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.
In this post we wanted to discuss why multifamily fundamentals are currently favorable and expected to remain so in the long run. Here it goes: Demand for the apartments is on the rise due to a number of factors: (1) millennials prefer the flexibility of renting and delaying marriage, (2) the number of 55-plus renters is on the rise, (3) immigration trends. According to WeAreApartments https://www.weareapartments.org/, the demand for rental housing will reach 4.6mm units by 2030: Another set of charts, provided in Camden Property Trust’s investor presentation (Source: Whitten Advisors), also supports the “Millenials” thesis. Not only millennials have high propensity to rent, a large share of jobs is also going to the 20-34 age cohort. Additionally, the increasing number young adults living at home or with roommates creates a potential pent-up demand as well: At the same time, the homeownerhip rate – the percentage of households that own rather than rent the homes that they live in—has fallen sharply since mid-2005. There could be many reasons for that. Jobs are becoming more transient, student debt carried by young adults is significant, access to credit after the Great Recession is more limited: The supply of multifamily units, on the other side, seems to be on the decline after multifamily starts peaked in 2016. Rising construction costs and reduced availability of construction loans make future development starts more challenging: The trends favoring multifamily are expected to persist in the future as population grows, especially in the markets where jobs are created and homeownership is least affordable. The pockets of overbuilding of course can depress occupancy and investors should always be cautious, however most of the newly created product tends to be Class A properties and not Class B/C, which tends to perform better in a downturn (some Class A tenants trade down to Class B during recessions, etc) and is SunSail Capital area of focus.
I did all the right things. I taught myself English, moved to the USA, got my MBA from NYU Stern when I was 24, got myself a hedge fund job through networking, got my CFA certification by 27. Everything was going according to plan and I loved what I did (distressed debt investing). I was young, smart, aggressive and hungry. Being ambitious as I am, I totally expected to become a portfolio manager one day and then eventually start a hedge fund of my own, naturally… Only it didn’t work out that way! Somewhere along the way, “life happened” – as they say. I ended up working for three different funds (was a partner at one of them); the job was a lot of fun but there was always something. The first fund had to downsize during the recession, the next one was shut down by the partners, and the third one faced redemptions. At that point I was well over 30 and it was becoming painfully clear that becoming a high flying portfolio manager at a cool hedge fund probably was not in the cards for me. Everyone around me was saying that those hedge fund jobs are too risky anyway and I should find something more stable where I can “build a career”. That’s why I decided to go work for a large bank. I knew in my gut it probably would not be a great cultural fit for such a free spirited person like me but decided to conduct an experiment and see if it worked. Well…let me tell you: it didn’t! I felt completely suffocated by bureaucratic and hierarchical organization I found myself in. After some time, there was an inflection point when I realized I am in unsustainable situation. I wanted more. I wanted to live my life on my own terms and not depend on a paycheck paid by somebody else. That’s when I decided I needed to get out and go out on my own. I was DONE being an employee. I didn’t want to report to anyone, I hated taking orders, I didn’t want to ask permission to take a day off and I also didn’t like paying over 40% of my top line earnings, before expenses, in taxes anymore. I began thinking about my next step: how can I be on my own, gradually build wealth and actually enjoy the process? After many months of agonizing soul searching, a friend/mentor mentioned multifamily investing to me and it just CLICKED. Real estate was always there, sure, but I never seriously considered it. I liked the complexity and intellectual stimulation of distressed debt investing and real estate seemed too easy in comparison…But now all of a sudden, instead of thinking of real estate as “too easy” I started to realize that it is just more analyzable – and it’s a good thing! And is just as intellectually stimulating and fun as distressed debt. And importantly for me, you CAN be […]