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In the latest issue of National Real Estate Investor there was an article discussing where the rich people (a.k.a. High Net Worth Individuals, “HNWIs”) invest their money.   According to the survey conducted by Capgemini, real estate is the third largest asset class for HNWIs, accounting for 16.8% of their assets. Interestingly, only 15.4% of that “pie” is allocated to commercial real estate – the rest is in other types of real estate assets – residential, hotels, land, REITs, etc.   Also, not surprisingly, Multifamily was named by 76% of the respondents as the #1 preferred property type in the commercial real estate category (followed by Industrial at ~47%).   Why is Multifamily favored by so many?   First, on a relative basis, it is a winner in terms of returns. Even though the return expectations have come down over the last year, value-add multifamily deals still often generate 7-8% cash-on-cash returns (with great tax benefits too) and 15%+ IRR over the life of a deal. As compared to the other assets classes, multifamily offers materially higher return.   The cover story of the latest Barron’s magazine talked about best income investments for 2019. Return-wise, none of them come close to what a multifamily investment can deliver, especially considering embedded tax advantages that real estate provides. 3% dividend stocks, 6% preferreds, treasuries. Come on… How exciting is that?! Some MLPs with 8-9% yields are probably the only comparable instrument return-wise, but still come short. And MLPs are correlated to oil/gas prices when the times are bad. Do you want that risk? Anyway… I digress.  Of course, we are not saying one should completely avoid stocks and bonds. They are obviously more liquid and have a place in an investment portfolio. What we ARE saying though, that multifamily is probably a better investment on a risk-reward basis. Real estate in general as an industry is much more predictable than most others. You have historical data available at your fingerprints and there’s much more visibility and cash flow predictability.   Second, historically multifamily loans have demonstrated solid performance with low default rates.   As you can see from the charts below, the default rates on Fannie and Freddie multifamily loans (and they finance ~55% of them) were very low in the last recession (less than 1%). Banks, which comprise about 25% more of the multifamily loan volume, had default rates that peaked at about 4.5%. For comparison, US leveraged loans had about 11% peak default rate in the last recession. Thus, multifamily real estate still a very compelling investment on a risk-reward basis and certainly is one of the most predictable ways for long term wealth accumulation.   As always, feel free to reach out with any questions, comments, thoughts!   Cheers,   Julia

We love following real estate industry news and believe it or not, we love reading 10Ks and earnings transcripts in our spare time. It is a great way to get a good sense of what is happening in the multifamily arena and helps answer some questions we get asked frequently by our investors. In this post, we provide excerpts from the earnings transcripts of three publicly traded multifamily REITs: Camden Property Trust (“Camden”), Mid-America Apartment Communities (“MAA”) and UDR Apartments (“UDR”). Enjoy!   STATE OF THE MARKET ­UDR “…the underlying macroeconomic backdrop for the apartment industry remains positive. This when combined with solid fundamentals will continue to support future growth. As such, we expect the apartments will remain a consistent short-term and long-term performer in a very volatile global economic landscape”.   Camden “…But overall, as you just kind of think about the drivers in our business, if you look at employment growth and supply, there’s really not a huge difference between the outlook of what’s happening in 2018 and what the outlook is for 2019, job growth comes down a little bit across our platform, new completion stay relatively flat, but the change in the ratio of new jobs to completions doesn’t really move that much, we’re a little bit above five times for 2018 that drops to a little bit below five times for 2019. So overall just looking at the macro data and not drilling down to each individual market which is the whole purpose of our budget process, you would just look at the macro data and say 2019 this should look a lot like 2018 maybe some slight improvements. So we’ll have to see how it plays out…”   “…The thing that’s interesting when you think about the 10-year treasuries obviously has gone up from the beginning of the year and people think about why haven’t cap rates gone up as fast as the 10-year. And therefore thinking that prices have to come down and cap rates have to go up. But there is a massive wall of capital today that continues to flow into real estate and multifamily specifically sort of the darlings are multifamily and industrial with Amazon effect with industrial.   We had a board meeting this week and we had HFF come in and update our board on current market conditions and they had a slide that showed $182 billion of unfunded real estate capital that needed to find a home and when you start thinking about apartments, when you think about cap rates, the 10-year is probably the last thing that influences cap rates, the first thing is liquidity and that’s how much money is in the market trades and deals, the second is market fundamentals or operating fundamentals, supply and demand, the third is inflation expectations, and the fourth is 10-years. And when you look at the relationship of cap rates today, we have massive liquidity, we have pretty decent supply fundamentals and demand fundamentals and if the Fed […]

I recently came across the excerpt from Seth Klarman’s annual letter to his investors. Seth Klarman is one of my favorite investors who unfortunately does not write much – the only book on value investing he has ever written, “Margin of Safety”, is out of print and its used version is available for purchase on Amazon for only $14,950 – which is a great value. NOT! https://www.amazon.com/Margin-Safety-Risk-Averse-Strategies-Thoughtful/dp/1893122816/ref=mt_paperback?_encoding=UTF8&me=&qid=   (But don’t worry…you can find a free PDF version online these days).   Anyway. When Seth speaks, the whole investment community listens – the Baupost Group which Klarman founded in 1982, is one of the most successful hedge funds and has generated an average annual return of 19% since inception (phenomenal).   When I was reading the excerpt from his letter, naturally I was thinking of how it applies to real estate in general and multifamily investing in particular and I wanted to share my thoughts with you. Below is my comments on some of the lessons, but I of course highly recommend you read the original for yourself – it’s only two pages. https://www.slideshare.net/vlad0/seth-klarman-the-forgotten-lessons-of-2008   7. The latest trade of a security creates a dangerous illusion that its market price approximates its true value. This mirage is especially dangerous during periods of market exuberance. The concept of “private market value” as an anchor to the proper valuation of a business can also be greatly skewed during ebullient times and should always be considered with a healthy degree of skepticism.   Same applies to the latest sales of houses OR apartment complexes in the particular area – so called “sales comps” which are traditionally stated in multifamily investing using a “price per unit” metric. Often, commercial real estate brokers would insist that the recent per unit comps are a true of reflection of a property value when in fact it only shows how exuberant other investors have become. A conservative investor would look to the cash flow the property generates first and derive the value range based on that cash flow. Yes, valuation is always a range and not a single number. As Warren Buffet likes to say “It is better to be approximately right than precisely wrong”.   9. You must buy on the way down. There is far more volume on the way down than on the way back up, and far less competition among buyers. It is almost always better to be too early than too late, but you must be prepared for price markdowns on what you buy.   I want to buy on the way down! But then – who doesn’t. In my frequent conversations with other real estate investors this topic comes up often – how we all need to be prepared when eventual downturn comes. The question here is – are we going to be mentally and emotionally prepared to pull the trigger when everyone around us thinks we are crazy, the mood is gloomy, the headlines are depressing and everyone around us is telling […]

Did you know that over 50% of commercial real estate is bought by private investors? I didn’t. I thought it was all institutions. Turns out – this is not the case! Who are those “private investors”? It could be either high net worth individuals (a.k.a. “very rich people” and their family offices) or syndicators (people who pull investors’ money together to buy real estate deals; min investment is often $50K). Syndicators’ backgrounds vary; I met investors that came from all walks of life – doctors, lawyers, engineers, pilots, fire fighters, accountants, psychologists, management consultants, marketing professionals, you name it. Finally, former finance people (me!) even though I am surprised why more bankers and hedge fund/private equity professionals don’t go into real estate – their skill set is directly transferable and real estate is one of the easiest businesses to start.   Below is the chart from a Viewpoint report published by Integra Realty Resources (https://www.irr.com/reports/IRR%20Viewpoint%202018.pdf): As you can see, private investors comprised more than 50% of the group in 1H2017. Another piece of data comes from the recent Avison Young Multifamily report for Triangle area (Raleigh/Durham/Chapel Hill in NC): Again, similar trend here – private investors are the dominating group by volume. Top 10 investors, however, are mostly institutional – let’s look at the chart below: My educated guess is that the institutional money mostly chases Class A assets and the percentage of private investors in only Class B/C value-add multifamily assets would be even higher. Also, institutional investors go for larger deals. From our conversations with commercial real estate brokers for example, large properties – over 200 units and over $20mm in value typically attract ~30 LOIs (“LOI” stands for “Letter of Intent” – in plain English, a first indicative, non-binding bid a buyer will submit) per deal, while smaller deals – below 150 units let’s say – typically generate lower number of bids, typically 10-15 per deal. Those number seem to work for larger and popular markets (Sunsail Capital is currently focuses on Atlanta and North Carolina markets).   How could be buying commercial real estate seemingly so easy for non-institutional folks? Well….let’s look at the financing for example. Turns out it is actually easier to get a loan for a 100 unit apartment complex than for a single family house! Any multifamily property with five or more units is considered “commercial” and as such, lenders do not look to the personal credit of the borrower but they do their own underwriting on the property itself and look to the strength of generated cash flow to decide how much they are willing to lend on it. And as of today, lenders are still all over each other to lend on multifamily deals – https://www.nreionline.com/multifamily/lenders-continue-fight-market-share-multifamily-deals.   What about equity for the down payment? Not that hard to find either. People just LOVE multifamily real estate (I certainly do!) and cannot get enough of it. And rightly so: you can get cash flow, equity build up (your tenants are effectively […]

Expected returns on commercial real estate investment of course do vary. How much you should expect to earn when investing into a syndication depends on numerous factors: for example, a type of the investor you are (different return requirements for institutional vs individual investors), a property class (A, B, C. D Class is considered a “war-zone” in multifamily and typically is not syndicated. This is for cowboys!), the type of real estate (industrial, office, self-storage, retail, leisure, student housing, healthcare, multifamily), the amount of heavy lifting required (how much of a turnaround is needed and how much of a renovation/construction a so-called “deal sponsor” (a person or a group who is putting a deal together) is going to do. The higher the risk, the higher is the expected return).   (As a side note, if you are interested in taking a look at some of live commercial real estate deals, nowadays you can see a few of them online by registering at www.crowdstreet.com and www.realcrowd.com – pretty cool, isn’t it?!)   In this article, we are going to focus on the expected return for passive investor partners (also known as “LP investors”) in our preferred strategy which is Class B/C value-add multifamily. “Value-add” means that there is a potential opportunity to increase cash flow (the most common cash flow metric in commercial real estate is “Net Operating Income” or “NOI”). For example, you could: Increase rents by bringing them to market levels (existing rents are not always there) Make renovations to upgrade the units and add amenities – and then increase rents Improve a property’s “curb appeal” – new landscaping, reseal parking, new signage, etc Add new revenue streams (new sources of fee income: pet fees, parking fees, laundry, etc) Renegotiate existing contracts to lower expenses (security, landscaping, cable, etc.) Install water-efficient faucets, toilets and showerheads to reduce water and sewer expenses Ok, enough of beating around the bush! What ARE the expected returns of this strategy? Typically, 6-10% cash on cash return annually (8% seems to be most common), which could be “preferred” return (i.e. with 8% return, if you invest $100k, you get $8K in distributions; “preferred” means that the sponsor (a GP that is putting a deal together) wont’ get a cent unless the LP investors get 8%. LPs are “first in line” to get paid in the waterfall) Total IRR of 17%-19%+ (internal rate of return, also takes into account the gain on sale on the exit. For those familiar with bond investing, IRR is the same concept as “yield to maturity”) Minimum investment is usually $50,000 IRR would of course depend on the holding period of the investment. We generally target five years however opportunistically might decide to exit earlier if the price is right – that would often result into a higher IRR. Alternatively, if we are forced to hold the investment for longer than five years, IRR could decline.

Is the multifamily market at its peak? Will interest rates force the real estate values to come down? Are you worried about [insert your favorite concern]? Is it the time for investors to stay on the sidelines? We get these questions all the time.   Experts say the real estate market has been going up for almost nine years straight. Experts say we are overdue for a correction. Experts say we should be fearful. The truth is, while nothing can go up forever, nobody really knows the timing of the reversal.   We all can recall numerous cases when the so-called “experts” were wrong. In 2008 for example, Goldman, the #1 investment bank on the Street, was calling for $200 oil price. The oil was around $140 back then. Lehman, at the very same time, was saying oil is about to decline to $93. How could two premier banks with an army of analysts and great access to information arrive to such dramatically different conclusions?   Anyone remembers Meredith Whitman and her call for a muni market collapse – the collapse that never materialized? It was all over the news in 2010. We won’t even mention what experts were saying about last year’s presidential election!   The point that we are trying to make here – you can know a lot about the market, study it for a long time and still turn out to be wrong. On a macro level, the best position an investor can take, in our view – is that the reality is unpredictable. You can, however, usually tell, on a relatively basis, if the pendulum has swung too far one way or another and adjust your investment behavior accordingly.   One of my favorite investors that greatly influenced my own investment philosophy is Howard Marks, the co-founder and Chairman of Oaktree Capital Management. I could not resist including a couple of his quotes here because I think they are very relevant to the situation we are currently in and the topic of our discussion:   “There are no facts about the future, just opinions. Anyone who asserts with conviction what he thinks will happen in the macro future is overstating his foresight, whether out of ignorance, hubris or dishonesty”.   “….rather than “what inning”, I’d suggest investors ask if thing are or are not in an extended state. Is psychology depressed, average or euphoric? Is the capital market shut tight, normal or unthinkably generous? These are the questions that can be answered in a helpful way, not how close the game is to being over. No one knows the answer to the latter”   “Most people don’t want to tempt fate by saying that things will go well forever, and in fact they know they won’t. It’s just that they can’t decide what it is that will go wrong. The truth is that while I can enumerate them, the obvious candidates (changes in oil prices, interest rates, exchange rates, etc.) are likely to already be […]

There was an interesting article in this week’s Barron’s https://www.barrons.com/articles/where-to-find-safe-5-yields-1527780368 (the subscription is needed to read it).   It talked about how great munis are as an investment because the average muni-bond yield of 2.5% is actually about 5% on an apples-to-apples basis with the regular taxable corporate bonds.   Here is the table from the article: Of course, it got me thinking about multifamily syndications’ deals that we see (and invested in). The returns for the passive investor that we and many other syndicators that pursue our strategy (often referred to as “value-add”) target are 8%+ “cash on cash” (annual distributions as % of equity invested) and 16-18% IRR (includes cash on cash + capital gains). Very often in apartment deals, due to the fact that the interest on the debt is tax deductible, and so is depreciation (and it can be accelerated), the taxable income over the course of the average holding period of five years is negative resulting in the effective tax rate of 0%. So….naturally, we wanted to recreate the table from the article and look at tax-equivalent yields for multifamily investing! See below. Isn’t it amazing?! For me, living in NYC, that alone is a reason to get excited about multifamily investing. And even if there IS taxable income leftover, in most cases it will be taxed at passive income tax rates, which are lower (needless to say, you should always consult your CPA).   As an additional bonus, when the apartment complex is sold after a few years, the capital gains and depreciation recapture are taxed at lower tax rates if we take a similar model investor as in the Barron’s example (married investors filing jointly with $250K annual taxable income). The details are beyond the scope of this article but it is clear that the tax advantages of real estate investing are very significant.   Now…I can see some of you rolling your eyes: “How dare you to compare munis and apartment complexes?! It is a totally different risk profile! Munis are so much safer! Plus you are talking about equity multifamily investing, not debt (which is presumably “safer”)”. Ok, fine, that is fair. No need to roll your eyes. But I do believe that such dramatic difference in potential return more than fairly compensates one for the risk taken. That’s a perfect example of an attractive risk-reward. At the very least, I feel much more comfortable with “value-add” multifamily investing than today’s High Yield bonds. Let’s say an average multifamily investment is an equivalent of a “B” credit profile bond (an educated guess based on interest coverage ratio, debt levels and single asset profile) – average B-rated bond effective yield (pre-tax!) is only 6.5% compared with 13-15% tax-equivalent yield on multifamily deals. Even the riskiest bonds (CCC and lower) trade at the average 9.85% yield (with over 45% of those bonds typically defaulting within a five-year period, see S&P table below). I would argue all day long that the defaults on well-managed […]

Being a data geek, I love analyzing historical performance of asset classes. Let’s look at apartments. NCREIF (National Council of Real Estate Investment Fiduciaries) tracks investment performance for Apartments. The NPI (NCREIF Property Index) Apartment Sub-Index is comprised of 1,557 properties valued at ~$133bn; the property return in the index is weighted by its market value so the index is more representative of the larger properties. As such, we should keep in mind that all the numbers below are for the aggregate market and for mostly larger and higher quality properties that are not directly comparable to the strategy that SunSail is pursuing (smaller, $4-$10mm Class B/C value-add deals) however the story behind those numbers is still relevant for us. So let’s get to the point: As can be seen from the table above, large apartments had rather strong performance over the course of many years. Thus, that’s no surprise there is no shortage of capital still chasing apartment deals. According to NCREIF:   “Each year, investors surveyed by Urban Land Institute and PWC for Emerging Trends in Real Estate have ranked multifamily in first or second place for investment/development prospects for more than a decade. Multifamily is also a perennial favorite among investors surveyed for the Association of Foreign Investors Real Estate. U.S. metropolitan areas most favored by investors – Los Angeles, New York, Seattle, Washington DC and San Francisco – account for over 30% of NPI Apartment Sub-Index value. These and other large coastal metropolitan areas have been magnets for investment and development of urban high-rise projects, which have dominated apartment construction activity for the past ten years. Apartment demand remains strong in these markets, where high-wage jobs are being created and homeownership is least affordable, but at this point in the cycle, pockets of overbuilding depress occupancy in many CBDs.”   This is all great, but as we all know historical performance is not an indication of future results…What would happen to Apartments as an asset class during the downturn? How would it perform? With capital preservation being our #1 goal and considering where we are in the real estate cycle, we are much more focused on the downside protection in today’s market vs potential upside. So what we wanted to know – how did multifamily fundamentals looked like during the last recession let’s say? We found some answers in the reports published by Wells Fargo: By looking at the data, we can see that overall, on average, multifamily fundamentals were not THAT awful even during the worst recession of our lifetime. People still needed a place to live. Yes, some lost their jobs, some had to move in with their relatives which drove vacancy rates higher but the occupancy still was over 92% and rent growth did turn negative – but it was not a protracted decline, and negative ~6% rent growth was not catastrophic. In many cases, depending on the area, rent growth was actually flat, or even slightly up. Location, location, location. Of course, […]

In a recent Op-Ed article that appeared in the WSJ, the authors Arthur Laffer and Stephen Moore offer an interesting perspective on the potential impact of Trump tax bill’s cap on the deduction of state and local tax on the migration patters across the US. If what they are saying does in fact materialize, it could potentially be very beneficial for many multifamily markets.   According to the excerpt below, the authors expect New York and California residents to leave those states in droves:   “Now that the SALT subsidy is gone, how bad will it get for high-tax blue states? Very bad. We estimate, based on the historical relationship between tax rates and migration patterns, that both California and New York will lose on net about 800,000 residents over the next three years—roughly twice the number that left from 2014-16. Our calculations suggest that Connecticut, New Jersey and Minnesota combined will hemorrhage another roughly 500,000 people in the same period.”   The full article could be found here: https://www.wsj.com/articles/so-long-california-sayonara-new-york-1524611900   Another recent article in The Seattle Times https://www.seattletimes.com/seattle-news/data/seattle-just-one-of-5-big-metros-last-year-that-had-more-people-move-here-than-leave-census-data-show/ also talks about how people have been moving to the Sunbelt states (and now Seattle too) for years from New York, Los Angeles, Chicago and other large metros.