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May 2022

What seduced me into real estate investing was simply the adventurous opportunities but what kept me interested early on and still today is the people I associate with. Nowhere else do you find people with such positive attitudes, ready to help with no expectation of anything in return.

Once I became connected with networking groups, the people I met gave their time to share experiences, caution me about risks, answer my latest how-to questions, and suggest new directions for me. I learn more from them than I do from the training I take.

Other investors hardly ever see us as competitors, much more likely as potential partners. We share a lot without needing NDA’s, and even when hearing that someone in our network is going after the same property as us, there’s a feeling of mutual support and respect.

I’ve had the good fortune to work in a number of different industries in my career as a consultant, and this just doesn’t happen in most other industries. It’s how people burn out in their day jobs and we can see from the great “Covid Reset” that many of us left jobs we didn’t like, even taking a pay cut. Reprioritizing our lives.

It’s why I enjoy conferences and meetups. I had that experience just last week speaking to a local group. They were enthusiastic, brought their positive attitudes, and jumped into the Q&A, answering each other’s questions. They weren’t there to close a sale or impress their colleagues. They were there to learn and contribute.

Real estate, what an awesome and rewarding place to invest our time.

Richmond, VA – Virginia cities all seem to have so much history and Richmond is no exception. As the capital of Virginia its business is government but because of its strategic location on the I-95 corridor it has attracted a substantial non-government business base. Leading industries include finance and law. Looking for big name employers? Good luck, as most of us won’t have heard of the big law firms. But they’re there and they provide great jobs. Also Philip Morris, the tobacco products manufacturer. However, Philip Morris’ growth has been through smokeless products, and
up until February its biggest cigarette growth market was Russia. But no more.

If you’re looking for that market where the next chip plant or auto manufacturing plant is going to be built, Richmond is probably not it. Richmond has struggled to diversify away from its older industries but often the real action is below the surface, and stagnation in big companies obfuscates excitement in new growth markets.

Where is the action? It’s hard to say, but clearly something is happening. Its population is growing, albeit at a lethargic pace, about 11% over the last 20 years. Year over year job growth over the last 12 months has been a respectable 4%. Actually 4% is incredible but much of that is just recovery from the pandemic crisis.

Colliers says rent growth in Richmond at the beginning of the pandemic was tops in the nation and has remained strong. I’ve read reports of other cities with similar claims but strong rent growth is highly indicative of good multifamily opportunities.

Richmond is a great low-cost option for northeasterners looking for warmer climates and laid back lifestyles. It remains to be seen whether they can entice more growth industries and the jobs they create.

Do Rising Interest Rates Kill Your Deal?
We’ve seen it coming and now it’s here. Rates on multifamily loans are 150 basis points or more higher than they were at the end of last year. Not just agency loans but across the board. Rates in the high 4’s? That’s outrageous! But it wasn’t that long ago that these were normal rates.

It remains to be seen whether high rates mean higher cap rates, and whether sellers will reduce prices. Lots of evidence exists that says demand and pricing will remain strong, but who knows. Pick your forecast.

Let’s look into the impact of higher rates. Clearly your interest rate is one of the biggest factors in cash flow, but how much of an impact is it, and is it the biggest factor?

I have reviewed several deals I’ve underwritten over the last year and modelled changes in interest rate to see the impact on cash flow. What I found was interesting but not encouraging. As you would expect, if your interest rate goes up and all else is equal, to get the same returns you have to pay a lower price.

But there’s more to it than that.

If you are comparing one interest rate and another rate that is 100 basis points (1 full percentage point) higher and your first year loan terms are interest-only, you’ll get a lower cash flow with the higher interest rate. I found that to be around 25% lower. And your annualized return over a five year hold will be lower by about 1.5-2%.

So how much lower does your purchase price have to be to get the same annualized return? I found it to be a little over 2%. Should that be your goal? Getting a 2% reduction in purchase price? Absolutely, but given there is still so much demand for multifamily these days, good luck with that. And even if you do get that 2% reduction in purchase price, don’t expect to recover your cash flow. It will still be 20-25% lower than if you got a lower interest rate, even with your 2% price reduction.

Another consideration is your prepayment penalties. When Freddie/Fannie prepay penalties are based on yield maintenance, that means they don’t want to give up their interest income. If you get a high interest rate loan today, then want to sell in, say, 3-5 years, and rates have gone down, your prepay penalty may be steep. But no worries, cap rates loosely correlate with interest rates and should compress as well, so if both interest rates and cap rates rates do decline later on, whatever you lose in your prepay penalty you should get back in valuation.

These coming months will be interesting. It looks like higher rates could cool down the overheating multifamily market, but probably not for awhile.

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.

May 2022

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