I came across the post below on Linkedin and I'm curious to hear everyone's opinions. Do you think we're going to see some overly aggressing MF shops blowing up or do you think they'll just ride out the storm until rates go back down?
"I saw a list of Sales Comps for larger Multi-Family assets in Las Vegas sold in 2022 that said the average in-place cap rate was 3.55%.
The 10 Year Treasury today closed at 3.70% and 2 year is at 4.112%.
I vividly remember being in graduate school and a very sophisticated investor speaking to our class said you can tell when a market is screwed when recent cap rates are the same as Treasury Yields because buyers are far too aggressive and do not have a large enough Risk Premium when buying. Now clearly none of these groups bought thinking yields on Treasury's would run this much but that's now reality.
Buying a Multi-Family project in a market as volatile as Las Vegas for a 3.55% cap rate is nuts to me regardless of the Economic cycle. Especially considering that the Vegas market has not been performing well the past 12 months with Net Absorption being negative and rent growth dramatically slowing. Any one of those deals done with aggressive financing is now basically under water and the equity is gone. Cap Rates today are probably 5%-5.25% for those deals so simple Math says if your NOI is $1M and your Cap Rate moves 150 Basis Points that's 30% in Value loss on paper changing nothing else. And most of those deals were done with probably 70-80% LTV so good bye equity on paper for now.
What's the Lesson, never ever ever buy aggressively at the top of the market/late cycle in secondary markets...EVER.
The buyers of these deals have to pray Interest Rates come down quickly or NOI Growth turns massively positive. If not there is going to be some large Capital Calls that are needed to save these deals from collapse."
I think some of the smaller more unsophisticated buyers that just jumped in because they thought it was "easy" might have problems. But if you had a robust financing/hedging program and stayed with better/top assets, you will probably be fine.
If you were buying 3.5/4.0 cap assets in 2018 when rates were near zero and you put on 10 year debt, you have a lot of time to ride out the market.
If you bought in 2019 and said I'm going to take a flyer and put on 5 year floating rate debt, you should still have some time once balanced against the crazy rent growth in some markets over the last few years + hopefully you bought an appropriate rare cap back then and didn't rush to put one into place recently
Something I've seen on deals a year or two ago is the caps weren't for the full term so now they're forced to buy new caps which could be a big capital call. For floating rate, 3+1+1, they'd also have to hurdle performance tests which may cause rebalancing. Not sure how sophisticated the smaller guys are or if their docs have this structure but possible pain if they're syndicates with smaller retail investors.
Devils advocate for the sake of it though using real numbers. Cap rate based on As-Is NOI and PP being 3.5%, sure I see that a lot. But what if rents increase by 20%? Spending capex and increasing rents by 20% supported by rent comps is one thing, but I am seeing an in place rent roll where the rents in the last 90 or 180 days already being 20% higher thus proving the thesis and any rents increase on top of that is just bonus. So your as stabilized NOI divided by purchase price + capex (this is conservative than just assuming a future stabilized price out of thin air) might be in the 5's. Suddenly this does not look that far fetched. Not ideal but also not unfathomable.
Real Example- Business Plan is to increase rents from $1300/unit to $1,500/unit. Trust me I have seen a lot worse than a $200 premium (I cringe when I see a $500 projected premium in an area that cannot absorb that increase which will increase in 100% turnover) and rents in the last 90 days are already closer to $1,400 without even any renovations. T-12 NOI is $2.50MM. Poorly mismanaged, non institutional, etc. As stab NOI is closer to $3.5MM and this assumes a tax reassessment as well. Cap rate based on As- Is NOI and PP is 3.50%. Cap rate based on As stab NOI and PP+capex is 5.50%. Note, assuming a stabilized value using just PP +capex is very conservative. Assuming the stabilized value to be as stab NOI divided by say 4.50% cap rate would be a value that is closer to $15MM higher than the conservative PP+ capex value in this example.
Yes this is the thesis behind it - the problem is that sure you can support rents going to $1,500, but can you actually get at enough of the units to turn them over?
Maybe you budget $50k/unit for renovations, but what about the cost of buying out long term tenants that don't want to leave because they're paying well below market rent? That might average an additional $10k/unit. Then you also have to factor in how long it will take to roll units to market. Maybe you only roll 15-20% a year, and now it takes 5-6 years to hit your expected NOI. If rates go up in that time, now you're bleeding money if you didn't put a fixed rate in place. Then further to that, what if 10% of your tenants won't leave at any buyout price?
It's great to say you're going to hike rents 20%/unit because they're below market but there's a lot of hoops to jump through to actually get there with older buildings occupied by long term tenants.
Look all this comes down to where the asset is located, I am not comfortable with this business plan in states with rent control but there are states where you can literally say to tenants GTFO, it sucks but it is what it is, then you have the tenancy and the tenant demographics, you will have assets which will have 100% turnover as they cannot pay the higher increase in rents even though the asset was "renovated". Tenants cannot ask to pay for a lower rent and have unrenovated countertops and flooring instead, it does not work like that if the demographics in the area can support higher rents. The market matters, you have markets with a potential increase in supply that can affect the vacancy, concessions and rent in your asset but doing that due diligence is part of the job. Lastly, the ownership matters, some are just not cut out for this (not just in terms of boots on the ground operations but you also have sponsors with a extremely low cost of capital, etc) hence you see some being more successful than others, not everybody is a monolith.
pain
COUGH* Tides Equities COUGH*
Agreed on all of Mr. Cheese's points, particularly about well-capitalized owners with quality assets being able to weather the storm. It's the syndicators and small fund shops buying highly-levered Class B/C stuff that will get smacked IMO.
Been watching for a couple months, but just now starting to see some of these "distressed" deals come out. All were bought in mid-to-late 2021 with 75-80% LTV bridge floaters. Bought at low to mid 3 caps and are no longer cash flow positive as of this month. Imagine the pain they'll see come Q1 if today's forward curves materialize (obviously depending on rate cap situation).
The three examples I've seen come out this week were all smaller/unsophisticated owners, one of which being a syndicator who bought his entire portfolio in late 2021 at an average LTV of 76%. Looking to get out at their basis, but man, it's going to be a tough sell with today's volatility. None of these are the Tides deals, but I would not be surprised if a swath of them hit the market over the next year.
For selfish purposes, what are the unit counts on these distressed deals? Anything over 250? 👀👀
Average across the three is ~240 units.
They get paid on the 2 and 20. The 20 is the distraction - the real money is in the 2. They don’t care what happens to the investors.
Most of the deals that trade at yields that low are not opportunistic groups that are using 70% leverage. They’re the most boring institutional of institutional firms that are using really low leverage
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