Investing In Multifamily In The New Year

By: Rob Overstreet, Forbes Real Estate Council

I think we can all agree that 2020 has been a challenging year for a variety of reasons. The most glaring challenge that we’ve all faced and that’s changed the way we live and invest is, of course, the global Covid-19 pandemic. As it pertains to the business of apartment investing, the pandemic has certainly had an effect on the way investors buy and sell apartment buildings. Let’s take a look at how the pandemic has affected apartment investing over the course of 2020, and consider some predictions on how the pandemic will affect the multifamily investment space moving forward in 2021 and beyond.

Early Effects Of Covid-19 On Apartment Investments

As mentioned, 2020 has been a roller coaster ride for many people in many different industries. The multifamily investment and syndication business has been no different. Early in the pandemic, the immediate effects of this crisis showed themselves right away. Multifamily transactions came to an abrupt halt — sellers weren’t selling, and buyers weren’t buying. Furthermore, the golden standard agency lenders — Fannie Mae and Freddie Mac — made drastic and frequent changes to their lending criteria and guidelines.

This of course is understandable because after all, lenders are in the business of making a profit and protecting their own investors. Some of the notable lending changes required borrowers to put up an additional 12-18 months — depending on the deal and the market — of principle and interest debt service payments, taxes, insurance and replacement reserves. This was a tremendous hurdle for investors to overcome and in some cases meant that the borrower would have to bring an additional $1 million or more in investor equity in order to close on a deal. As you would guess, this was a serious blow to investor yield and overall returns.

What’s the fix? Lower prices of apartments of course! However, sellers didn’t want to reduce their pricing, and therefore, we witnessed a “stalemate” in the markets over the several-month period roughly between March and June 2020. This can be seen partly in the lower monthly sales volume of $4.7 billion in May. Transaction volume came to an abrupt halt while sellers, buyers and lenders were all looking at each other and waiting to see how the very fluid pandemic situation unraveled.

What Happened Next?

Slowly, lenders began to update and change their lending guidelines to make borrowing more feasible and to increase the transaction velocity on multifamily investments. They did this by loosening up some of their reserve requirements, reducing the amount of reserves needed from 12 to 18 months to nine to 12 months of reserves. Some of the lenders even dropped the need for reserved taxes, insurance and replacement reserves on a given deal and only required nine to 12 months of principle and interest debt service payments.

This was a bit of relief to investors, and it began to open the markets up again. From that point, there was a flood of sellers coming into the market offering their apartments for sale. Much of this was likely due to pent-up sellers waiting on the sidelines for the previous three to four month period. The demand continues, as shown in a quarter three report from Multi-Housing News.It was at this point that investors began to pay extremely close attention to the income and delinquent rents on apartments being underwritten. Each new month was a collective hold-your-breath moment for operators as everyone waited to see the damage done by the many jobs lost in the economy. However, collections never fell off a cliff, and outside of a handful of cases, the majority of tenants in every market continued to pay their rent.

This may be a byproduct of the CARES act that was introduced by Congress in late March, which provided millions of Americans much needed financial relief. Because income remained relatively healthy across most apartment investments, many in the industry did not see much — if any — downward pressure on the pricing of these assets through the summer and fall.

Apartment Investments In 2021: What’s Ahead?

The whole investing world has been waiting for pricing adjustments as a result of Covid-19. The reality is, it’s just not here yet. I believe that there is more economic damage to come and that many of the effects of the pandemic will have lagging economic indicators. Although the CARES Act was created to help millions of Americans in financially stressful situations who were impacted by the pandemic, it’s also likely the CARES Act has artificially kept apartment real estate pricing inflated. It succeeded in helping those in financial need. However, the federal government cannot continue to provide this kind of federal relief indefinitely. At some point, the lagging indicators and effects of Covid-19 will catch up, and there is reason to believe there will be some kind of pricing correction in the multifamily investment world. That may come as early as the first or second quarter of 2021, or it may take a bit longer. In any case, I feel that there will be some tremendous opportunities to acquire some very high-quality apartment deals in 2021 at discounted rates.

In The Meantime

Investors continue to look at investment opportunities every day as a place for strong yield and equity preservation. Investors should adjust their underwriting and projections to safely navigate any future turbulence by doing such things as holding back on any proposed value-add opportunities during the first year of operations, paying very close attention to apartment delinquency and making sure you are well-capitalized in a given investment. It’s also important to adjust your exit CAP rate assumptions in order to realistically project investor returns based on forecast inflation rates — which will affect U.S. treasury rates and subsequently real estate CAP rates.

Real estate investing is a long-term commitment. I believe real estate is one of the greatest investment vehicles that investors can use to achieve generational wealth and freedom. My company and I are very bullish on the future of multifamily real estate with the caveat that it takes disciplined underwriting and a clear understanding of all the market forces that affect cash-flow and equity appreciation. In the meantime, happy investing.

SOURCE: Forbes



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