Treasury Yields are Nearly Equal to Multifamily Real Estate Market Returns
Why would an investor not lever up and buy fixed income products rather than lever up and buy real estate which they have to manage? Most fixed income is highly diversified, and you are the highest up on the seniority list.
Why be an equity investor in a 5% return asset like multifamily (deduct negative leverage) when you can be a debt investor in a 4.5% return highly diversified asset? Hell, a savings account provides equal return (unlevered) to real estate.
The 5-year T-bill is at a 4% rate at the time of writing and multi in west coast markets is generally a 5%-5.5% cap rate. While I agree that the spread is tight, I think that the reasoning here is that there is usually appreciation through rent growth. For round numbers, if you are assuming 3% rent growth and expense growth, then you have a 3% growth in NOI. Unleveraged that works out to an 8-8.5% yield. If you are about 66% leveraged, appreciation alone translates to a 9% yield. If you are neutrally leveraged, that should be somewhere around 14% return if you're ignoring fees and transaction costs.
The thought process that many shops have taken is that the lack of new construction is going to eventually lead to strong rent growth even though in many cases, recently, expenses have outpaced anemic rent growth. While that is true, I would argue that the upside is capped given the amount of entitled projects waiting to break ground once a certain rent level has been hit (or cap rates compressed or construction costs come in more).
Okay, you've objectively answered and it makes logical sense. Now imagine this:
It kinda seems disproportional to me for such a low spread and I am not even sure the spread is there once you pay all the staff on your investment team (asset level employees would be viewed differently here).
Where are you getting the 5% number? Your entire argument revolves around the fact that MF returns are 5%, but you do no work to prove it
I'm not buying multifamily right now, so take all of this with a grain a salt, but the groups buying core multifamily right now are not very concerned with the illiquidity of real estate. They have liabilities that are in many cases decades out, and the opportunity to buy a hard asset that can yield high single digits / low double digits over a long-period of time with pretty low volatility is kind of the point. They also have allocation targets and alternatives, like real estate, are an important component. If your portfolio manager says we need to be at 10% real estate, and you're currently only at 8%, guess what, you're buying more real estate.
To your other points, salaries and fees don't necessarily need to be deducted from returns. For a large allocator, you'll have personnel obviously but that is a portco cost. There is no additional salary involved with a buying one more property, at least in theory. Rents don't always go up, but over a long enough period of time, they tend to follow inflation. Sometimes you do buy at the top of the market, but if you are investing over 15-30 year time horizons, does that matter much? Tenants don't always pay their rent, which is why you underwrite bad debt into your pro forma. Your real estate could be wiped out by a natural disaster, which is why you have insurance to rebuild it. Wars, pandemics, recessions are much more likely to ruin your return in fixed income assets (corporate bonds, etc.) then they are unlevered or low leveraged multifamily.
Answers are in CAPS below :P :
Here is another way of thinking about it. Not all strategies revolve around buying a stabilized building and holding it for a very finite duration. It seems like most of the strategies that do buy stabilized buildings either have a very long time horizon whereby illiquidity is less of a concern and the 8-9% provides outsized risk adjusted return. CRE is theoretically hedged against inflation in the long term which is a risk to bonds and there are tax benefits
"Real estate is extremely illiquid, fixed income is very liquid."
Risk and reward. There is greater risk to illiquid assets, but that also means there could be greater reward. Those who understand the market and product better can generate outsized risk adjusted returns
"Salaries and fees need to be deducted from these returns"
What salaries and fees? I own 3 investment properties and don't have anyone on payroll nor do I have a property management company. A tenant calls me about once every 3-4 months about something and if I can't easily fix it, I just send my plumber/electrician/handyman to fix it.
"Real estate does have a 1031 swap available"
Yes and don't forget about depreciation and if the property is your primary residence, you can deduct mortgage interest, real estate taxes, and if you live there for at least 2 years, up to $250k of your gains is tax free ($500k if you're married)
"Rents don't always go up"
Companies don't always perform and service debt. Is your point that there is risk in investing? Thank you for that insightful comment. If you know your market, then you will price the asset accordingly to reflect the rent/vacancy risks. If you misprice and overpay, oops, but this can happen both in bonds and real estate.
"Sometimes you buy at the top of the market in RE."
Same with bonds...you can buy at the top of the market with any asset...You should really look into what happened to Silicon Valley Bank. They held $91B (half their assets) in treasury bonds and then went bye bye
"Tenants dont always pay their rent"
And companies don't always service debt and rates could go up, which devalues your existing bonds. Once again, as an investor of anything, you need to know your market and product and price the risks in accordingly.
"Your real estate could be wiped out by a natural disaster"
That's what insurance is for. Do you own any real estate?
"General risk (wars, pandemics, recessions) can ruin your return, not true with FI."
What? Are you saying there are 0 risks to investing in fixed income debt products? Then why are there different tranches and ratings for bonds? Shouldn't they just all be AAAAAAA++++ if there is 0 risk?
I think a couple things are pretty clear from your comment. 1.) You don't really know much about investing. You don't understand the whole "risk reward" appetite. Some people are willing to take on more risk for more return. If that is not you, that is okay. 2.) It seems that you are a pretty lazy investor. Any sign of risk or uncertainty and you run away rather than try to mitigate that risk with knowledge, which is fine. Many people would rather have less headaches, but also make less money 3.) You don't understand that illiquid assets, with a lot of regulations (aka imperfect market), and a lot of asymmetric information i.e. real estate, offers great opportunity to generate significantly outsized risk-adjusted returns. And this is the primary reason I like real estate, specifically development. I'm willing to put in the work and learn about zoning laws, construction, etc...so that my knowledge actually gives me a leg up over my competitors and generate outsized returns
Also when you say leverage up on bonds, how much leverage are we talking? 75%? 80%? 97%? Because that's how much you can leverage real estate.
How did you calculate the 8-8.5% yield?
So we value CRE as NOI/Cap_Rate which is the same thing as the Gordon Growth Model where they value stocks as D/(R-g). D is the Dividend Yield, R is the constant cost of equity capital (aka the total return) and g is the dividend growth rate into perpetuity. Therefore the Cap Rate is equivalent to R-g. So R is equal to the cap rate + the growth rate.
You can test this theory out in Excel using the IRR function.
Because when me plug in 5% rent growth and 3% exit cap the returns go boom!
I'm glad someone else in the industry understands it really is a joke. Everyone is making (or losing) their money due to macro forces. I feel like a pawn.
You feel like a pawn, because you are a joke. Special little snowflake who demands anyone who disagrees get out of the room. No wonder you don't understand, well... anything at all.
This is true for the vast majority of investors in general...when the president implements 145% tariffs on one of our largest trading partners and a lot of uncertainty is created, almost everyone is losing money. When the Fed pumps the economy with money and reduces rates, almost everyone is making money. This isn't unique to real estate. It sounds like you have "grass is greener" syndrome and believe that other assets are easier and have a better risk reward ratio than real estate. You're welcome to try your hand at other assets, but my guess is you'll just come back to this forum complaining that your TSLA stock blew up because Elon Musk decided to play politician. From what I gather, you seem to just be a bad and lazy investor that just wants money handed to you. If you owned real estate in any market that people want to live in from 2009-2021, which you obviously don't, you wouldn't be complaining about real estate because you would have made a killing. The problem is that you are entering the real estate market in one of the most turbulent times and then complaining that you're not making millions by doing nothing. Investing is all about risk and reward. The sooner you are able to wrap your head around this concept, the sooner you'll actually start making money.
Treasury rates aren't perpetual. At some point your t-bill ends and you have to redeploy it at the rates at the time. So if you think the long term treasury rate will settle lower, then real estate is a better bet especially since you can have appreciation to your yield
Makes sense in a perfect scenario. I offer a rebuttal: fixed income is highly liquid, if a great opp comes up you can take it where in RE you couldn't (with the same capital).
On the flip side, if rates go down and causes cap rates to follow, you just get double whammied. Your T-bonds lost value and real estate prices went up.
Yield + NOI growth + debt paydown + depreciation & other tax benefits
Regardless of the debate on the merit of real estate vs debt investing, your initial premise is flawed. What do you mean it's a " highly diversified asset"? Diverse compared to what? If you put all your money in 10y treasuries you are by definition not diversified. Real estate can be diversified across geography, property type, core vs. value add, etc. If you put $500m in bonds, they're just a pure interest rate play, there isn't much you can do except change your duration or country (but then you wouldn't be getting the same interest rate). Putting $500m in real estate lets you invest in Virginian data centers, Texas warehouses, Los Angeles apartments, New York City hotels, Miami malls, and Seattle office buildings. If all of those have the same beta, then the world is a lot more screwed than comparing 4.5% to 5% rates.
Highly diversified in the sense that the basis of the rate is the entire US economy's health among other factors that are too complex to write-up here.
I personally prefer treasuries to real estate in the current market, and believe the risk premium for acquiring multifamily real estate is insanely high at the moment. (not looking to argue this, just my personal belief)
HOWEVER: from my observation, money is still being deployed into real estate because the massive allocators are driven by allocation / portfolio balancing - and not the rationalizations / intellectual exercise of 'why real estate?'.
In essence, a CALPERs allocates to a Greystar who buys a 5-cap MF property, because CALPERs needs to balance their portfolio and not because they think 'oh this 5-cap garden apartment in arizona is better than a 4.5% treasury.'
This is partially true. People think that institutional owners are the biggest piece of the pie here, but thats not the full story. The bigger issue is not funds like Calpers, its the retail investors (including syndicators). A bunch of these guys overpaid for assets and now the only way out is to hold onto their price expectations. We still have record low transaction volume and thats in part to these guys not wanting to sell at a loss and look like fools whereas Calpers, Blackstone, etc. literally will sell at the market rate because their fund is coming to an end or they need to liquidate.
I would argue that the drop in transaction volume is due to institutions holding onto their assets longer, not retail investors. Most retail investors are buying securities that have an indefinite hold period (REITs, mutual funds, etc). Firms that structure their investment offerings in this manner are focused primarily on distributions and growing their AUM - most of the time they do not have a set hold period or need to transact to realize incentive fees like private equity firms do. As a result, these types of companies do not sell assets very often - if they are it is typically because they are refocusing their strategy (typically done in a non-dramatic way over time - “pruning” their portfolio), have capital needs and selling a property is the cheapest source of capital, or they get an unsolicited offer at an attractive price. It is against their interest to shrink their AUM - both currently and in the past when there was high transaction volumes.
On the contrary, private equity funds do have a specified hold period (subject to optional extensions to wait for better market conditions - exactly what is occurring now), and in order to realize their promote they do need to transact. If a PE GP believes they will achieve a higher return (and promote) by waiting for better market conditions, then they are incentivized more than any other type of firm to do so.
Edit: One more piece of evidence - secondaries have been increasing in a big way the past couple of years due to LPs wanting their capital back but GPs not wanting to sell in the current market.
There have been other periods in time where cap rates on MF have been lower than treasuries. This usually indicates the market expects high inflation ahead. Talk to some of the old timers about the early 80s.
That being said, I’m not personally buying MF at a 5 cap. I’d rather own a warehouse with way below market rents if I’m paying a 5 cap. I’ll take some vacancy risk and make some leasing brokers rich on my way to what I perceive to be superior risk adjusted returns.
That’s just me, though. I’m biased because I’ve never done a MF deal. Not my wheelhouse and I don’t feel like learning in a negative leverage environment.
OP Here: Thank you, this thread was created as a discussion piece and not REAL ESTATE PPL ARE DUMB.
Here's a duplex deal I'm working on now:
Purchase price $1.150mm
LTV: 83%
Renovation cost: ~$100k (equity)
Interest Rate: 5.75%
Annual Rent: $120k
Taxes, Insurance, Water, PMI: $12.6k/year
Annual Debt Service: ~$67k
NOI: ~107k
Cash Flow to Equity: $40k
CoC Return: ~13%
Based on other sales comps, I estimate my post renovation value to be $1.6mm-$1.7mm. If I were to immediately sell at $1.65mm, after deducting 5% for sales cost, my profit would be ~$300k or a 2x EM multiple in ~6 months time. Or I could hold onto the property, which I plan to do, and clip 13% return a year, while the property appreciates and yes the property will appreciate. I live in a major city that has a severe housing shortage. On average, SFH prices increased ~10% in my city from a year ago. Furthermore, I can deduct ~$30k of depreciation a year against my $40k cash flow to equity, which brings my taxable income down to $10k.
Now I didn't factor in vacancy because the vacancy rate in my city is like 3% and I haven't had a vacancy in any of my units in over 10 years. I also didn't factor in property management because I self manage my units, which at the scale that I'm at isn't that much time and effort. But if even if you factor in a 3% vacancy rate and 5% management rate, your CoC is still 10%.
I would love to do something like this with a safer asset like AAA bonds. @walkerg How can I achieve the same return and benefits but take even less risk?
While the comments are all true currently. It's interesting to think what will happen over the long term if the federal government keeps borrowing like it is - particularly with more tax cuts.
A long-term Treasury rate breakout to 6-7% over the next decade doesn't seem crazy to think about.
Thanks for contributing. Real estate is in for a rough ride ahead! We are all in for a rough ride ahead!
I think treasuries at that yield would be catastrophic for the U.S. government and economy. We’re already spending more on interest than defense. Treasuries at ~7% would cause a massive reset for just about every asset class IMHO.
I have no clue why anyone would be investing in Multi Family right now at these yields
It’s stupid and makes zero sense
Fixed Income is a way better play right now or investing in debt
OP Here: Thanks for contributing.
All comes down to location. I wouldn't invest in Scottsdale, Arizona, but I would invest in Tier 1 markets like LA, DC, Bos etc...
why not in Arizona?
Lots of great comments in here,
Another thing:
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