“It’s never a waste of time or money to invest in yourself, no matter the source. True wealth begins inwards and emits its light outward into everything else, including the people you surround yourself with.” — will.i.am
You may be familiar with a deal that recently got in trouble.
3,200 units in Houston, Texas lost over $200 million of loans and foreclosed.
What really separates a great multifamily deal from one that’s really struggling?
In our multifamily deals, we’re seeing well-performing investments start to slow down a bit.
The cash flow isn’t quite what it was 12 months ago due to higher costs in labor as well as insurance expenses.
Today we’re going to talk about why multifamily deals get in trouble and what you can do to prevent it.
1. The Present Danger
We’re gonna start by talking about the present dangers in multifamily.
It’s been a golden age of multifamily for a long time.
We’ve seen amazing cash flow until around March 2022.
That’s when the Fed started raising interest rates.
They raised rates from almost 0% to around 5%.
It’s been one of the fastest increases we’ve ever seen.
We’re seeing the rates affect a lot of multifamily and commercial deals, particularly those with bridge debt.
Around 80% of commercial loans have bridge debt, which is similar to multifamily.
As rates rise, it’s causing some pain in the multifamily space.
Even if you have a cap on that rate, it’s still costing more than it did before.
It’s affecting valuations as well.
Let’s just talk about bridge debt for a minute.
Why would people have bridge debt?
For a while, people would only work on deals with bridge debt.
People weren’t doing fixed rate because fixed rate didn’t work.
It required too much money down.
The numbers didn’t quite make sense.
For the last 10 or so years, bridge debt worked out well because rates stayed low.
Well, now it’s gone the other way and created a very painful situation for a lot of people.
We’re seeing higher costs in our Florida deals.
Labor and material costs have risen 30% to 50%.
In Florida, we’re also seeing insurance costs going up by 3x-4x because of hurricanes.
Even though we’re seeing higher expenses and rents stabilizing or even going slightly up, we’re not necessarily seeing higher income.
This all has a big effect on the cash flow.
2. Good Operators vs. Poor Operators
What’s going on here and how does an investor weather a storm?
How does a multifamily deal get in trouble?
One important factor is operators.
There’s a huge distinction between good operators and poor operators.
My good friend Ken McElroy says that 2023 is the year of operations.
He’s talking about multifamily operators.
If you’re a good operator who is conservative on your projections, then you’ll be just fine.
Good operators go after something in their wheelhouse.
Typically, they’ve done multiple deals in those markets.
They have a great team.
Often, we’ll see a lot of great operators who are wonderful at communication.
They’re great at communicating with their investors and tenants.
A lot of them go after value-add properties.
If you invest in new construction, you typically have two to three years before that property is fully in operation.
On the other hand, if you’re able to invest in an older property or one that needs some work, you will see the benefits right away.
The rents will rise and provide an additional margin of safety.
Warren Buffett talks a lot about this.
If things don’t go exactly the way you want, are you still able to make money?
Can you still have some margin there?
That’s what great operators do.
With poor operators, it’s the opposite.
There’s typically bad communication.
They won’t operate according to the plan.
They may have great ideas, but aren’t actually able to operate it.
As a result, deals will struggle and some will even be lost.
Watch out for these red flags in operators.
I understand that this can be a lot for a lot of new investors.
They don’t know how to tell apart good and bad operators.
If you want to avoid that trend, pay attention to reputation.
Talk with other investors.
Educate yourself and make informed decisions.
3. Two Ways to Look at Multifamily
How should we look at multifamily?
There are two ways.
The first way is seeing all of the challenges:
Multifamily may not be looking that great anymore.
It’s not the right time to invest.
You don’t have cash on the sidelines.
Cash flow has slowed down.
Some of this is true.
There are about 80% less transactions in large multifamily in the last 12 to 18 months.
That’s a significant reduction in the number of deals.
A lot of people want to sit and hoard cash as they wait out the recent challenges.
At Bronson Equity, we’re operating our current multifamily deals and also managing other investments at the same time.
We have deals in oil and gas, ATMs, and car washes.
All of these are cash flowing deals.
I don’t like to have personal money on the sidelines just sitting there.
If you do that, you’re losing money to inflation.
This is made worse by 15% actual inflation, which is higher than the official rate according to Shadow Stats.
But things don’t have to be so doom and gloom!
In fact, the second way to look at multifamily is as a great opportunity.
Instead of looking at the situation as a great challenge or great crisis, you can look for opportunities.
There’s currently a huge shortage in multifamily.
We’re short three to eight million apartment units.
Population shifts and population growth has exacerbated this demand.
I think the interest rates will rise but then they will lower.
The federal government can’t keep the rates too high.
The gross national debt in America is currently $32 trillion.
We gain $1.5 trillion in interest annually if we’re paying 5% interest.
Even former Federal Reserve Chairman Paul Volcker said he would not have been able to lower rates in the current environment because we have so much debt.
As much as Jay Powell wants to be Paul Volcker, it’s going to be an uphill battle.
In general, you should look for value-add deals.
Look for a long-term focus.
Know that there is an inflation hedge with multifamily as well as tax benefits.
Don’t be afraid to wait for the right deal.
We’re keeping our eyes out for better pricing and better opportunities.
You should be ready for things to change.
If you’re feeling the pinch in cash flow, that’s okay.
As long as the deal can be maintained, there should be a good long-term outlook even if the cash flow is lower.
Just make sure you have a good operator!
Now I want to hear from you.
How do you look at multifamily?
Let us know in the comments!
Before you leave, make sure to check out our special report about inflation investing. It shares the best choices to invest during an inflationary environment.
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Disclaimer: I am not your investment advisor. This is for educational purposes only. I am not giving specific advice on what you can do. I am simply giving my opinions.