“If you want to know what a man is really like, take notice of how he acts when he loses money.” — Simone Weil
What is going on with multifamily deals?
If you’re in multifamily syndication right now, particularly value-add deals, we’re seeing some real challenges.
I spoke with one investor who said he was in five capital calls with different deals.
We’re also seen a couple capital calls and other struggles in our deals.
What’s going on?
How are we going to move forward?
Today, we’re going to talk about the current state of multifamily and what you can do as an investor.
Let’s get into it!
1. Interest Rates are Rising and Valuations Are Dropping
Why are interest rates rising?
The same thing is happening in single family.
If somebody has a 4% interest rate on the home they’re selling, the buyer can’t afford to pay the current price because they’re paying a higher rate of 7% to 9% which leads to higher monthly payments.
That’s a pretty large difference.
The affordability is not there.
I’ve talked about the margin of safety before.
Warren Buffett loves this term.
If things don’t go perfectly, what is your margin of safety?
Our margin of safety in a lot of deals has been the value-add portion of multifamily.
If you renovate units, the market rents can rise from $1,000 up to $1,500.
Now, we’re seeing deals where we’ve renovated the majority of the property and the value is below what we paid.
How is that possible?
It’s because interest rates have risen so sharply.
This chart shows the increases in interest rates in recent history.
In the last 43 years, we’ve seen interest rates increase the quickest they ever have.
This other chart shows that from 1979 to 1980, the rates rose faster, but we also started at a higher rate.
Right now, we’re seeing a very sharp increase, starting at almost zero and increasing to 5.5% on the Fed fund rate.
This leads to even higher rates for consumers.
Valuations are dropping because the cost of money is up.
The same numbers that worked a few years ago don’t make sense now because you can’t make the property cash flow positive.
That’s the primary challenge.
Buyers are willing to pay less for the same property.
That’s something to be concerned about and keep your eyes on.
2. Capital Calls
If you’re in a multifamily deal, you may have encountered a capital call.
I know people who have been through at least five capital calls recently.
Why is that?
What is triggering these calls?
Capital calls happen when operators come to their investors and say we need more funds for the investment.
Or maybe they had an additional external problem come up that requires more money.
The investor then has to judge the legitimacy of the claims.
They need to see if the claim is a unique situation and worth funding.
Sometimes operational issues can cause this.
If you have some property manager issues, that can reduce occupancy and lead to other issues in the property.
Expenses have exploded, even those who have fixed debt.
We’ve seen insurance triple in Florida.
Costs of labor, services, and materials have gone up substantially.
It leads to something called break even occupancy.
Break even occupancy is the occupancy a property needs to hit in order to become profitable.
For a while, a lot of our deals broke even at 65% to 70% occupancy.
Now, we’re seeing deals breaking even at 90% to 95%.
How is that?
Firstly, rents have risen, but maybe not as quickly as the expenses.
Rents are still a little low and they need to go higher.
That relationship creates a very challenging dynamic.
When you go to sell or refinance, particularly with bridge or shorter-term debt, a lot of the value is not there.
If the property is worth less and you’ve put all this money into it, then there’s a problem.
3. Fixed Rate Debt is More Attractive
Fixed rate debt is more attractive because you don’t have to sell within a short period of time.
With fixed debt, you will often get 5 to 10 years of the same fixed interest rate.
Sometimes, fixed rate loans are challenging because you need to put more money down.
This could be 35-50% down as opposed to what has been 20% to 25% for bridge debt.
Those higher down payment amounts are a downside depending on your situation and lower investor returns.
Also, with agency fixed rate debt, when you go to refinance, there’s also something called a prepayment penalty.
With homes, this usually doesn’t exist.
If you pay off your loan early, you own the house.
In a multifamily, if you sell the property (or refinance) or you pay it off early, you will be penalized.
The banks want to know they’re getting paid with a degree of certainty for the next 5 or 10 years.
If you pay the debt off early for whatever reason, you could pay millions of dollars in prepayment penalties.
We’ve had to do this before.
Using fixed debt is not always a bed of roses.
After all of that, the question now becomes:
How do you tackle a deal that is struggling?
The first thing is readjusting expectations.
Your cash flow investments may require more cash to continue the business plan.
You need to evaluate if the plan will actually work.
The second thing is to focus on learning.
Treat this blog as a learning experience.
If you lose money, don’t beat yourself up about it, learn from it.
I once lost $70,000 (a third of my net worth at the time!) in one day in an options trading strategy.
I learned a lot that day and used it to my advantage to grow.
A friend of mine says that in life, you either have success or a seminar.
I think that’s great advice!
Remember that as you’re observing the multifamily space right now.
Pay attention when rates are high and low and what that does to the value of a property.
Will you need additional cash?
What kind of rate would work best for you?
Don’t be afraid of failing; be excited to learn.
Now I want to hear from you!
What do you think about the current state of multifamily?
How will you handle your investments during this strange time?
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.
If you are interested in investing with us, we are happy to answer any questions that you may have. Join our investment club today and we will be in touch.
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.