Trying to make sense of multifamily (acquisitions) right now
For those working in the multi space, are you worried about the declining profitability of the asset class given how competitive deals are and where cap rates continue to go? I just looked at a deal in an "ok" part of the Tampa MSA and the thing got 40+ offers with best and final pricing at a 3.3% tax adjusted cap rate.
Am I missing something? I believe the fundamentals are strong for multi demand, so much so that the asset class could be considered much lower risk relative to others, but I worry this asset will turn into what NNN Arby's are, essentially a low risk bond with extremely limited profitability.
Its tough for sure. We're UW deals left and right and can't make it work simply because our equity is not willing to accept those returns. In general, this has all been exacerbated by the Fed. I know everyone is quick to blame them, but in reality we have fundamentally made it so difficult to earn a return on savings, that the only buyers that are getting these properties are large institutions or UHNW individuals. MF is a great asset class, but my concern now is that it is so bid up that the returns are not worth it, even if you can try to do some value-add. Remember you get in a 3.3 cap, you're saying you will have to exit at a lower cap than that. Some of this stuff is priced so thinly that a 10% decline in occupancy would put the deal at negative debt coverage.
Assuming there are no meaningful changes from the Fed, what is your outlook? Do value-funds / middle market buyers focus elsewhere, which would balance out the competition?
Too much liquidity in the market for cap rates to rise. With leverage the returns are par for the risk curve based on how low treasuries are. Unless you’re doing value add Multifamily is low risk and bond like and institutions are treating these stabilized deals as a viable diversification out of bonds
Unlikely that buyers go elsewhere because technically every asset class is bid up. I think the only real changes that happen are that LPs and other equity have to take a lower return. Eventually they will bite the bullet and do it because it beats staying liquid in this market. Some other funds that have stricter underwriting guidelines will just stay out of the market. The problem is that buyers are not going elsewhere they are sitting on liquidity hoping to jump back in which is creating large reserves of capital. These same buyers will then just suck it up and end up overpaying for some deal. Anyways this is what I have been seeing, we're one of the those buyers with stricter underwriting guidelines and its been tough for sure.
I get what you are saying, but this is not necessarily true assuming that you have rent growth over your hold period.
As long as there is excess capital there will be low cap rates. That is just what it is. New strategies are what it is going to take to get healthier returns.
Agreed with Teddy.
I think there will be a set of consolidation for those firms that can consolidate debt and equity. A huge reason why we've lost out on deals to Starwood and BX for example is because they just get better financing...because they do their own financing (at least with the few deals we had looked at) and they finance it at extremely low rates, so it works out for them offering stupidly high prices for deals. So I wonder if other firms will try to go this route too.
Short-mid term your concerns of MF assets becoming no more profitable than bonds is valid, due to excess liquidity, low rates, competition, etc. Even worse is RE, though MF less so, is prone to swings through small occupancy changes.
Long term, it's likely that, through consolidation, divestment, rate rises, etc. we'll see a return to larger margins. Consider the post-GFC environment in commercial RE and how BX et al benefited tremendously through the next decade by scraping the barrel during the GFC. Probably see a similar trend with long term margin growth.
Or we'll see new strategies take hold of the MF market. Either way, probably gonna be larger equity firms that win out.
Mind you I have zero experience in RE and am saying this as somebody who did some quick reading on the topic.
One thing American buyers have a difficult time comprehending are the cap rates in other highly developed, Western countries. Canada, Western Europe, Australia, Japan - all these have cap rates that are in some cases much lower than cap rates in the US. If our monetary policy continues to look more like the monetary policies of other countries, you're going to continue to see cap rates for core product trending into the low 4's and high 3's. And the crazy thing is, cap rates at those levels will still look attractive to foreign buyers relative to other options (I'm not including any hedging/currency costs in that equation because I'm too dumb to think about those but I know that they can have a meaningful impact).
Agreed. We have a European partner that is buying industrial and resi on the continent at mid to high 2-caps and they're financing it at all-in rates of 0.90% or below. The 3-caps on US multifamily deals are still very attractive to them. While things feel tippy toppy, the fundamentals of multifamily are incredibly strong and have great structural tailwinds vs the universe of other investment opportunities. That said, returns will undoubtedly compress, and we all know it, but no GP or LP will say that out loud.
Alternatively though, if cap rates go to the mid 3s, and than stay, that also means you’re exiting at a mid 3 or low 4 in a value add deal. So assuming you buy at a 3.5% cap, add some value and get to a 5% return on cost, but sell for 3.75%, you’re still making a solid IRR on a 3-5 year hold.
That is essentially how I'm getting value-add deals to pencil. Buy at 3 to 3.25, stabilize it at a ~4.25 untrended and ~5.0 with trended rent growth, and exit at a 4. The obvious risk is if interest rates blow out in 5 years and cap rates rise. I'm not smart enough to tell you what happens there. My cash on cash is nonexistent, and I'm really betting on strong growth and that a buyer will be able to take me out when I go to sell. That's to hit our fund's returns (12-13% L-IRR net of fees and before promote). I'm trying to de-risk the deals by doing ones in top quartile submarkets and product that is 90s and newer.
It sounds like how one decides when they invest in New York - absolutely no cash flow and it’s all appreciation. I’m curious - what are you guys modeling as the next buyer entry cap rate, adjusted for taxes, and next buyer IRR? If you’re exiting around a 4%-4.5%, am I correct to assume the next buyer is really buying at a 3.5% to 4% due to taxes, and also assuming an exit of 4.5% cap rate?
You can invest in NYC with no rent growth and not assume appreciation drives value - you just need to be a little creative in how you deal with the other side of the ledger. Not a great place to do cookie cutter cash flowing deals.
We're hitting a mid teens return on MF assets in NYC on a routine basis, though a lot of that is obviously predicated on low rates. On a more general note, if interest rates do go up it implies inflation and therefore rising rents, so you'd hope to be held harmless in your investment thesis, getting bailed out by stronger rent growth, even if cap rates blow out too.
I’ve never done much in NYC - how do you structure a deal with no rent growth or appreciation and make money? Do you work in the affordable MF segment and assume tax abatements etc., to drive value?
Exactly. A lot of banging your head against the wall with the city. Taxes are by far the biggest expense item, so if you can cut them in half, that is a lot of up front value. Just a pain in the ass to negotiate and adds some complexity to the asset management side of things to keep on the right side of the regulatory requirements.
And we don't model no rent growth, just very little, and less than opex growth. Adams may end up being more generous to landlords with RGB increases, which would also be additional upside.
Interesting. I guess that’s how that space works in NY. So you buy a building and go to the city and say, can we have a tax abatement if we keep this affordable? Do you start talking to the city while it’s under contract and only buy if the city says yes, or do you only start talking to the city post closing on the deal?
It's changed a lot in the last few years thanks to some (shortsighted) legislative changes in 2019. But yes, the way it would have worked was you'd identify an asset, and at the same time engage HPD (the city housing department) to receive a tax abatement in return for varying levels of affordability. It used to be to protect rent stabilized units from being deregulated and converted to market rate housing. Fair bit of upfront savings on transfer and mortgage recording taxes and the like, which also helps juice returns.
Since that's no longer possible the math has changed a bit, and opportunities are rarer, but it's the same concept.
Very interesting. Thanks
Most markets nationally are ~4.0% at the exit give or take 10 bps. We generally underwrite the tax reassessment in the reversion NOI so that is cooked in there, using local customs as a guide (i.e. 90-95% in Texas).
Can you further explain what you mean by accounting for tax
It can mean a couple of different things, but in context it is talking about the reassesment values for sales impacting the return structure for a buyer. Transfer taxes are a large upfront cost, some jurisdictions allow for it to be amortized over time but those are not the norms, that impact the return picture for a buyer.
Your criteria allow you to assume selling at a 4% exit cap in 5 years? and you dont solve for cash flow? that does not strike me as attractive relative to bonds especially given the lack of liquidity (i know you can sell fast, but it still takes 2 months). Are these core deals? How do you grapple with exit price per unit, which i assume is super high?
Yes. Underwritten hold is 5-7 years. The deals cash flow, but CoC averages like a ~4% vs the 6%+ it was three years ago. I'm not saying it makes a ton of sense, but the real yield on the 5-YR UST is roughly -1.7% so who the hell knows. The deals are generally core or core-plus.
out of curiosity, what is the profile of the euro partner? life co, bank, etc?
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