As we know the Fed Funds Rate does not directly drive commercial lending rates. Those are driven more by the bond markets, and the 10 year Treasury yields are the best measure of that. They peaked and are heading down. Look for it not to be a steady drop but there’s more reason to see a decline than a rise. The world is watching two significant wars, and actually I read there are 26 active wars currently in the world. Investors conserve cash in turbulent times. Additionally GDP was revised downward and unemployment notched up this month. Ten year Treasuries are the safe harbor so when investors buy them, their price goes up and yields go down.
Construction has been going gangbusters for the last several years. That’s good for affordable housing but puts downward pressure on rents at all levels of asset classes. Delivering Class A product creates supply that pulls tenants out of other assets including Class B. And Class B pulls from Class C. Especially when a lot of supply is coming to market, those new owners need heads in beds sooner, not later.
You can even track markets where rents declined the most and correlate that with high construction completions, as a recent Bloomberg News article did. High rent decline markets like Boise (deeper dive below) and Austin were also high construction delivery markets. Great markets, lots of tenants, just lots of new supply too.
Distressed properties come in different flavors. Some are financially distressed. They bought at the peak and over-leveraged, or couldn’t lease up at the rates they projected, or their debt is short term and coming due. They’re already hitting the market and if they are physically in good condition, they should be able to sell quickly.
Some are physically distressed. They were bought without planning for sufficient capital needed to renovate and improve. Maybe they were going to fund renovation from cash flow, maybe the units were in worse condition than they thought, and they ran out of money. When tenants see their apartment buildings in decline and improvements stopped, they tend to move out. This is a compounding problem that the owner can’t stop. Hopefully it’s otherwise physically stable and in a good market, and fresh capital is all it needs. Those are good buying opportunities.
Many buyers today have been sitting on the sidelines. Maybe they were smart to do that but they won’t stay there long. The smart ones won’t wait until the big green light flashes saying it’s safe to come back into the market. We’ll continue to see more of the dry powder brought back to multifamily.
Likewise, sellers who wanted to sell but held off will bring their properties back. The pricing gap between buyers and sellers has been closing, but very slowly. We’ll see more closing of that gap, but not much more. There is too much demand for housing by renters and for multifamily investments by buyers.
Lastly, election year. The party in power wants to please everybody, and today both parties have power. We won’t see big new legislation for tax increases, budget cuts, or other laws that you may want but which will be unpopular with large groups of voters. In most cases, no legislation is better than the laws we see getting passed, so we can expect that next year.
None of this is assured. We can’t predict how the Fed or Congress will react to economic events, and if they tell us we’re in a recession, that just by itself is enough for companies to stop spending and hiring. It snowballs. And we can’t predict wars. Always a risk to a healthy economy.
But as investors we have to take a point of view. Don’t guess at it. Choose your point of view from an informed perspective.
Market update
Boise, ID – I have always liked this city because it combines many desirable qualities. Just to name a few it is in a nice climate, seasonal but not extreme, it is close to mountains, it is not far from west coast destinations, and it is in a right-to-work state with low taxes and favorable property ownership laws. It has been growing because people and businesses like that you can get land for much less than the big cities. In-migration comes from Seattle, Portland, San Francisco, Los Angeles, and every other west coast city that’s struggling with unaffordable homes, crime, and tenants who decide not to move out after they’ve stopped paying rent. There’s only so much of that you can take.
Boise has been on the top of many lists for multifamily investing. The adjacent cities of Meridian, Nampa, Caldwell, Eagle, all growing. Employers love that there is a growing labor force.
Boise, a population of 237,000, has grown over 20% in the last 20 years. That’s very high growth. Neighboring Meridian, population 125,000, had only 36,000 people 20 years ago, an astounding growth of 247%. Nampa went from 54,000 to 106,000, and Eagle from 12,000 to 32,000.
These sleepy little towns have waken up.
Jobs growth? As you’d expect, averaged 4.4% last year and 3.6% this year. For context, anything over 2.0 is considered pretty great.
Rent growth? Over 30% since 2020! But wait, not so good in the last year. Down over 5%.
What happened is what happens everywhere when rents are skyrocketing. Building. There is land and a favorable regulatory climate for new development, and new apartment units have been delivered to the market. With a one to two year development cycle, many projects were started over the last three years and now they are available.
Supply drives down pricing, and demand has not kept pace with supply. Apparently it was the pandemic that pulled people into better lifestyle areas, and this compounded growth. Certainly there are other reasons, but this growth has cooled somewhat. It is easy to see from a chart in a recent Bloomberg article:
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What Boise lacks, though, is larger apartment properties, 100 units or more, especially in the B-/C classes. The population just hasn’t required them yet, but those assets are coming to the market.
If you decide this market has good opportunities, be sure to line up your contractors. From property management to renovations, contractors are always in short supply in high growth markets. Your renovation plans could be significantly disrupted if you have to delay the start for several months, or you underestimated their costs because their fees go up when demand is high too.
Boise is a long-term fantastic market. There is no reason to believe rents won’t rebound. Companies continue to move there, thanks to the affordability gap and entrenched anti-business leadership in west coast states. People will too. And with interest rates so high now, fewer construction projects are being started this year. That means that as demand climbs over the next several years, supply won’t keep up.
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Finer Points of Multifamily Properties
Terminating a Property Manager
We’ve written about this previously but it bears repeating. And I just went through it again so there’s more to share.
You found your killer deal and you’re early in your acquisition process. Among your many tasks are finding a property manager. Maybe you had your PM selected even before you found the deal. One who thinks like you, an investor. Whose clients have done well with them, who knows how to manage your kind of property, and who presents you with a plan for improving your new property’s value.
You close on the deal, they get started managing your property, and things go okay for a while. You have a few things you need them to improve so you have discussions and hopefully that’s fixed, and you move on.
As the months go by, you find more evidence of performance that isn’t “fire them now” level bad, but it is unacceptable anyway. These things compound and next thing you know you’re thinking you made a mistake.
Clearly the first course of action is to try to fix the problem. You want to work with your PM, explain clearly what is not working, and ask them to suggest solutions. Their problems, their solutions. They have to own it, not you.
In that discussion, propose accountability metrics that you can track. Turns taking a long time? When did they get into the unit, itemize make-ready tasks. When did they reach out to their contractor. When did they get into the unit. Those kinds of things. If a turn took four weeks or more, you can be sure they didn’t do any of these tasks on time.
If you decide they should not be your PM any longer, research the market for PMs, again. If this was your first property in the market, you should have a better idea of who the good PMs are. Talk to them, find your top three, visit the property, and meet each of them there. Look at issues around the property and ask what they would do. Ask any of the questions you had not yet asked or which you want to hear their answers again.
Your goal here is to assess their knowledge of solutions, their sincerity, and how well you will work together for the next several years. If they tell you how thorough their marketing processes are, how quickly they respond to prospective tenant inquiries, you’ll be able to see if they are BS’ing you. There is no substitute for face-to-face time.
Be aware, also, that many lenders, including Freddie and Fannie, require you to get their approval for any new PM you choose. If the new PM is already on their list of approved PMs, that makes the process quicker but you still have to go through the process.
I have experienced significant delays in getting approval. They apparently get backed up. Plan for that as there’s not much you can do about it. Do you want to be angry and demanding to your lender because they aren’t responding fast enough? Don’t be, as you always need a good relationship with your lender.
Push the start of the transition out if you need to, and keep following up with your lender contact, have conversations with them, explain what you’re doing. Let them finish their approval process.
Once you have picked your new PM, plan the transition.
Here’s a strong recommendation. When you hire your PM, read their contract thoroughly. I have made the mistake of not reading it thoroughly enough once, and won’t ever again. Does the contract allow you to terminate with 30 days notice? Yes, great. But read further.
Do you owe a lot of fees for all those tenants that they placed or the work they have to do to turn over management to a new PM? Don’t under any circumstances agree to that. They don’t deserve those fees because they’re not managing the property. Get them to remove the fees or move on to the next PM.
Keep in mind that Freddie Mac and Fannie Mae will require you to have a PM contract that can be cancelled with 30 days notice with no fees. Most PMs know this if they have worked with Freddie or Fannie. It’s your job to keep that wording out of the contract.
So now you’ve done that and you’re ready to cancel. It is respectful to your current PM to give them more than 30 days notice.
You want to provide them a clear statement of how you need them to handle lease-ups, vacancies, repairs, and major projects during the transition period. They have a vacancy and applicants and they’re about to place them in a unit. Maybe that’s the issue you have with them, that they accept bad tenants. Then stop them, don’t let them sign any new leases. Take the vacancy for another month or two so you can be sure to get good tenants in.
Get them to provide you a list of repair issues they have been working on, completed work that hasn’t been invoiced, and unpaid invoices. Don’t let them dump a pile of new expenses on you that they “just hadn’t had time to enter yet”. Look at every one of them carefully and push back if you didn’t approve them.
Utility account conversions are important as you don’t want late payment notices, especially when they go to the old PM. Mail and notices to them for your property will get pushed to the bottom of the pile.
Discuss tenant notifications with the old PM. Your new PM will have a plan, and keep in mind it is your plan because it’s your property and they are your tenants. You should control how this is done and not allow your outgoing PM to prevent it or slow-walk these.
Do stay in communication with your outgoing PM, though, through the transition. You want them to be aware of what you’re doing and what you’re expecting. This is especially true about transferring leases and other contracts. At the end of the month, they get busy. It’s not reasonable to expect them to drop all that work for their other clients so they can facilitate the handoff of leases, keys, and funds to you. Do the leases early in the month. Plan for your new PM to pick up keys. The more you ask of your outgoing PM, the longer it will take.
Funds transfers do take more time and won’t be finished by the first day the new PM takes over. The outgoing PM has to account for work not yet invoiced and other last minute expenses. They will want funds in your operating account that they can use to pay these invoices.
However, most of the remaining funds can be transferred. They should not hold onto security deposits after their last day, or to reserves they set up for your insurance, property taxes, or capex. Plan for that transition.
Security deposits are not their money or your money, they belong to tenants. There are laws controlling the management of those funds so don’t be careless.
Be sure to have funds available to pay your mortgage. If that gets pulled from a bank account, give your lender notice of the change in bank accounts, and be sure to have funds there ready to be pulled.
Also rest assured that this top-notch new PM you chose will have gone through this process many times. Place your trust in them, they’ll work out the details and don’t need you micro-managing it.
Start out right with your new PM. Document the things you didn’t do well with your old PM, the things they failed at, and communicate clearly and often with your new PM. Give them your priorities for the property, discuss the management budget and have one you both agree to, discuss rents, renovation finishes, exterior projects.
Decisions will be made about every aspect of their property management responsibilities. You want to be the decision-maker. Either decide on the solution or decide that the solution is for them to decide. But don’t default to not addressing it or being involved.
I have never regretted changing property managers. I have put it off because it is not easy but it has always been the right move. On every occasion I have been able to see tangible improvements in tenants, income, and valuation as a direct result. This more than makes up for the transition pains.