“The time to buy is when there is blood in the streets.” – Baron Rothschild
Will There Be A Recession in 2023? What Are The Upcoming Opportunities?
Not according to Goldman Sachs who forecasted that the U.S. will avoid a recession and continue towards a soft landing. I learned this after attending a recent Real Estate Investing Conference.
Highlights and key takeaways from this Economic Outlook Presentation were:
- Real Income is Strong
- There is Low Unemployment
- Consumer Debt Is Low, Savings and Net Worth Are Up
- Increased Exports
- Demand for Housing is Outstripping Supply
- Distressed Commercial Real Estate Buying Opportunity is Coming
Best CRE Property Types on a 5-Year Horizon
Check out this quick video discussing 6 different Commercial Real Estate (CRE) property types and their outlook over the 5 year horizon
Amid Fears Of A Recession, What’s Been Driving Demand For Multifamily Real Estate?
In 1956, the world witnessed perhaps the greatest twist to a corporate tale in history.
After several years in partnership with the McDonald’s brothers, Ray Kroc had little to show for his efforts. His salesmanship had guided him into the growing McDonald’s fast food business and earned him a franchise in Illinois, but the money coming in could not outpace the costs of running up another franchise.
In the Netflix movie “The Founder,” Ray Krok’s lawyer, Sonneborn, summarizes Kork’s dilemma: “You don’t seem to realize what business you’re in,” he says. “You’re not in the burger business. You’re in the real estate business.” According to the lawyer, it would be impossible for Krok to amass a fortune franchising, but he could easily do it by purchasing the land the franchisee operates on.
So began the delectable twist which turned a fast food joint into one of the largest owners of real estate in the country. In 2021, McDonald’s reported $46.7 billion of total long-term assets, the majority of which come from property, plants and equipment. Fortunately, building fortunes through real estate is not exclusive to corporate elites; it’s available to the general investment community as a potential low-risk opportunity to generate passive income.
Here’s what the market looks like and how you could get involved.
The Multifamily Real Estate Market
In the real estate market, multifamily housing is a booming sector. According to the U.S. Consensus Bureau, a multifamily residential property is one “containing units built on top of another and those built side-by-side which do not have a ground-to-roof wall and/or common facilities.” A common form of a multifamily residential property is an apartment building, where units are separate but stacked in close proximity to one another.
The multifamily real estate industry is one of the oldest forms of real estate and one of the most popular. According to a report by CBRE Group Inc., the multifamily rental housing market includes 14.5 million units across the 62 largest metro markets in the U.S. The National Multifamily Housing Council (NMHC) estimates that the total value of these units is more than $3.3 trillion.
Even in 2022, as the Federal Reserve’s monetary policy ushers interest rates to a range of 3.75 to 4%, demand for multifamily real estate property appears to be holding steady. According to a report by Fannie Mae, the multifamily sector experienced strong demand in the first half of 2022, despite concerns over a global recession. This trend is expected to continue in 2022 and beyond. One strongly opinionated source has even stated that “there’s no end in sight” for multifamily housing demand.
The sustained demand is reportedly driven by fundamental factors. On one hand, a rising interest rate environment means higher mortgage payments for potential buyers, which dissuades purchases. On the other, the multiple revenue streams arising from multifamily houses, as opposed to family houses, could ease the burden of higher mortgage rates and even offset it if there’s enough cash left over.
The narrative for a strong multifamily housing market is confirmed and reiterated by market players themselves. In interviews with Multi-House News, investment arms Three Pillars Capital Group (TPCG) and Bell Partners (BP) and development arm Kaplan Residential (KR) remain positive about the multifamily housing market. For KR, opening up the business plan to include multifamily sectors has “proved to be beneficial for the company,” and for BP, value-add multifamily operations are still a target area.
What to Look For When Buying A Multifamily Property
Buying a multifamily property can be overwhelming. There are local price trends, zoning rules and vacancy rates to consider—not to mention financing and renovation costs.
But doing your research is a vital first step. “It’s important to get a comprehensive look at the property and consider all potential scenarios prior to purchasing a building,” said Kaj Lea, Head of the Pacific Northwest and Central Region, Commercial Term Lending.
To help you narrow down what to look for in a multifamily investment property, begin with three areas:
- The building itself, including the number of units, amenities, overall quality and purchase history
- Location, including the neighborhood, proximity to transportation and any environmental concerns
- Finances, including renovation and repair costs and the property’s capitalization rate
1. Building details
Start with the basics: square footage, size and number of units. It’s also important to keep in mind the scope and capabilities of your operation. But in general, the more units, the more potential sources of income. Other factors to consider include:
- Condition: Aside from the obvious—such as visible mold and fire and water damage—look at window quality, insulation, piping and wiring, which may increase your utility bills depending on their efficiency. The building may also require immediate repairs, which you should factor into the purchase price.
- Property class: Are you looking at a luxury apartment building or workforce housing? And do you want to keep the property in its current condition? For example, a property with older appliances is great for workforce housing, but if you want the multifamily property to become a luxury one, you’ll need to make upgrades.
- Amenities: Amenities may also be tied to the property class and location. “For example, suburban apartment complexes are usually expected to have more amenities, while well-located urban properties can often do well with minimal offerings,” Lea said. Generally, the more amenities the better, whether you’re offering smart-home thermostats and lighting, a digital rent payment platform or services such as an on-site gym.
- Sales history: When you review the property’s history, you should look at more than the property’s sale price. If the property repeatedly changed hands every two to three years, for example, that’s a red flag to keep in mind.
2. Location
A building’s location is just as important as the physical property. “As an investor you’re looking for asset appreciation and income growth with the least possible risk,” Lea said. “Property location has always been a primary focus in real estate investment as this plays a significant role on the expected return.” Several factors can help you get a better picture of the property location and surrounding area, including:
- Walkability ratings
- Crime rate
- School district ratings
- The condition of nearby homes and buildings
- Local price trends
- Vacancy rates
- Future projects planned for the area
When looking at a building’s location, you’ll also want to consider its proximity to points of interest, local policies and regulations, and environmental concerns.
- Proximity to points of interest: Future residents want to live near public transportation and highways, grocery stores and restaurants, and often their workplaces. As you scale your business, you may also want to consider the building’s location in relation to your other multifamily properties to help create economies of scale for maintenance and management.
- Environmental concerns: “In certain markets, buyers must be aware of environmental factors—such as earthquake and flood risk—and the impact they may have on the individual property,” Lea said. Conduct a thorough physical and environmental assessment to make sure you aren’t overlooking potential costs. For example, areas at increased risk of natural disasters may require additional insurance.
- Local policies and regulations: Local regulations can vary widely. Be sure to look at real estate taxes, zoning, rent control, insurance requirements and upcoming legislation that may impact your purchase and expected returns. For example, you may not want to buy a multifamily property and add high-end cabinetry and quartz countertops if the building is subject to strict rent control requirements.
3. Financial considerations
Make sure the property’s characteristics fit with your goals and experience. Specifically, look at your:
- Property acquisition and exit plan: Whether it’s a buy-and-hold strategy or rehab, your plan for property acquisition will influence your debt and equity structure and purchase price. “Make sure you understand the historical actuals on the expense structure, not just what the broker estimates they could be,” Lea said. “Each building is a little different based on its physical features and mechanical systems.”
- Repair and renovation costs: The general rule of thumb is to set aside 1% of your property’s value for maintenance. But that doesn’t mean you won’t have costs upfront, whether that’s standard maintenance or extensive upgrades. Even if you aren’t renovating a property and the building is in good condition, there can be additional costs involved, such as updates to comply with new building codes.
- Cap rate: Calculated by dividing a property’s net operating income by its asset value, the cap rate asses the yield of a property over one year. The higher the cap rate, the greater your risk and return—and the greater impact on your bottom line. You don’t want to overleverage yourself. “Appropriate leverage on a property loan can go a long way to mitigating cash flow problems, especially during an economically challenging environment,” Lea said.
