that rents are difficult to control or anticipate, whereas capturing value up and down the operating expense budget, while harder and more labor intensive, is more within the control of the operator/owner.

  • VP in RE - Comm
May 25, 2022 - 2:55pm
Sun Wukong

How do you win deals? Do you just find dumb sellers?

Typically you win deals by paying more than other buyers. You see when you pay more than other buyers, the seller will typically make more money.

Example. I have property for $1M I am selling. One person offers me $950k and the other offers $975K. I will take the $975K because I profit $25K more. Let me know if you need more help and I can send over a detailed excel file on this.

Jun 1, 2022 - 8:52pm
Ozymandia, what's your opinion? Comment below:

I'm not sure why you have to be condescending.

Why is there a presumption that I shouldn't be?  I don't think that whatever verbal diarrhea gets deposited into a post is automatically worthy of respect - it's something that's earned, not given.  If idiots like Sun Wukong, or bigots like T30Alumnus, are going to double and triple down on obviously stupid (or bigoted) positions, why am I required to act like they're making decent points?  To spare their feelings? 

  • Associate 1 in RE - Comm
May 18, 2022 - 6:42pm

I always thought of negative leverage as cost of debt being higher than unleveraged returns, not higher than cap rates?  In value-add deals, at least ones I am looking at, you can still get to decent underwritten returns even when buying sub-4% cap rate deals with 4%+ effective cost of debt.

  • Associate 1 in RE - Comm
May 18, 2022 - 6:59pm

Typically underwriting 10-20bps of cap rate expansion per year of hold depending on market.  Stabilized YOC at or just above exit cap.

May 20, 2022 - 3:14pm
picklemonkey, what's your opinion? Comment below:

Core buyers are still actively acquiring assets in solid locations, but really just those who are very low leverage call it <25%. The 70%+ LTV buyers should be on the sidelines, but most of them can't help themselves and will keep buying on the hope this ridiculous rent growth continues. 

May 20, 2022 - 7:50pm
sk8247365, what's your opinion? Comment below:

Can someone clearly explain the negative leverage concept?

Leverage should increase your levered returns. So as long as the all-in interest rate is lower than the equity IRR, it should be accretive.

But everyone is saying the interest rate is higher than the cap rate, so it is negative leverage.

Sure, if you bought at a 4.0% cap rate, with 100% financing at a 5.0% rate, had zero cash flow or value creation, and then sold at the same 4.0% cap rate. But who has that business plan?

May 20, 2022 - 8:37pm
Levered2Gills, what's your opinion? Comment below:

If you bought at a 4 cap, even borrowing 1% LTV at 5% is negative leverage. Your levered yield is lowered than your unlevered. Many people buy stabilized assets without dramatic business plans, and just because we have become complacent throughout this cycle by experiencing a "new norm" of continued strong rent growth, doesn't mean the music can't or won't stop. Rents could flatten for a length or time - you can't just assume blanketed no question rent growth forever - that's bad risk management.

May 21, 2022 - 12:20am
REmonkey2, what's your opinion? Comment below:

I'm closing on a 22 unit in the midwest on tuesday. had this sucker under contract in late feb and it's a going-in cap rate of 8.6% right now. 

can bump up rents with m2m tenants and refi most of my money out

May 23, 2022 - 11:21am
Ozymandia, what's your opinion? Comment below:
pudding

What market in the Midwest is selling at a 8+ cap and why? Is there deferred maintenance? Poor demographics? 

Usually it's a Purchaser who doesn't understand that a broker or a Seller's opex numbers are almost always bullshit.

That 8%+ cap rate looks a lot worse when you realize that there is half a decade of deferred maintenance that needs to be done because the current owner has been paring back their opex in order to make the NOI look good.  Or that the physical act of selling a property might trigger a tax reassessment that hasn't happened in 15 years.  Or that half the line items were just made up to begin with.  Or that property management is being passed through to a different entity.

I could go on...

  • 2
  • Associate 1 in IB - Gen
May 23, 2022 - 2:55pm

Starting to see some cap rates adjust upward. Not as much in new construction in core markets, but it's moving. +10-25 bps for quality assets

May 24, 2022 - 12:01pm
C.R.E. Shervin, what's your opinion? Comment below:

A lot of people need to start understanding the simple math for negative leverage. Cap rate is a percent return on one dollar. A debt constant is your actual annual debt payment including amortization as a percentage. Now, Debt Constants are not linearly related to interest rates. As rates go up, lets say 1% your actual loan payment cost percentage does not increase by 1%, maybe .75%, and as rates get higher that spread decreases.  A 3% all-in rate amortized over 30 years gives you an annual debt cost of 5.10%, a 9% all-in rate's annual cost is 9.73%.   So you take your % equity, call it .20(20%) and find your Cash Flow After Debt Service or at 5%, your debt constant of 6.51% is 6.51% *(1-equity% or 80%). SO if your cap rate is 5%, and your cost of debt is 5.20%, well that is negative leverage.  It is a super easy calc to do in your head.

May 24, 2022 - 4:20pm
C.R.E. Shervin, what's your opinion? Comment below:

Didn't I just explain it above?

Cap Rate 

Debt Constant (learn what your debt constant is for this quarters interest rate) 

Multiply 1-LTV * Debt Constant = Cost of Debt/leverage.

If your cost of debt is more than the cap rate then you are in negative leverage territory.  You don't need an actual purchase price or loan amount, just use $1 for purchase price, makes the math super simple, and you get your return metrics.

May 27, 2022 - 3:57pm
SLCCRE, what's your opinion? Comment below:

Not to be a dick here, but if you're going to speak in specifics (and criticize lack of simple math skills) you should probably calculate the debt correctly. Mortgages accrue interest monthly, not annually. Your loan constant of 5.10% is actually 5.06% and your 9.73% should actually be 9.66%. 

Yes, it's a pretty slow day in the office for me. 

May 25, 2022 - 11:55am
Sham Wow, what's your opinion? Comment below:

So if SOFR is going to 300bps+ and debt funds are quoting 375bps+, bank debt is around +200bps

What should we be buying 5/6 caps? explain to me where to find those?

May 28, 2022 - 10:07am
CRESF, what's your opinion? Comment below:

I think the point is, transaction volume is going to fall off a cliff here for most people unless they are comfortable making a very large bet on where interest rates and cap rates are heading. 

  • 1
May 25, 2022 - 4:37pm
apricots, what's your opinion? Comment below:

Biz plan needs to execute... need to hit your projections/actually pop CF.. Deals need to actually pencil (gotta say 50+ right now do not, its lol).. no longer shit equity getting saved by shittier equity / cap compression. You've likely seen lenders/funds are more selective now.. 

May 31, 2022 - 4:27pm
Ozymandia, what's your opinion? Comment below:
VolatilitySmile

Who the fuck is buying?

-People under pressure by fund commitment periods, 1031s etc

-People who use aggressive model assumptions

-People who don't use debt

-People who find value beyond the tried-and-true "install new fridge and countertops and jack rents" business plan.

As I've said to others, we underwrite tax savings through negotiation with municipalities.  Since taxes are generally the single biggest line item expense, that means we can generate a lot of value early on, instead of waiting years for tenant turnover to allow us the opportunity to renovate apartments.  That Day 1 value, and more importantly the certainty that comes with boosting NOI through opex savings instead of hoping for an increase in rents, allows us to pitch lower investment hurdles to our equity folks since there is less risk in the cash flow.

May 31, 2022 - 3:52pm
T30Alumnus, what's your opinion? Comment below:

By golly this Ozymandia dude really sucks at his job. He has a nonsensical investment thesis he's peddling to internet strangers. When he gets called out for this he gets all ad hominem and makes his shortcomings seem like brilliant advantages. All because he blames himself for his son being a tranny!!

May 31, 2022 - 4:24pm
Ozymandia, what's your opinion? Comment below:
T30Alumnus

By golly this Ozymandia dude really sucks at his job. He has a nonsensical investment thesis he's peddling to internet strangers. When he gets called out for this he gets all ad hominem and makes his shortcomings seem like brilliant advantages. All because he blames himself for his son being a tranny!!

Yep, the last sentence should give away the first three are just random ramblings.  My investment thesis is pretty specific, which several people have acknowledged (I understand you are incapable of even seeing something that doesn't agree with you), so I am hardly going to take it personally when you cannot understand or recognize it.  At least 3 or 4 other people on this thread have responded affirmatively that they understood and appreciated the point I was making.  Why would I suddenly question the quality of my response when the best you can do is resort to naked bigotry?

Funniest
May 31, 2022 - 4:42pm
T30Alumnus, what's your opinion? Comment below:

Three 18 year olds drank your kool aid. Crossing my fingers one doesn't try to actually engage in "tax arbitrage" as you inadequately described it.  Fortunately it is safe to assume you're nothing more than a W-2 worker whose biggest risk taken is switching from Roth to regular 401k as his wife leads the house 

  • VP in RE - Comm
Jun 1, 2022 - 3:04pm

This thread became a shit show because one guy couldn't help but insult others and kept bringing up politics in a thread that had the potential to be interesting.

Jun 1, 2022 - 7:24pm
[email protected], what's your opinion? Comment below:

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Jun 1, 2022 - 8:52pm
T30Alumnus, what's your opinion? Comment below:

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