Is Multifamily Still a Good Investment? | Top of Mind Series

Today we wanted to talk about multifamily, and this is an asset class we've talked on and off about really for the whole past year on this podcast. But we've gotten questions recently. Is multifamily still a good investment, right? With a lot of the turbulence going on in the capital markets right now, it's a great question. And we've been invested in multifamily for a while. And we've looked at a lot of deals recently and have passed on a lot of deals for certain reasons. So we wanted to kind of get into what we're seeing in the market, where we're seeing opportunity, and just as kind of a macro look at what is the market doing.

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Hello, future billionaires. Welcome back to the Invest Like a Billionaire podcast. I am your co-host Ben Frazier, joined by fellow co-host Bob Fraser. And today we have another top of mind episode that we want to bring to you. So again, these episodes are meant to be shorter, focusing on one or two things that are going on in the market, in the economy, and things that our investors or listeners are asking us. And we wanted to, you know, talk about these for the benefit of all of our listeners. So before we jump in, though, I do want to let you know if you have not seen it yet, check out our new website for this podcast at thebillionairepodcast.com, thebillionairepodcast.com, and you can see all the episodes there. You can leave reviews. You can also do what's called Ask Anything, which is a kind of a cool new feature we wanted to add to this show where we can have you as listeners reach out to us and share thoughts. Ask questions, and they may even be brought into future episodes. So with that, Bob, what are you seeing? I know you've been looking at some of the kind of macro trends going on in multifamily, but kick us off here.

Yeah, we've got obviously a lot of turbulence in the market and, you know, so in the midst of really household formation and lots of demand, so you know, the, the big, the big tides that we've been talking about are still in place. And meaning that the, there's been a chronic underinvestment in housing since 2007. Households are being formed and there just is not enough housing supply. So that is still the foundation. But what's happening is because of this rapid rise in interest rates, well, since all these multifamily properties are bought with debt, it's creating a big issue, right? With profitability. So it drops profitability of new deals. So anything with fixed debt in place is fine. And then you have, so you have this whole debt issue and then you have the recession issue. So if there's a recession, is multifamily, is it safe to be in real estate? And I just still want to point out in high inflation, the one of the least safe places you can be is cash because you can, you're guaranteed to be losing 8% per year or 9% per year, right? And guaranteed, you know, because of inflation. So cash is not safe in high inflation. So let's look at multifamily and let's first talk, kind of talk about recession. So yeah, it is recession. How does recession affect multifamily? Well, definitely, definitely has an impact. But multifamily is considered the safest of all real estate classes.

Right.

And the reason is because people need a place to live.

Right.

And so you need a place to live. What are you going to do? It's like, you know, so businesses, you can go out of business and, you know, so warehouse space can empty up or you can stop shopping. And so retail dries up. But at the end of the day, it doesn't matter what's going on. You still need a place to live with what's going on with the economy. And so it's considered the safest and has the lowest cap rates because of that, meaning the lowest yields to investors. And so it's one of the, it's considered one of the safest places. So that really doesn't change. So today, you know, you've got, you've, you've got a, you need a place to live, you know, you're just forming your family, you're getting married, having kids or whatever. You need a place to live. Well, what's happened is now housing, single-family homes or condos are kind of out of reach, right? For a lot of people. I mean, the affordability has just really, you know, hit the tank, you know, with interest rates rising simultaneously, prices rising. I mean, costs are just out, out of bounds. So what's, what's, what is people's alternative? Well, now you rent. And I'll pull up this chart from Marcus Millichap, which I just, I love. And it really shows the dynamic. And here you see the top, the blue line is how a home payment, a principal and interest payment, mortgage payment on a home versus the average rents in the United States. And you see there's this push me, pull you relationship. So anytime housing prices and the mortgage payments go up, well then rents start going up because people, people choose not to do that and they choose to rent instead. Anytime, anytime they come together, anytime rents and mortgage payments get close, well then people choose to buy a home. And so that it begins rising. So, so there's this relationship and right now, you know, you can't see it on the chart, But the blue line has gone even further high and the gold line there, which is rents, is, has stayed pretty steady. So what's happening is rents are going to be going up. Now, I don't believe they're going to continue to go up at the rate that they have. I mean, there was really extraordinary rises. So yeah, so demand is going to be there.

Well, I think it's an interesting point, right? Because in several markets, you know, this is a national look at overall rents, you know, relative to average home price and home payments. But, you know, the misnomer is that, well, rents have gone up so much in the past 2 years in multifamily across the board, and especially in growth markets, that it's unsustainable. And it's, you know, maybe there's The landlord's been pushing too hard and there's going to be kind of this falling off the cliff here when it kind of catches up. But looking at this chart, I mean, it's hard to think that that's going to happen. Even though rents have gone up quite a bit the past 2 years and really the past 12 months, it's still substantially cheaper than a mortgage payment.

You have to live somewhere. So what are you going to do? And you know, so you know, our view is that rents will continue to rise, but at a much more modest pace. It's still a great investment. So let's talk about the multifamily space. So we're quite active in the space. And as you mentioned at the top of the show here, we've passed on a lot of deals, right? And we've actually, actually exactly what we said was going to happen at the beginning of the year is happening. So, I guess we got one right and we got one right. And we were talking about the danger of bridge debt. And for those that are not super versed in the market, what's happening is, let's say the last 2 years, especially investors realize that within this high rent growth market, you could go buy an old Class C property, let's say an old 1960s vintage or '70s vintage apartment complex. And you go buy it, you go fix it up and rehab it and flip it. And it's called a value-add strategy and you make a lot of money. And what these guys did primarily is use bridge debt. They didn't go to banks, they went to what's called bridge lenders. And so these bridge lenders, you know, basically offered very sweet terms, meaning, and you could leverage as much as 80% of your cost. So you only need like 20% equity or even as little as 10% sometimes. So you could get in with very little cash, but they had variable interest rates. And that's the thing. And so that whole market, the whole bridge debt market has completely shifted. And I said, it's going to be very dangerous. What happens if these highly leveraged properties, let's say you're 80 or 90% leveraged, you just bought this apartment complex, 80 to 90% leverage, and that you've got a floating interest rate. What happens if 3 years from now when that note is now due, that interest rate rises. And what if now you can't cover your debt service because you have a little bit of a recession? And because if cap rates went the wrong way, the property isn't worth what it is. You are forced to liquidate. You can't refinance and you know, and you're not going to break even. On this property and you're going to see a lot of equity wipeouts and it's playing out. It's playing out. So you could talk about the bridge debt space a little bit here, but we're seeing a lot of properties coming on the market, especially the Class Cs and the, you know, and to some degree the Bs coming back. And that's primarily an age designation, you know, but I'm seeing those coming back in the market. And the bridge debt is no longer available. All of a sudden the bridge debt guys have just pretty much disappeared. So talk about what you're seeing a little bit.

Yeah, well, I think this kind of underscores such an important point in looking for opportunities. You know, you can have strong macro trend support as multifamily does, and there's going to be continued demand. I mean, there's, there's no doubt about it. That's the question going up. But it's really important to understand your capital stack, to understand your financing and the impact that has.

Capital stack, just for those, is basically what does your debt look like and what does your equity look like?

Exactly.

And how that's structured makes all the difference whether this is a good deal or a bad deal.

A couple years ago, because of how strong multifamily was and how strong lease growth was and all these things, lenders, these bridge lenders got very aggressive. And so they wrote out 80% loan to cost.

These multifamily flippers, I mean, they came out of nowhere. It's like, I think the number of multifamily flippers went up like tenfold or twentyfold. Like, why flip a single-family house when you could do a multifamily flip? And you know, here's how to get rich quick. And so all these young entrepreneurs, you know, went out there to go do it and they used bridge debt.

100%.

Now it's in, it's, you know, yeah. And we're actually, we're actually very optimistic. We think this is good, a good buying opportunity, right? Not good for the investors who partnered with these guys, but for the more seasoned investors, this is a great opportunity. So we're seeing, so here's what happened. So people bought, let's say you bought your, you got your bridge debt, bought this multifamily deal, and what happened? We had this great inflation. So anybody who's in the construction business knows that suddenly over the period, about a 9-month period, Costs, construction costs just ballooned, ballooned. So, so you, you, you built your rehab budget at, at X and you, and all of a sudden when you, you bought this property, put your rehab budget at X and you started building and you started doing your rehab, your project, all of a sudden it's X times 2, your cost balloons up.

Yeah.

Well now, and now you've got this bridge debt and, and got your cost. It doesn't make it doesn't make economic sense anymore. And number, number 2, you're outta cash. You raised your money from your equity partners. And so you've got this half-finished project, you, and you've got a bridge lender, you can't refinance this. And so we're seeing actually prices come down and cap rates going up. So cap rates is basically the yield return of a property. And when cap rates go up, prices go down. There's a, they're inversely related. So what's happening, we're seeing the Class Cs, a lot of them, the prices are softening dramatically.

Yeah.

And we're, but we're not the same in the Class As, right?

If you think about, you know, just the term bridge debt, the whole point is that it's a bridge to permanent financing, right? And it's intended for these heavier value-add projects. Well, I was just having a conversation with a national broker, a debt broker, who places debt on mostly multifamily properties and been in the space for a long time. He said what they're seeing, it's really interesting. A lot of these operators have been hitting the original business plan from a rent growth standpoint, right? Because we all believe in that story. It's apparent what's going on in the growth of rents, and that was what drives NOI growth. Which drives value, right? But what they're finding is because whether they kept it at a floating rate and/or the cap rates have gone up to the point where a lot of these properties, they can't refinance right now. If they refinanced, they would actually be in the red, meaning they would have to write a check to pay off their loan.

Either way, you're writing a check and these guys are not going to do it.

They're not going to do it. And so what's happening is at the same time, The bridge lenders are all of a sudden feeling the pinch, right? They're like, oh man, we've gotta tighten up the reins. You know, bridge debt is getting a lot less aggressive. They also, and I think the bigger problem is they have not enough cash to deploy because they expect a certain level of churn in their portfolio as these shorter-term loans pay off and they can redeploy that. I'm really curious to see what happens over the next, you know, 12 to 24 months. Because they're extending right now and they're probably willing to do that because, hey, you changed your business plan and et cetera, et cetera. But if interest rates remain high, which, you know, we laid out a case, you know, last episode or two on why we think they're going to stay high probably through 2023, it's going to put a lot of strain on these properties and a lot of strain on these lenders.

Yeah. I think we're going to see a lot of Cs coming, the prices coming down dramatically.

And we don't have a chart here, but if you look at the cap rate compression based on a class of an asset, you know, A, B, C, C actually had the biggest compression of all 3, whereas actually trading at similar price per unit, meaning the prices spiked highest for the Cs.

And this is because of this value uncertainty and all these young entrepreneurs go enter the space using bridge debt and it's going to, so it's going to come back down to his historical, right? No, and actually it's, you know, honestly, I'm very bullish.

All right.

This is a good opportunity for us to look at it. Look at getting indices at a better price, especially if you see, you know, economy does slow down and create, makes construction costs a little bit more reasonable. Get in at a good price. I mean, you know, then all of a sudden it makes great sense and we can get these properties at a very, you know, discounted price.

Yeah, right.

And there's no such thing as a bad apartment complex, right? There's only a bad price. And so at some price, it all, everything makes sense. And so, so good, good opportunities for us, you know, so, so begs the question, you know, is this a good time, you know, or is multifamily still a good investment? And so what we're seeing, so, and to your point, we're not seeing cap rates move on the Class A's. Which is very interesting. So Class A's, you know, I guess we could argue that, well, in a recession, Class A's may be hit. These Class A's are more expensive, right? So Class A's may take a hit. So what do you think about that?

Yeah, you know, I think it's interesting because every recession is different. You know, if you look at the '08 recession, that was pretty deep and pretty long. Class A definitely was impacted. Because there was high unemployment for a longer period of time. If you look at COVID, the most recent recession we had, it was disproportionately affecting the lower end of the workforce, the more blue-collar, retail-focused jobs and those that could work from home and more white-collar jobs. They were kind of not really that impacted. And if you further break down Class A into luxury, And what I would say is affordable Class A, I think there's a pretty big distinction there. And so, well, that's a good point. Yeah. One of the things, I mean, we kind of see this in the capital markets inflows, outflows, as we hit turbulence in a market, institutional investors, generally there's a flight to quality, right? Because quality is perceived as less risky. And so as we're kind of going into potentially turbulent market here, I would make a case that there's going to be opportunities in Class A. The returns may not be as high, but you're going to have lower maintenance costs. You're going to have much higher margins. And if you do it with smart debt, you can ride it out. And then in a good growth market, you can ride and expand those margins.

So there's like everything, there's always niche opportunities. So one of the things, we just uncovered this incredible deal that we're going to be we're excited about and it's got assumable Fannie debt at 3.49%. So literally fixed debt for 9 years at 3.49% and it's assumable. So we'll basically assume that debt. Holy smokes. We'll all assume.

Yeah.

This property is just wonderful. And it's a Class A and one of the fastest growing markets in the United States and super demand. So these are super hard to find, but there's always good deals, right? There's always good deals that are going to work. So, but having the debt like that makes it a very, very sweet deal.

100%. I mean, it's kind of a unicorn deal right now, right? I mean, we've seen a lot of people talking about trying to go after the fixed-rate assumable loans. I mean, it's a no-brainer, right? If interest rates right now are 6.5%, 7% on a residential mortgage. It's, if you can decrease your interest carry costs and you have long-term fixed rate horizon, I mean, it's amazing right now, especially if you can be in a market that's going to have top line growth. You lock in your interest carry costs and you can expand your NOI through the growth. So we're seeing a lot of opportunities there. They're very hard to find, to your point, because a lot of people want them. But you know, we, we have one that we're super excited about.

So yeah, we've got this unicorn that we're going to be getting into, but, and we're going to be looking for more deals in '23. Again, play, play the mega trend. And one of the best times to make money is when you have a well-identified, clear, powerful mega trend, which we have in the housing shortage, but it's punctuated by counter-trend moves, right? So all of a sudden there's a big sell-off because of whatever reason. Well, that's perfect. That's the, that's your entry point. Those are gifts. Yeah. When those happen. So, you know, and I, I'll pull up another chart here from Moody's Analytics and this is just recent and they're calling for massive cap rate compression primarily in apartments. And you see cap rates are quite a bit lower for apartments because they're perceived as a less risky asset class. Yep. No matter what, and they're actually calling for continued compression. This is right. Yeah, there you go. You know, We're not very excited about office right now. We're not very excited about hospitality, but some of these plays are going to be fantastic.

It's a really helpful chart because one of the points that I wanted to kind of make is where do we, what's the strategy? Where are the opportunities in this market? And I think you have to shift from these shorter-term holds that are doing a quick high IR. I mean, you've seen this, like these, Operators delivering these 30, 40% IRRs because of this massive compression in the market. They just timed it well, right? And they were shorter period holds.

Well, the best in the world is luck.

That's what I'm saying. That felt like luck. But I think that the point here is because we're kind of at this counter move to the longer-term trend, it would be important to adopt a longer-term mindset in your investing, right? Because if you believe in a longer-term trend, Eventually it's going to normalize back to that trend and they're not going to keep interest rates high forever. I mean, they've shown that they will not do that and maybe they're longer than we expected. Maybe it's going to create more turbulence and it's an unknown factor you can't control. But if you can lock in your debt, right? And if you can be in a market that's going to have strong growth, you can ride it out and look for those better opportunities. But I think it's important to have that longer-term mindset because to this point, Cap rates are still projected to go down, right, over the next, you know, many quarters. And so it's very bullish for apartments. But right now, you know, it's not a great time to be a seller. So I think that's one of the big points that I wanted to bring up.

Bottom line is, is multifamily still a good investment? The answer is selectively, absolutely.

Yeah. Awesome. Well, if you guys have thoughts on this, if you have rebuttals, we'd love to hear them in the Ask Anything. And always appreciate you listeners listening to this podcast and more to come. We, like we said, are uncovering opportunities in these verticals that we're excited about and look forward to sharing those. So if you are interested in joining our investor club to be notified of these deals right when they come out, Please join the Investor Club. It is on thebillionairepodcast.com. You can join right from that webpage and be notified of future deals as they come out. Thank you so much and tune in next time.