December, 2022

Where are you finding opportunities in multifamily today? I’m reading that deal volume has dropped off a cliff. Clearly the buy sell dynamic has changed. Is it that owners who want to sell are holding properties off the market? Or do sellers still have expectations that buyers will pay for proforma?

Does the property need work to get it to stabilization? You’re looking at bridge loan at 8-9%. You need a highly probable path to meeting NOI targets, and most likely little to no income until then. How sure you are you the market rents are substantially higher? Did you get your information only from Costar and Rentometer? Or did you ask a PM? Conduct your own research? How certain are you that you can get occupancy up? Will you have to lower rents, lower your tenant qualification criteria, give away concessions? And what if rates are not down much in two years and you can’t refi? If you are betting they will be and lose that bet, what happens to your property?

This is the reality check for high interest, low proceed loans. Investors aren’t interested in high risk these days, not when we’re staring down an upcoming recession. Compounding an expected downturn that includes rising unemployment with a property that isn’t stable is not prudent. The old west term “gunslingers” has applied to investors who make short term investments expecting to make a killing. When they go in, they’re all in. Then they get very rich – some of them.

These dates are also a test of your resolve, and how much you believe in what you’ve learned. Specifically, property values over a 10 year period have always risen for as long as records have been kept. Over five years it is almost as reliable. And the Federal Reserve has always followed dramatic rate increases like what we’re seeing today with rate decreases. Maybe one year after rates peak, or possibly two or three years. When rates decline, investors return to the market, prices get bid up, and cap rates decline. These are the likely outcomes but when? Based on historical performance, almost always before five years.

Are you willing to step into a market that is teetering, believing strongly that your worst case outcome is lower growth but not zero or negative growth? Real estate investing is not for everyone, for good reasons.

Macon, GA – Macon benefits from a warm climate and proximity to Atlanta, the gorgeous coastal city of Savannah, and Warner Robins Air Force Base, home of the Air Logistics Complex as well as stable government, aerospace and high tech. This area of middle Georgia is referred to as the Aerospace Corridor because of its high concentration of aerospace companies. Although clearly a different market than Warner Robins, Macon still benefits from the many growth drivers originating from Warner Robins.

Macon struggles though. Many reports optimistically suggest strong growth, but the data has not yet supported this optimism. Study the contrasting data on Macon. Google says population is decreasing, and Bureau of Labor Statistics says jobs growth is very strong, averaging over 3% over the last two years. Decreasing population is a strong headwind that should generally be avoided.

The contrarian in us, however, says that when we signs of a turnaround, that’s the time to get in. When it is in full growth mode, momentum carries prices forward and it is late to get in. Emerging markets will nearly always offer better opportunities than markets that have “arrived”. Look at Nashville, an afterthought only 10 years ago but now on nearly everyone’s top markets list. Phoenix and Las Vegas – wastelands of falling housing prices and unemployment after the 2008 recession. Today also top U.S. markets for multifamily investing.

Finding opportunities in a high interest rate world
Did you buy all the deals you wanted before rates started climbing? I sure didn’t but I may have been lucky. I bought a deal earlier this year whose loan rate was locked in pretty low. It was in a strong market where vacancies and unemployment are still low, and no one is hesitating about paying up for premium renovated units. That’s not the case in a growing number of markets, though.

This year both interest rates and cap rates have risen. Interest rates a lot more than cap rates. In fact, cap rates in a lot of markets have hardly risen at all. Good luck finding a property in a market where cap rates have not increased, because it probably won’t pencil. Loan proceeds will be low, possibly 60% LTV or lower, your cash flow will be low and maybe 0, and you may have to accept a huge prepay penalty for paying off your loan sooner than its term. Defeasance or yield maintenance prepay penalties say if I’m paying off the loan early, I need to also compensate the lender for all the interest they’re not going to get. When interest rates are high today, there will be an extremely high fee to sell or refinance your property early.

So what to do? You found a value-add property, you can invest in unit renovations and increase rents. Not only do you have to know how much you can increase them, but also how sure are you that you can increase them. Is the economy tanking? Then certainly unemployment is around the corner and with that comes vacancies. What happens when you can’t increase rents. (- – > disappointed investors)

When faced with the realities of a high interest rate loan and low loan proceeds, a stabilized property has to be priced to allow an investor to make money, and unfortunately most are not today. Investors buying these properties are making a bet that they can refi into a more favorable loan very soon, because rent upside and therefore income will be limited.

But here is another suggestion. Unstable properties are generally defined to mean occupancy is low. How low depends on the lender but let’s say it’s 90% occupancy. When you the seller are selling an unstable property, your expectations are lower. You didn’t succeed in getting it to a stabilized position in the market and now you need to sell it. You know you’re going to take a hit. That’s a buyer’s opportunity.

The buyers for these properties know there are units to lease up. This is their value-add opportunity. They also know they’ll need a bridge loan, which is a loan designed for unstable properties. Those loans unfortunately come with higher interest rates, roughly 8-9% today depending on the property, the sponsor’s experience, the market, and other factors. You’re not going to cash flow a low occupancy property with rates like these, but you have a clear path to profitability.

With a bridge loan you are also likely to be able to borrow more. Possibly 75% of the purchase price or more, plus most will include your renovation expenses and most don’t have any prepay fees.

Are you betting rates will go down? Yes, most definitely, but when you execute your business plan, do your renovations, and lease up to 95% occupancy, you’ll see your income rise and provide you cash flow. If your bridge loan term is long enough, say 3 years or more, and your interest rate is locked for that period, your likelihood of seeing lower interest rates in the next 3 years is high. That’s the way interest rates have historically worked. The Fed spikes the Prime rate, the economy cools, then the Fed drops rates. There’s no predicting when the cycle will complete, but if you think that rates at least won’t be any higher in 3 years, you are in good shape.

Finding investors for an unstable property in today’s market? That’s a big challenge but certainly not insurmountable for the right property and the right story.

Who We Are

Cardinal Oak Investments acquires, improves, and manages under-valued commercial apartments. We buy B and C class properties of around 100 units in the Southeast and Midwest. We look for properties whose amenities, aesthetics, and appeal have fallen into obsolescence, whose care reflects tired management, and whose location is where a stable workforce wants to live.

And we partner with like-minded investors looking for stable assets that produce good cash flow and strong appreciation.

Founded and managed by John Todderud, Cardinal Oak Investments has acquired properties on both coasts and in between creating annual double-digit returns.

For more information, schedule time with me or contact us.

Please note: Past performance is no indication of future performance.