Founder, CEO of Blue Lake Capital LLC. Helps passive investors grow wealth through real estate. Podcast Host: REady2Scale.
Now that the government has passed the $1.9 trillion American Rescue Plan and millions of people are getting vaccinated, there is finally some light at the end of what has been a very dark pandemic tunnel. Unemployment has dropped to 6%, down from a whopping 14.8%, job creation continues to rise and the GDP is recovering — all signs of a stabilizing economy.
As a multifamily property sponsor, operator and investor with more than 2,300 units in five U.S. markets, I thought I’d provide my perspective on the state of today’s real estate market and how it’s impacting multifamily properties.
The year started out very lean, with very few deals in the pipeline during January and February. The only deals that appeared were small (up to 100 units) or deals that had low occupancy rates and high delinquencies, mostly from “mom and pop” operations that were divesting assets that didn’t perform well during the Covid-19 pandemic. In March, we saw many deals come into the pipeline, but they were still lower in number than last year.
Competition has been extremely fierce, and capitalization rates are at an all-time low. In order to secure a deal, investors are overbidding large deals ($550 million-plus) by 5% to 10% over the broker’s initial recommendation and providing up to $1 million in hard money as a deposit, which is nonrefundable, on day one. It’s a result of family offices and institutional investors that didn’t deploy capital last year, as they were sitting on the sidelines and waiting for the “fire sale” prices that never materialized. They’re investing now, in part due to speculation that 1031 exchanges will be repealed by the Biden administration. In addition, investors who normally purchase non-multifamily properties (retail, offices and hotels) are turning to multifamily due to its resilience in the market.
Agency debt is starting to ease up on reserve requirements. Until now, they required nine to 12 months of reserves of principal and interest, even in a full-interest-only deal. Now, they’re requiring six months of interest only (Fannie Mae) or waiving it completely if the loan-to-value ratio (LTV) is below 65% (Freddie Mac). Prior to Covid-19, agency loans had an LTV of 70% to 80%. However, LTV given by agencies is dropping as treasuries are increasing.
Class A and B properties are performing well in the market. We’re collecting between 95% and 100% of rents every month. We’ve also been able to raise rents from 6% to 12% on average, depending on the asset. The NMHC collections tracker shows that in February 2021, 93.5% of rents were collected across all asset classes. Several factors are at play: tenants just received $1,400 per individual stimulus checks, unemployment benefits were extended through September 6 with $300 supplemental payments for those who qualify, and counties are making direct payments to landlords to cover delinquent rent. All three factors have helped to pay rents.
Due to the fierce competition for properties, investors have had to adjust their expectations with regard to return on investments. Some investors still have unrealistic expectations, expecting returns that were achievable before the pandemic. A 6% cash-on-cash (CoC) return and 11-13% internal rate of return (IRR) are now the norm for Class B value-add assets. While a 6% CoC return is lower than it was pre-pandemic, it’s still better than other real estate assets, like retail or office. In addition, if the assets are performing well, the Covid-19 reserves held by lenders will be returned to the owners, which can also help to boost returns.
The news media is busy promoting the fact that more and more Americans are getting vaccinated against Covid-19, which is a good indication that we’re on a course to keep the pandemic in check. At the same time, unemployment has fallen, job creation continues to increase and other signs of the economy are indicating that we’re on a rebound from the lockdowns of last year.
I’ve had the opportunity to witness firsthand how this is changing the state of the real estate market today. While 2021 started slow, deals are now coming into the pipeline, competition is fierce and agency debt is easing up. With Covid-19 coming under control, we can expect that returns will return to their pre-pandemic levels.
As the market stabilizes, talk to brokers and others to see how deals are being bid. Hopefully, the need to overbid on large deals will diminish and the need for large, nonrefundable deposits will be reduced. I’m optimistic that with a more stable market, the “new norm” of lower CoC and IRR returns will be a thing of the past.
The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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