$44 Billion Funding Gap in Multifamily Properties | Top of Mind Series

Welcome back to the Invest Like a Billionaire podcast. I am your co-host Ben Frazier, joined by fellow co-host Bob Fraser. Got a top of mind episode for you today. These are shorter episodes focused on interesting topics that are trending in the economy, in the news, and things that we think are relevant for our listeners. And so today we'll be reading a lot, and this is something that we've been paying attention to for some time, and it's the funding gap of new deals and existing deals as it's hitting multifamily kind of pretty acutely here. So, uh, Bob, what does that mean? What's the funding gap?

Okay, so the funding gap is when investors who own, let's say, multifamily apartment complex, it's time to refinance that deal and it won't qualify for an existing refinance. Because of the values. So typically, you know, banks like to loan, you know, 65% of the value. You've got to have 35% equity. But if the values drop when you refinance, so the value of, imagine, you know, the apartment goes down in value by 10%. Well, then you have to add equity. You have to bring new equity in, in order for them to finance a lower amount loan.

This is the Invest Like a Billionaire podcast, where we uncover the alternative investments investments and strategies that billionaires use to grow wealth. The tools and tactics you'll learn from this podcast will make you a better investor and help you build legacy wealth. Join us as we dive into the world of alternative investments, uncover strategies of the ultra-wealthy, discuss economics, and interview successful investors. Looking for passive investments done for you? With Aspen Funds, we help accredited investors that are looking for higher yields and diversification from the stock market. As a passive investor, we do all the work for you, making sure your money is working hard for you in alternative investments. In fact, our team invests alongside you in every deal, so our interests are aligned. We focus on macro-driven alternative investments so your portfolio is best positioned for this economic environment. Get started and download your free economic report today.

Let's say it was, you know, just for rough numbers, there's a $30 million apartment complex and you have a $20 million debt on that. But now it's, it, the, the, the $30 million apartment complex drops by $5 million in value just for an FYI. Well, you've gotta bring, you've gotta bring now, so they're only gonna loan, you know, two-thirds of the $25 million. Value. So you've got to bring the difference. And so that's a funding gap. Well, so the big news is that while there's been a funding gap in office buildings, which everybody knows, I mean, office has seen, you know, roughly a 50% decline in values and a lot of people are hurting there. And multifamily, we have, as we've been warning about for, you know, over a year now, you know, multifamily is now seeing the same thing. So they're saying according to CBRE, which is a big commercial brokerage firm, that there's now a $21 billion funding gap in multifamily right now. So again, points out to distress in the multifamily space. So a lot of these guys, these apartment guys, they're watching their maturities dates, that the maturity date is coming like a cliff. Right. They're on a train, you know, and the train is just moving because the train is called time.

Right.

And it's just moving. And at some point their loans mature and they're looking, okay, you know, I've got X more days until my loan matures. And they're trying to figure out what they're going to do to either go back to investors and raise more money or bring money out of their pocket or try and sell it or something. And there's not enough cash. So these guys are just cash poor. I mean, You know, so we personally know, I mean, dozens of investors that are exactly in this situation, right? Friends of ours that have, that are like, what am I going to do? And right now they're just like, you know, biding their time going do, do, do, do, do. It's, that's all good guys.

Don't worry.

But the truth is they know that, you know, the, you know, the deadline approaches.

And they have to stop at some point. Yeah. It's the same article from CBA is saying even through loans that are maturing through 2026, the funding gap is closer to $45 billion.

Wow.

Yeah. And so it's going to more than double over the next few years. And so we already have this issue right now and it's only going to get bigger as a lot of these loans are coming due. And I mean, we've talked just offline a minute ago, we're talking you know, we have a lot of banker relationships because we do a lot of deals and, you know, I used to be a banker, a commercial banker. And so, you know, have a lot of connections in that space. And this is exactly what they're all saying, right? I mean, it's kind of like a perfect storm in a lot of ways because we have interest rates that have skyrocketed up, right? And so put a lot of pressure on, you know, borrowing costs and Meanwhile, NOI are being massively compressed because you've got operational costs that are skyrocketing.

You know, and just to, just to review, NOI is net operating income. That's how much an apartment complex earns after expenses. So you take your rents in, that's your income, you deduct your expenses, your cost, and that's your net operating income.

Exactly. Yeah. And so, so it's, and it's going down because expenses are rising.

Because of inflation, taxes are rising.

So I was literally talking with the banker yesterday. He said, hey, some point we got a property, a good property, good borrower. They got an insurance, basically new quote for this next year that is double what they were paying before.

Property insurance.

Property insurance. So it's a $50,000 hit to their bottom line. Well, if you understand values of apartments and commercial real estate, NOI is the golden number for valuation. And so a $50,000 hit to net operating income is, what's that at a 5 cap rate? That's a massive value. Let me do this quick calculation here because I'm on the fly here, but 105, that's a million-dollar hit in value. Just from that one item.

So if your NOI goes down, the way commercial properties are priced is a multiple of NOI and the multiple is the cap rate. So if your income drops, that property's value drops. If it goes up, the property's value goes up. So yeah, so this is an issue, right? And across the space and let me just say, so somebody's going to hear this and say, okay, the sky is falling and they're already saying this, banks are going to collapse and it's 2008.

All over.

And you know, it never fails. I've been through, I don't know how many cycles, and everyone is predicting the previous cycle repeating itself. Everybody, right? And the one thing that's for sure not going to happen is the last cycle repeats itself. Whatever the last crisis was is not going to be the next one. That, that's a for sure, right? Because everybody's on guard against that one, and it's the one before that or before that or before that. Well, You know, so this one is definitely not a great financial crisis. And the reason why is for one, there is a housing shortage in the, in the United States. And so we need these, we need these apartment complexes and they're going to be great investments. Just they're, it's not a good time right now. The other, the other thing is that there may be a couple banks that get in trouble, regional banks, because they're overconcentrated, but it's going to be small and they'll be, they'll be bought up. And the real reason is there's, you know, hundreds of billions of dollars in capital sitting on the sideline waiting to scoop up these assets. Right. And on a, you know, a good fire sale price. So it's just not going to be, you know, in fact, I doubt it'll even hit Main Street, right? You know, it's going to be a tempest in a teapot, but a great, great opportunity. And speaking of opportunity, what is on our brains at Aspen where we think this is a good thing.

Well, I mean, it plays into our themes, right? We're looking first at kind of the macro picture where what's happening and where are the opportunities that are being created. And right now it's this kind of tale of two, you know, themes of we're having some short-term stress in especially multifamily, right? Where you have increasing operating costs. We have a massive amount of supply coming over the next 24 months, right? Record levels of new product being delivered.

New apartments that are finishing being delivered to the market.

And, you know, at the time when it's, you know, when it's under pressure, stress in the market, then you want borrowing costs, putting pressure on cap rates, and banks are pulling back their leverage. They don't— they're going, you know, risk on. We do not want to A lot of banks aren't putting out new money at all. A lot of banks, if they are putting out new money, are massively decreasing leverage points. And then all these maturities that were on short-term notes are hitting. So what we're seeing is there's a lot of good properties, well located with good business plans that are halfway through, but they're running out of interest reserves. They are, they have an interest rate cap that's expiring. Meaning they have to buy a new cap on their interest rate to extend for a little bit longer. They don't have the cash to do that. Or the point you made earlier, they're short on refinancing. So the values have gone down in the short term, but long term, if you believe our themes of we have a housing shortage, we've talked about this in other episodes, long-term housing is one of the best ways to ride the inflation reality, right? It's one of the most tightly correlated asset classes to inflation, you know, from our research historically. And so if you believe that long-term thesis, this is a great way to come in. So we are putting together a fund that's going to be gap funding a lot of these deals that are good deals in good locations with good operators, but they're just short for a variety of reasons. And he talks this gap they need filled. You can come in at a preferred position in these deals because they have no other options, right? Banks aren't lending anymore. Their investors don't want to do capital calls. And you know, it's generally not a huge sum of money that's needed to kind of bridge this gap.

And you come in at preferred position, you get actually incredibly high rates of return. You know, I mean, basically they're desperate. And there's a, there's this funding gap where there's no money available. So if you come in with even $1 or $2 million on a, you know, a $60 million property, that's all they need. And we can actually step way into the, down in the capital stack. So, so, you know, you know, where we get a preferred position and extremely safe position because we're way low in the capital stack. And yet get super high returns. And so we're seeing an incredible opportunity, you know, and you know, people think, oh, it's going to be so risky. You know, you look at a distressed debt fund or something, or, you know, or strategic credit fund, something like that, but it's going to be so, but it's not.

Okay.

So even the great financial crisis, all these homes that, you know, the values blew up, but how many homes vaporized? How many actual physical homes disappeared? They don't. And same with apartment companies. They don't disappear. You can have perfectly beautiful, wonderful properties that they don't disappear. What happens, it's a capital wipeout. And so, and how many lenders, how many lenders lost their shirts? They don't, right? In this kind of space, you know, if you're at 65% loan-to-value ratio, you're a bank owning the first lien, they're not going to lose. They're not going to lose in these, in these deals. And so that's where you can just make outsized returns. And so we're pretty excited about, of course, Aspen is, we're experts in distressed debt and have been in it for 10 years. So it's kind of right up our alley. So incredible opportunities, guys. You know, there's no such thing as bad news, right? There's just every, it's two sides of the same coin, right? There's every bad news is someone else's good news and we just, Right. There's every crisis is an opportunity, right? So we think this is an incredible opportunity. Yeah.

And we'll be talking more about this over the coming months. You know, some we've been talking about for a while, we're putting together. And so, you know, be sure if you want to learn more about this, as we kind of go into specific details on this kind of new focus of ours, be sure to join our investor club. You can go either to thebillionairepodcast.com and sign up, or you go to Aspen and click on the Investor Club at the top and be sure to jump on that and get notified as we come up with some of these new ideas and things for investors. So with that, hope you enjoy this episode and if you're enjoying this, please do leave us a review, share it with a friend. We always appreciate that. And tune in next time.