The BLVD Distribution November 10, 2023
Warren Buffett said it best, “Be fearful when others are greedy and greedy when others are fearful.” Among the items to fear in multifamily investing are high-interest rates and rising operating costs. In the current market, fear is reflected in the form of fewer offers and a heightened caution displayed by investors.
Recently, we submitted an offer for a value-add property in the Twin Cities Suburban area. Our initial offer was lower than the competition, and they secured the deal. However, a few weeks later, their equity source unexpectedly fell through. Today, we've successfully secured the property under contract at our original, more favorable price. This accomplishment can be attributed to our strong broker relationships and established reputation. It's evident that concerns about overpaying played a role in this turn of events.
Warren Buffett's words are incredibly wise. Those who had the foresight to invest in multifamily properties during the Great Financial Crisis were essentially preparing for a remarkable bull run that extended well over a decade, leading to substantial wealth accumulation. While the current landscape doesn't mirror the same level of financial turmoil, the value-add property in the Twin Cities area still presents us with a significant opportunity.
Before we review why the present market presents an excellent opportunity to purchase multifamily, we invite you to join our investor portal. Once registered you can see our future deals and invest alongside us. Registering is easy and will only take a few moments.
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Currently, some less committed buyers seem to be taking a coffee break, leading to a reduction in property offers. A property that might have attracted ten offers just a few months ago is now seeing significantly fewer bids. A contributing factor to the decline in offers is the uncertainty regarding interest rates between the time a buyer goes under contract and when they close. This is precisely why Loan Assumptions have become a sensible choice in the present market. Considering there are now fewer offers, there are also fewer instances of 'best and final' calls for offers. Lastly, there's a noteworthy uptick in off-market transactions, particularly among reliable and efficient closers.
Lower Purchase Prices & Higher Returns
Interest rates are connected to cap rates, which, in turn, play a key role in determining the purchase price of a property. It becomes clear that higher cap rates, which are often associated with lower property prices, can create a favorable buying scenario. Let's illustrate this with a simple example: a property with a Net Operating Income (NOI) of $500,000 and a cap rate of 6.5% corresponds to a purchase price of $7.69 million. However, in a scenario where interest rates are lower, causing cap rates to drop to 6%, the same NOI would result in a higher purchase price of $8.33 million. This example demonstrates how fluctuations in interest rates can significantly impact property valuations. Lower cap rates lead to higher purchase prices, potentially making it less attractive for investors. Therefore, when interest rates are on the rise, it can be a valuable time to invest in real estate, as it allows for the purchase of properties at higher cap rates and more favorable price points, potentially leading to a stronger return on investment.
Revenue - $1,000,000
Expenses - $500,000
NOI - $500,000
Cap Rate - 6.5%
Purchase price $7.69m
Same scenario with a 6% cap rate = $8.33m
Cap rates and interest rates are closely intertwined. While there's no direct one-to-one correlation, their historical trends often move in tandem. As interest rates rise, cap rates tend to follow suit. Many economists suggest an approximate 3% spread between cap rates and the 10-year Treasury.
As a standard, investors expect cap rates to trail an increase in interest rates by an average of six months. Even though interest rates have risen rapidly in the past year, cap rates have made only modest adjustments. Their steadfastness in the face of higher capital costs is a promising sign of the enduring demand in the multifamily real estate market.
Rents Remain Steady
Rent prices in the United States are still on the rise, but the pace of growth is gradually slowing down. Interestingly, this slowdown is primarily due to a surge in development caused by historically low interest rates. Currently, we find ourselves in a phase of short-term absorption, leading to leasing concessions in numerous U.S. markets. As these new units are gradually absorbed, there is a theory that heightened interest rates may drive up the cost of homeownership, thus increasing the demand for rental units. In regions where it's more challenging to construct new housing, we are observing strong rental growth. Additionally, the increase in housing supply has significantly slowed down, making it increasingly difficult to justify new development projects. These dynamics present a compelling case for potential rent increases in the future.
Resilient Asset Class
Multifamily real estate traditionally performs well in inflationary environments and is often considered recession-resilient, as demonstrated during the Great Recession just over a decade ago. Currently, housing affordability has reached all-time lows, driven in part by rising interest rates that have discouraged potential homebuyers, pushing them back into the rental market. Furthermore, despite the recent surge in development, there remains a severe housing shortage. The National Multifamily Housing Council estimates a need for 4.3 million new apartment units. These factors are contributing to the strength of multifamily cap rates, even as capital costs increase.
Recently, sellers have begun to adapt to the pricing demands imposed by buyers. This adjustment may stem from market dynamics or could be driven by the necessity to sell due to maturing debt obligations. Regardless of the reason, our team at BLVDremains both opportunistic and bullish on the multifamily market. We consider it a 'Green Light' for acquiring strong, cash-flowing assets, at favorable valuations.
As of 11/6/2023 we have reviewed and analyzed 18 multifamily investment opportunities maintaining our focus on multifamily value-add opportunities. We are continuing our broker outreach, making new connections with local brokers and sellers, as well as continuing to follow up with our existing relationships to stay top of mind as soon as a deal hits the market.
Since our last update, we have developed a strategy to locate off-market deals and are building a database of potential opportunities. We are refining our outreach process to establish and maintain relationships with asset ownership groups, ensuring that we are well-positioned when the opportunity arises for them to sell their assets. Furthermore, we've been strengthening our relationships with third-party property managers in our target markets. In Greensboro, NC, we're actively working on a deal and have had preliminary discussions with a potential management team.
It's worth noting that asset prices are beginning to soften as capital costs remain high. An illustrative example is a local deal that has returned to our attention for the third time, with the ownership reducing the asking price by $1,500,000 since our initial site visit in July of this year.
This month, we have submitted two offers, both situated in the Twin Cities suburbs. One of these offers is now under contract, we are excited to share more details as we progress through due diligence and work towards finalizing this opportunity. Stay tuned for updates!