Why buy Multifamily in ’09?

As I sit here looking out at the snow while I’m taking time to review and update my goals for the year there are stars aligning to make the new year a positive one. Especially if you are looking for alternatives for your investment and retirement money. The stock market hasn’t been good to us (I look at my account statement from between my fingers!) and the prognosis for the next year or two isn’t much better.

In contrast there are a number of reasons to consider owning multifamily properties, specifically apartment complexes with more than 100 units. Before I go into the reasons why now is a good time let me first be clear about what I’m NOT recommending, the landlording business. The reason to focus on properties with more than 100 units is that they are large enough to support both professional management and professional maintenance; most likely having both onsite full time if not living there. As an owner of this type of property your job is to review the management reports and manage the managers, not unclog toilets or take phone calls from tenants.

Reason #1- Show me the money! The properties we’re talking about produce cash flow in the low to middle double digits and total annualized returns in the high teens to mid twenties on five to ten year holding periods. Before you say 10% cash and 19% total a year doesn’t sound like much let me be clear that we’re talking about existing buildings with existing tenants and provable revenue, not dream stage tech start ups or land speculation in Vegas. Besides what are treasuries, money markets or even dividend stocks paying lately?

Reason #2- There are 100 or more people paying the bills for you. One of the things that make multifamily a good investment in tough times is the diversification of income streams for the property. As opposed to a rental house, or even a commercial building, strip mall, etc., no one tenant moving out will destroy your cash flow. A certain amount of turnover is expected and your professional managers will have a marketing plan in place to provide the necessary replacement tenants.

Reason #3- Good supply/demand characteristics. No one is lending on property development now, developers are shuttering any project not already out of the ground on construction and the number of new completions are dropping every month. There is some new supply on the upper end as condo projects are switched to rental (or being UN-condo-converted) but the multifamily properties we’re interested in are the mid-level complexes that have good characteristics not top of the line luxury properties.

On the demand side there are three sources of tenants: Those who are renters by necessity because they can’t afford to buy; Renters by choice who don’t see the value in purchasing a home; Former homeowners who have been driven out of their homes because of the mortgage meltdown. For the ‘B’ properties, as they are called, there is an additional source of new tenants, ‘A’ renters moving down to reduce monthly expenses. B properties have most of the amenities of A properties but typically are a little older. Most were A properties when new and are in good neighborhoods which is also a factor that keeps B renters from moving down to C properties.

Reason #4- Competition for properties is low. While there a good deals to be had, especially from over-leveraged owners and bank REOs, most of the institutional money and foreign money is sitting on the sidelines waiting for the next upturn. Of course waiting for the upturn means that they’ll be paying up for properties, maybe even for one that you acquire now.

Reason #5- Buy low, sell high. Prices in most markets have come off their highs and sellers are starting to become reasonable in their understanding of market fundamentals; they’ve been watching the same news reports as everyone else.

Multifamily pricing is often described in terms of ‘Cap Rate’ which is similar to the dividend yield on a stock. Buyers are demanding a higher return on their investment which means that Cap rates have been rising, in many places by as much as one to one-and-a-half percent. A one percent move in cap rate can mean a significant change in price. For example a 100 unit property selling for 3.5 million at a 7% cap rate would sell for just over 3 million and an 8% cap rate. We typically want to buy at cap rates of 8.5-10% or higher and are uncovering properties now in that price range.

Reason #6- There is money for apartments! Fannie Mae and Freddie Mac are being pumped full of liquidity by the government and while it’s not publicized, they would MUCH rather lend that money on multifamily properties with steady revenue than on single family houses whose value may fall to the point where borrowers just walk away. Lending standards have tightened, which means that financially strong buyers have more opportunities and fewer competitors for the good deals. Commenting on the announcement that the Fed would aggressively buy Fannie and Freddie paper, even stock guy Jim Cramer announced on his show that now is the time to buy real estate.

Reason #7- Interest rates are low and inflation is coming. Interest rates are being held as low as possible to stimulate the economy and multifamily borrowers can lock in 30 year fixed rates as low as 6%. At the same time the government and the Fed are printing and pumping out money as fast as they can and when that money starts moving through the economy interest rates and prices will rise. If you’ve already locked in a low interest rate you will be perfectly positioned to benefit from rising rents. Just think about it, fixed expense with rising income, just the opposite of having a job and paying bills!

Remember the multiplier effect of cap rates, every dollar per month that rents go up in a 100 unit property is $15,000 of additional value added to a property at an 8% cap rate, with fixed expenses. Raise rents 10 dollars a month and you’ve created $150,000 in value instantly.

Now is the time to get in at low prices with good returns on conservative deals before the big money and inflation start driving up prices on properties, that you own. Market selection, property selection and manager selection are all critical of course but in a tough market and in any economy short of dig a hole and crawl in with freeze dried food and crossbow, owning multifamily will provide both current income and positive growth.

Here’s to a happy, healthy and profitable New Year everyone!

Giovanni Isaksen
Ashworth Partners Ltd.

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