As active market participants, we have witnessed and adapted to a wealth of various market conditions in the multifamily industry over the past decade. Understanding these market cycles is an essential ingredient in our recipe for success.
Our experience has taught us that while it is impossible to time the market perfectly, staying informed and flexible is vital to surviving- and thriving- in both upturns and downtowns.
We cannot time the market. However, by closely monitoring trends and economic indicators, we can make more informed decisions about acquisitions and financing strategies.
This means always staying up to date with market movements, following different data sources, and actively consuming real estate intelligence from a range of industry publications. We also skip the “middlemen” and go straight to the source- the best information often comes from direct conversations with market participants.
Above all, we strive to maintain a balanced approach. We are opportunistic when others are fearful and prudent when others are overconfident. We exercise caution and discipline during market booms, ensuring we remain steadfast in our data-driven approach to investing.
Regardless of market conditions, we maintain a focus on fundamental factors such as employment trends, population growth, and local economic indicators. These elements form the foundation of our investment decisions.
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Multifamily Market Shifts
We have observed several significant trends in the multifamily real estate market over the years. These trends have shaped our investment strategies and continue to influence our decision-making process.
During the post-financial crisis recovery around 2011-2012, we saw that folks were very wary and selective. However, those who decided to invest in those early years did extraordinarily well. This period reinforced the value of calculated risk-taking during market downturns.
From the post-Global Financial Crisis era to the pre-COVID period, we experienced what we call the good years. We saw a lot of deals get done in the value-add space, typically with 3 to 5 year holds.
It was a low-interest rate environment where we could get high leverage, and rates consistently remained low. Asset valuations continued to increase, and people made a lot of money.
When COVID hit, everything slowed down, and valuations dropped briefly. However, they quickly spiked back up. We observed that investors started to put higher leverage, variable rate debt, repeating what they were doing pre-COVID all over again, but at even higher prices.
Any market presents unique challenges. Sponsors who relied on low rates during the COVID days got into trouble because they could not service their debt when rates spiked and could not refinance out of their variable rate loans.
This was because values dropped as cap rates increased and their loans became economically untenable.
Our takeaways from these market cycles have been invaluable. We now look very carefully at the appropriate debt products at different times of the cycle. Our approach is that if we can buy a property at a strong basis and put fixed rate debt on it, that is our preference.
However, we remain flexible, recognizing that sometimes variable rate leverage may be worth considering for shorter-term value-add strategies.
Market Analysis
We utilize a range of resources and methods to stay informed about market movements. County and city websites are an excellent source of information for researching what is going on in a market, including new development projects that add to supply, and business initiatives.
We are constantly reading real estate articles from sources like The Real Deal and Globe Street. Costar and Yardi Matrix are also great sources of information containing a wealth of numerical data and well-written, informative articles.
We stay up to date with political developments and market conditions across the country, and to some extent, global markets, in order to maintain a competitive advantage and anticipate multifamily growth patterns and market trends.
In certain circumstances, we even review city council minutes to understand their discussions on local budgets, planned expenditures, enhancements, and potential property tax rate changes for the upcoming year. This helps us prepare for potential changes.
When analyzing potential investments, we focus on several critical economic factors. Employment and population growth are paramount. We assess whether there is a strong employment narrative, with companies moving to or expanding in the city, offering well-paying jobs, and having long-term stability.
From a population growth perspective, we consider whether the city or metro area is an attractive place to live. Are people moving in? Is the move-in ratio higher than the move-out?
On a more local level, we examine household incomes in the target area to ensure residents can afford the rents we plan to charge.
Balancing staying informed with actively seeking deals is crucial. We ensure we are not spending too much time on market research at the expense of finding new opportunities. It is a balancing act of staying updated with general news and continuing to find new deals while avoiding analysis paralysis.
Financing and Capital Structures
Our preferred financing methods change with market cycles, but our preference is always fixed rate products, with around 60-70% leverage. This is the sweet spot we need to hit to achieve levered returns that are attractive for our investors on a 5-to-7-year business plan.
We evaluate whether agency loans from Freddie Mac and Fannie Mae are the most suitable loan products. These agencies sometimes offer incentives, such as higher LTV ratios and lower coverage ratios. Banks are also an option, though regional banks can face challenges.
Particularly in the two years leading into mid/late 2024, there were fewer regional banks offering products compared to the pre-COVID period.
We are open to various product types and regularly engage with different lenders and brokers in the marketplace. Our team has also utilized debt funds and life insurance companies in the past.
The key is to stay informed about available options while responsibly managing our fiduciary duties and protecting our and our investors’ capital.
When determining the optimal capital structure for a deal, we consider levered returns and the cash-on-cash returns we can provide to our investors. We aim to offer cash-on-cash returns that are attractive and competitive compared to Treasury Bills or high-yield savings accounts.
We factor in the tax advantages of owning real estate, such as accelerated depreciation and 1031 exchanges. After considering these factors, we strive to deliver better returns than zero-risk options like T-bills or high-yield savings accounts while focusing on risk mitigation.
As sponsors, we invest alongside our investors, ensuring alignment. We contribute our own capital and, naturally, want the project to succeed, just as our investors do.
In some cases, when we believe interest rates have stabilized and might decrease, variable rate debt may become appropriate again, as it can provide higher loan proceeds. However, we always prioritize being good fiduciaries and using leverage judiciously to protect investor capital.
Risk Management and Stress Testing
We stress test our assumptions by increasing cap rates, typically raising the exit cap by 25 to 50 basis points beyond our underwriting to evaluate the impact on returns. We also adjust vacancy rates and lower rents to conduct various sensitivity analyses.
The goal is to determine where we would stand at the end of the business plan if all these downside scenarios occurred. If we can still achieve positive returns and at least protect our investors' initial capital, and preferably their initial capital plus their preferred return, under extreme downside conditions, we consider the project viable.
We recognize that in such adverse scenarios, it might not be the best environment to sell. As a family office, we have the flexibility to refinance and hold, which is not a part of our initial business plan but provides an advantage compared to some closed-ended funds with strict buy/sell deadlines.
Generally, if we can acquire a property at a strong basis and secure fixed-rate debt, that is our preference as it is the most prudent option regardless of market conditions.
Nonetheless, we remain flexible, acknowledging that sometimes variable rate leverage may be advantageous for a year or two while implementing a value-add business plan, with the intention to refinance into a fixed-rate product later.
We always keep our responsibility as fiduciaries in mind. We aim to use leverage appropriately to enhance returns while managing downside risk, avoiding reckless decisions that could jeopardize investor capital.
Managing Rent Control Legislation
Rent control is a significant consideration in our acquisition strategy, particularly on the West Coast. California has state rent control under AB 1482, which limits rent increases to 5% plus CPI.
Oregon's state rent control is set at 7% plus CPI, while Washington is currently discussing potential statewide rent control.
Finding deals that make sense under rent control can be challenging. We must be aware of individual cities, such as LA and Portland, that have legislation containing very restrictive rent control measures.
We try to avoid doing business in cities with more restrictive rent control laws than the state in which they are located, unless there is an exceptional deal to be had.
In Southern California, for instance, we look for properties in cities without local rent control. We need in-place rents at the property to be close to the market rates to be able to create turnover for our value-add business plan.
In the Southeast, rent control is not as prevalent. The markets we operate in do not have any rent control. While there have been some discussions about rent control, the political climate in the Southeast generally does not support it.
We do not anticipate any meaningful shift in this dynamic during our typical 5-7 year business plan.
Rent Control Compliance
To ensure compliance with local and state rent control regulations, our property management team stays up to date with all local jurisdiction requirements.
Our team consists of property management and operations veterans who have experienced many market cycles and are well-versed in the regulations of our local markets.
Having these capabilities in-house gives us confidence that our properties are managed appropriately and in accordance with the law. This helps us avoid putting ourselves or our investors' capital at risk due to compliance issues.
Committed to Prudent Multifamily Investing
Throughout our experience in multifamily real estate, we have learned that success comes from a combination of market awareness, strategic financing, careful risk management, and adaptability to local regulations. We recognize that the market is always evolving, and what worked in the past may not be the best approach for the future.
Ultimately, our commitment is to be good fiduciaries for our investors. We participate alongside our investors in deals, aligning our interests with theirs. We are always striving to balance the potential for attractive returns with prudent risk management.
As we move forward, we continue to adapt our strategies to an ever-changing market landscape.
By staying informed, being flexible, and maintaining our commitment to being prudent fiduciaries, we can continue to find success in the multifamily real estate market, regardless of the challenges that may arise.
