We might be at the bottom in Multifamily (MF)

PacNumber's picture
Rank: Neanderthal | 2,351

It was just a few months ago when treasuries were at 3.25% and it appeared that 6% interest rates were a year away...5 caps in major markets appeared to be upon us. Then it didn't happen. Since I got in the business in 1995 one thing has remained true, we never raise rates to previous high's and we lower them beyond the previous low. So, if we are in fact due for a recession in the next 18mo, is it fair to say negative interest rates are coming our way? We all saw what fixed rates in the low 3's did to caps. Imagine fixed rates of 2.5%. Throw in the lack of new home construction and for rent product, it seems that for MF is due for another run up.

Rents just keep going up in SoCal too. It appears that 400k a door is the new norm for B locations.

Short of some crazy trade deal being struck with China, it appears markets are steady and rates aren't going to make a big leap. We just might be at the beginning of something wild happening again in MF.

Comments (67)

Mar 4, 2019

U think were heading for a negative libor?

Mar 4, 2019

Ugh have you follow the market at all? LIBOR is just below treasury currently....

And it will be replaced by SOFR soon

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Mar 4, 2019

Fed Funds guys...Fed Funds. And I'm not talking about today. I'm talking about the next time the Fed makes a move at lowering rates.

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Funniest
Mar 4, 2019
PacNumber:

So, if we are in fact due for a recession in the next 18mo

You shush your mouth

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Mar 4, 2019

Lol...

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Mar 4, 2019

Would suck for @CRE & developers with stuff in mid-production, but candidly from the REPE side I would be happy if this was true.... Finally some buys that would be easy to get through committee...

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Mar 4, 2019

I think the amount of supply that has been delivered in the last 18 months + the current construction pipeline will offset any QE4 type of shenanigans.

Mar 4, 2019

Fed Funds guys...Fed Funds. And I'm not talking about today. I'm talking about the next time the Fed makes a move at lowering rates.

Mar 4, 2019

Why do you keep repeating this?

Mar 5, 2019

It depends how pro-active the fed is to a downturn. I think the fed has changed and are better at acting early. So the cut is smaller.

It does feel like we are close to cycle highs on rates. I could see the ten year rises 100 bps but not much more. The thing you are seeing with rates never going back to previous highs is the fed used every recession in the past 30 years to lower trend inflation. We are now at a little sub 2% inflation. So they no longer see a need to fight inflation. Any time the market hiccups like December they are more likely to ease (or stop hiking sooner) since inflation isn't a problem.

On real estate I'm fairly bearish core. I'm not sure how much the trump tax cuts will hurt core. A lot of people lost their tax deductions and effective taxes in the big markets have increased a ton. The tax benefits of moving from the blue states to Texas, Arizona and Florida have increased substantially. Plus the weather. Will be interesting to see how this plays out over time.

And by bearish I'm not an actual bear. Just think at 4.5 cap rates that rental growth rates in core may disappoint or be flat over next decade. So I'm not expecting losses but poor returns.

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Mar 5, 2019

I'm betting that the Fed Funds rate is heading straight to zero in the long run. Raising rates in this country with record massive corporate debt loads is impossible at this point without risk of a complete implosion of the modern financial system. There is no way we grow our way out of this conundrum - its either war or ZIRP.

Also - I think real estate is one of the only places you can get a decent cash yield. For comparison - the average dividend yield (%) of the Dow Jones (non-zero dividend yield payer only) is 2.62%... I'll bet on projected rent growth of CRE in major growth markets versus revenue growth of Dow Jones.

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Mar 4, 2019

The reason interest rates dropped substantially is that the Fed needed to stabilize the economy--or else. So, we'd need some sort of adverse catalytic event to put the economy in an anemic state. If that happens, there will be a lot of fear before investors are overpaying with rates at 2.5%. Thus, in OP's scenario, we aren't at the bottom right now but buying today would still be very profitable if you can weather the "storm" that's supposedly coming. I'm not convinced that storm is coming soon for the reasons people expect (most private sector debt levels still aren't egregious, but corporations are getting close to scary territory).

The biggest risk, in my opinion, is the 2020 election and the resulting tax ramifications. Think: no more 1031 + increased capital gains tax + changes to depreciation. That combination would reprice the majority of assets overnight and the market would temporarily come to a halt. I'm not saying that's the scenario that will play out, but anything is possible now that it appears a big part of what Democrats will run on is taxing the wealthy. No better way to get back at a controversial real-estate-developing POTUS than to completely re-write the tax codes that benefit him as soon as he's out of office.

As an aside, I think real estate as an asset class has matured and it's now a lot harder to make outsize returns, leading to investors hoping for a recession. Tangentially, it's a lot harder to make money in hedge funds today because of the amount of money in the market.

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Mar 5, 2019

It seems there's legit theory that cycles turn when the White House changes flags. I think business sentiment is wildly different once Trump is out of office in 2020 and Democrats rally behind some more liberal policies, including pro-social spending, tax hikes, loophole changes, a shift back "on" towards regulation, etc.

Kinda joking here but I bet you'll start hearing "but muh exploding government debt & deficits" all over again from Republicans and all of that negative sentiment will create a drag on the economy.

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Mar 4, 2019
Surfing Pirate:

It seems there's legit theory that cycles turn when the White House changes flags. I think business sentiment is wildly different once Trump is out of office in 2020 and Democrats rally behind some more liberal policies, including pro-social spending, tax hikes, loophole changes, a shift back "on" towards regulation, etc.

I think the degree to which this happens depends a lot on which Democrat gets elected too. There's a big difference between Biden and Bernie

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Mar 5, 2019

I think you'll also see some changing over the next couple years while Trump is in office. He staved off a slowdown with the tax bill, but that basically was a one time shot in the arm, a sugar rush, and the fall off will be worse for it delaying it.

Mar 4, 2019

The multifamily market is rock solid
Fundamental is healthy, interest rate is low, and investors love multifamily being the safest CRE asset

2019, especially first half 2019 while life co still have allocation, will be a great time for borrowers. You guys will see the lowest note rates due to competition among lenders.

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Mar 5, 2019

Varies widely by market. Houston, for example, is supersaturated with cookie cutter wrap stick-build multifamily.

Mar 5, 2019

The thing that worries me the most about the multifamily market is all of the assets trading at 4.00-4.25% cap rates. It'd be unreasonable to expect further cap rate compression, and likely to see some contraction. To keep the same value rents will have to climb aggressively.

Mar 4, 2019

National is 5.2%, 4% is only in Manhattan SF LA

Mar 5, 2019

Most of the stuff trading at those cap-rates are in dynamic walkable locations in the city centers of major markets. I'm more worried about all the shit trading at 5.0-5.5% cap-rates in places like Central Florida... Only reason they trade for these cap-rates is cheap subsidized non-recourse debt from the Fannie/Freddie whores all backed by the American taxpayer. They are so out of market on permanent multifamily financing it is frightening.

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Mar 20, 2019

Life co's cant even get in the door, even the small guys that underbid just to get the deal done. The agencies are massacring almost everyone out there. Seems like they're bidding inside just to fill up that $36B of appetite. You can have all the appetite you want, but when the agencies are bidding inside everyone, including the debt funds - good luck getting that deal.

Mar 21, 2019

Not sure what you are talking about, agencies have been competitive on pricing, sure. But on proceeds we have been seeing them losing big time to banks, life cos, debt funds, etc.

Mar 4, 2019

life co is always the lowest on pricing, and at least 20-30 bps tighter than agency, the catch is that life co only want trophy asset.

I've seen life co regularly go under 100 bps on pricing, and agency is normally 130-150 bps

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Mar 21, 2019

I think the elephant in the room is the rent ceiling.

It seems rents across all classes are outpacing CPI. When do people tap out? I suppose SoCal is a good example of market where rents don't seem to let up, but there are many other areas of the country where renters can just move an extra 10 minutes from their job and save hundreds of dollars.

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Mar 4, 2019

Yeah AB84. I think that Multi-Family has some crazy assumptions to it. You can just increase rents by 5-10% (25% with a remodel every 5-10 years) forever. Eventually people will tap out on the increasing rents. The first thing people do when the economy is struggling a bit is downgrade apartments.

In the long term all the apartments that exist now have millennial in them + boomers who could never hack it. I think that eventually these 2 giant generations will move out and I think apartments will go the way of malls, the A class apartments will there to stay but the B/C class will just be vacant ghost towns sometime in the next 10-15 years.

Mar 5, 2019

Class B apartments in most major markets have seen occupancy booms. Class C rent-restricted apartments are often 100% full with wait-lists.

Class A apartment rent to median HH income ratios are surging, which is causing a huge affordability crisis. This is where the bubble is because Boomers will need to sell their homes to pull equity out to afford assisted living/memory care. Home prices will drop accordingly, millennials will buy homes in droves, and ageing Class A apartments will be left vacant until a price correction allows rates to drop.

We are on the same page if we consider today's Class A stick-build apartments with no walk-ability to city center as the Class B apartments 5-10 years from now.

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Mar 4, 2019

I don't know who told you that MF rent is modeled to increase 5-10%...

Historical long term average is 4% rent growth and that's what everyone's using, and yes it will go on forever because MF rents have been increasing at 4% rate in the last 30 years

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Mar 4, 2019
AB84:

I think the elephant in the room is the rent ceiling.

I think it is much higher than many people thing. The millennial generation can afford a mortgage, but it struggles to come up with a downpayment. It also wants to be in the action, in the thick of things, not in a starter home in the sticks.

Mar 5, 2019

Mobility is preferred as well as young folks stay at jobs for shorter durations than past generations. Oddly enough, the high income renter is the fastest growing cohort right now and I think this subset of the renter pool will continue to drive high end MF.

Mar 11, 2019
AB84:

I think the elephant in the room is the rent ceiling.

It seems rents across all classes are outpacing CPI. When do people tap out? I suppose SoCal is a good example of market where rents don't seem to let up, but there are many other areas of the country where renters can just move an extra 10 minutes from their job and save hundreds of dollars.

This x1000

Mar 20, 2019

100%

There will be a practical limit to rent increases on the whole of the market. At some point they will slow to CPI, or CPI will rise to meet them. Still opportunities out there of course.

Mar 6, 2019

Recessions rarely happen when there is a ton of liquidity. Right now, there is plenty of liquidity. I am actually hoping for more multiple rate hikes. Not because it would put valuations back in check, which helps me personally, but because this is the Fed's only tool. If they raise rates now, when unemployment is at a record low and corporations are earning record profits, then they have room to cut when things go crazy bad. Unfortunately, Powell freaked out when the stock market fell. The market fell because guidance for companies is no longer 5-10%+ growth in rev/eps as it used to be but there is still positive growth nonetheless. Consumer spending is still strong, wages are beginning to growth faster than they used to as local/state governments push increases. Just cause there are a few hiccups doesn't mean they should freak out and stop everything. This is Fed's most important tool, they don't want to cut unnecessarily and be screwed when they exhausted that option.

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Mar 5, 2019

This is the right call, but the cowards in DC will not allow this to happen. We are going to continue to exacerbate the out of control debt situation which will eventually be hell to pay. My pessimistic view is low Fed funds and QE into perpetuity until rates hit zero. They simply can't reverse course without causing another depression, which could permanently destroy America because of growing political/cultural division.

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Mar 17, 2019
InVinoVeritas:

This is the right call, but the cowards in DC will not allow this to happen. We are going to continue to exacerbate the out of control debt situation which will eventually be hell to pay. My pessimistic view is low Fed funds and QE into perpetuity until rates hit zero. They simply can't reverse course without causing another depression, which could permanently destroy America because of growing political/cultural division.

Fuck man you're giving me nightmares.

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Mar 5, 2019

There is a complete lack of liquidity in American small business, which has been the fundamental driver of American economic growth. The recent primary driver of F500 growth has been acquisitions, as internal organic YoY revenue growth has declined. This ties right into looking at how YoY GDP growth has substantially outpaced real wage growth, resulting in dramatic spikes in auto/consumer credit. We cannot keep financially engineering our way out of this into perpetuity.

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Mar 19, 2019

how does this likely play out? interest rates are going down, maybe even negative as suggested in this thread > investors move into MF seeking higher returns > increasing asset prices and lowering cap rates > but renters can't pay increases even keeping with CPI (see graph above) > ??? not sure what happens - owners can't make debt service? properties go into foreclosure? more investors exit MF space, decreasing asset prices until they're back to a higher cap rate in line with lower rent? equity flees to large cap/blue chip stocks where there is still great liquidity and semi-decent returns?

Mar 17, 2019

Definitely not the bottom.... we're much further up the mountain. Although multifamily is pretty recession proof. Businesses disappear or downsize (office). Businesses and consumers may travel and spend less (hotel & retail). Unless WeWork begins offering sleeping bags next to their kombucha taps, people will always need a place to live (multifamily).

Robert Clayton Dean: What is happening?
Brill: I blew up the building.
Robert Clayton Dean: Why?
Brill: Because you made a phone call.

Mar 5, 2019

That's probably a good business idea for WeWork - the San Francisco special!

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Mar 18, 2019

It depends how pro-active the fed is to a downturn. I think the fed has changed and are better at acting early. So the cut is smaller.

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Mar 5, 2019
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Mar 5, 2019
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Mar 4, 2019