In this week’s episode of the Actively Passive Investing Show, Travis Watts highlights the major challenges multifamily investors are currently dealing with and shares his insights on how to successfully tackle each of them:
- Systematic risk. When it comes to publicly investing — for example, through REITs — you are subject to the volatility of the market. If the stock market at large is down in a big way, whatever real estate you’re currently holding will likely be down as well.
- Interest rates. Because the Feds anticipate raising rates in order to tackle inflation, real estate pricing will be negatively impacted. However, when investing in a private placement or syndication, you can underwrite with these rising rates in mind. This works for factoring in the possibility of cap rates lowering as well.
- Financing. Luckily, there are many advantages when it comes to financing real estate. You can negotiate flexibility, use agency debt to lock in a great rate, or get private loans with no prepayment penalties. Purchasing interest rate caps is also an option.
- Political risk. While investors have little control over political events, controlling your reaction is key. For example, during the eviction moratorium, Travis saw syndicators maintain excellent communication with their residents to provide them with the information and opportunities they needed.
- Other obstacles to executing your business plan. There are many unforeseeable issues that can throw a wrench in your plans — for example, the supply chain issues many investors are currently facing.
- Wage increases. With today’s rising wages, inflation, and labor shortages, properly underwriting and anticipating raises for maintenance personnel, property managers, and contractors is a must.
Tips to combat these challenges include:
1. Start by identifying your goals.
2. Get educated.
3. Only work with operators in the space that match and meet your criteria.
4. Do your due diligence.
5. Start building your passive income stream.
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Travis Watts: Hello and welcome, Best Ever listeners, to another episode of The Actively Passive Investing Show. I'm your host Travis Watts. In today's episode, what we're focusing on are the biggest challenges that multifamily apartments face today.
We're basically revealing the elephant in the room. We're in a rising interest rate environment, we'll see how far that goes. There's turmoil around the world, we've got Russia-Ukraine stuff going on, we're in a very high inflationary environment... That's a lot to digest, and it's on a lot of people's minds as to what this means for multifamily or how to interpret this kind of data. As always, I'm going to take the complex, try to make it as easy as I can to digest and understand. We are going to address these challenges in today's episode. Alright, let's get started.
I've made five quick points that I want to cover with you guys. The first point is the great thing about multifamily real estate is that it is essential. People do need a place to live at the end of the day, despite what's happening with the economy, the stock market, or what's happening overseas, or even domestically, for that matter. Multifamily apartments and more specifically, affordable housing or workforce housing, is very much in demand right now, and has been for the last 20-30 years.
A different way to look at it would be this. Think about a lot of different stocks out there. Not every company, I would argue, is completely essential. We'll take a stock like eBay, for example. None of us have to use eBay, it's not part of our livelihoods, I guess; maybe if that's your career or something like that, or your side hobby. But for most of us, we could let a stock like that go or sell it off and be fine. For most of us listening to the show here, we can't do the same with our housing. We deem that to be pretty necessary, pretty essential.
Something to think about when it comes to choosing what you're going to invest in, whether you're currently a real estate investor or currently a stock investor, or not an investor at all, always think about the demand and the essential-ness - I don't know if that's really a word, but think about how essential it is to society. With apartments, in my opinion, there's a little bit of risk mitigation already built in from the get-go.
The second point that I want to make is that multifamily apartments, when stacked up to just real estate as a sector in general, tends to be the most stable and the most consistent, if you look at the actual stats and facts of this asset. Think about real estate at large, let's involve all commercial, malls, warehouse, retail, office, hospitality, and self-storage - multifamily apartments really are not that volatile and they really are that stable. So again, from the investor perspective, when you're thinking about what to invest in, it's important to understand your own risk tolerance. Can you stomach volatility?
There's also publicly traded real estate versus private real estate. When you're investing publicly, in a REIT or master-limited partnership, or whatever it is, on the stock market, you are subject to the volatility of the market itself. You have both cyclical risk, but systematic risk. Systematic risk refers to if the stock market at large is down in a big way, let's call it 40%, more than likely, whatever you're holding as far as real estate is concerned is down with it as well. At least to a point; it may not be all the way 40 but it'll probably be down.
The third point I want to dissect, because it's what I mentioned at the beginning of the episode, and that's interest rates. The feds come out to say, "We anticipate raising rates, we have to tackle this inflation that's happening." That is, historically speaking, that's negative for the pricing of real estate, because people can afford less when interest rates are higher, when mortgages are higher. Makes sense, right? But here's the cool thing about private real estate anyway, if you're going to buy, whether it's a single-family home or you're investing in a real estate, private placement or syndication - you can underwrite for that actually occurring. If the numbers still make sense, even after factoring in the interest rates may go up, it might still make sense to do the deal.
I'll give you an example. You're buying a property today, whether it's single family, multifamily, whatever; you're going to get, let's call it a 4% interest rate. But you believe that interest rates might be up to 6% here in just a few years, so you just run your underwriting and your math based upon that. Then, again, if the whole IRR returns still makes sense, you might still want to move forward with the project, rather than letting a factor like that scare you off completely.
Now, again, when you're in some of these evergreen funds, which means that they continuously are buying and selling real estate, or if you're in a publicly traded REIT on the stock market that's always buying and selling properties, unfortunately, they can't underwrite in the same way... Meaning, if I got in one of those funds 10 years ago, well, that wasn't the environment we're in today. So then, when the Fed comes out and says, "Okay, we're about to hike interest rates 1%," that stock is very likely to fall, because people are thinking it's going to hurt the price of the real estate. In the private sector, not so much the case; in the public sector, that would be the case. Another pro to investing privately in real estate versus publicly.
On the same note, I've talked a lot about cap rates. I did an episode a few back where I analyzed cap rates, what that means, how they work, the definition of them. With cap rates, every syndicator that I partner with as an investor underwrites conservatively. If we're going in and we're purchasing a property today and the cap rate is 4%, just for example purposes, they're going to underwrite for a softer market condition down the road. Now, we don't want that to happen of course, that's not a good thing.
But they're going to underwrite to sell the deal it, let's call it a five cap, or even I've seen as much as like a 6.5 cap from four, which. It means that, of course, they're thinking that the price of the real estate could actually come down. Again, if the numbers still make sense for you, the investor, it doesn't have to be something that scares you off. Because if you look at the 50-year chart, or 20-year chart of cap rates, they have just come down, down, down just like interest rates have. What's the probability they go lower? I don't know, they might.
What's the probability that they start bouncing up and go higher? They might. Let's always think about the worst-case scenario, hope for the best but plan for the worst. Again, as an investor, you're always looking at your criteria, you're always looking at your risk tolerance, you're thinking about things like volatility, you're thinking about private versus public, you're thinking about individual asset versus fund model. There's a lot to factor in but keep these top of mind.
The fourth point I want to share with you is about financing and about getting loans. Another great thing about real estate is that you can negotiate flexibility within the loans. You can do a certain period of interest only, for example, you could use agency debt like Fannie and Freddie for longer-term holds on properties 10 years plus, let's say. One advantage to that is sometimes you can lock in some really great rates and have a low fixed-rate mortgage on it. But one of the cons to agency loans is that you can have a high prepayment penalty. If you get an off-market offer, or you want to refinance sale early, something like that, you can be affected by that negatively.
But to the point of saying that this is a pro topic here, you can also get private money and private loans that may have no prepayment penalties, or much lower prepayment penalties, or only have, let's say, 12-18 months from a lockup period perspective, to then allow you to offload your properties in the future in a shorter timeframe. Additionally, what I'll add to this is that you can purchase interest rate caps. Think of it like an insurance policy. If you're getting a 4% interest rate today and you think they're going up in the future, you could buy a cap at 5% which means if you're holding that property and the Fed decides they're raising rates to 7% or 8%, you're going to be capped at 5%. It's just a way to mitigate risk in a rising inflationary and interest rate environment like we have today.
Travis Watts: The fifth point and really kind of the final take home point for this is that you can insure real estate. That's also a beautiful thing when you're thinking of it as an investment and not just your owner-occupied home. There could be a flood, there could be a fire, vandalism, theft, hurricanes, tornadoes, you name it, it can be tricky to insure a stock portfolio back to the example I gave earlier of purchasing an eBay stock. It can be tough to insure something like that. There are some risks, I guess is the point that I'm making, that can be addressed proactively with real estate.
But then, let's talk about some additional risks because, quite frankly, it's not all rainbows and butterflies. There are some definite cons and this could be said to any investment. But let me share a few of these. There are risks such as political risk that's really not in any of our control, there's really not much any of us can do about it besides vote. That would be what we saw during the pandemic where the government says we have eviction moratoriums in place. You cannot evict your residents even if they're not paying your rent, that was a tough one to battle.
The groups that I partner with in these syndications, they did the best that they could, they kept great communication with the residents. They shared with them what opportunities are out there, job-wise and stimulus-wise and rent relief-wise. It's really about all you can do in that scenario, and then just hang tight and hope for the best. But it is a risk to consider when you're investing in an asset class like this.
There's another big risk that a lot of folks don't talk about and it's the risk of not being able to execute your business plan for any given reason. Again, the folks that I partner with when I do a syndication investment have a track record. They use really specialize in one kind of business plan, they've got proven results, and it's about all you can go by. But then you have these risks like what we're seeing right now with the supply chain, that's another big risk happening. It's tough to get supplies and, as you all know, with new cars and the microchip, we're just so behind right now in so many different things.
Of course, I'm making this up for example purposes. But let's say we're renovating a ton of apartments or a big 600-unit apartment building, and we're going to put a value-add business model over it. We're going to put all new appliances, kitchen flooring, countertops and all this, let's say they stop manufacturing appliances, refrigerators, stoves, microwaves. Well, then we can't put them in the property. If we can't buy them, then we can't properly execute the value-add plan. Now prospective renters come in and they see these old 25-year-old appliances and go, "I don't think so, I'm not going to rent here." That's going to hurt our ability to raise rents and to effectively do a value-add business plan.
Something else to keep in mind, that's really tough, supply chain. I guess you could pre-order as much as you can and store it somewhere, but the logistics around that could be challenging. Just keep in mind that there's risk to any kind of investment. Those are just a couple examples of what we're seeing in the environment right now. Another headline you guys may have seen here lately is that wages are on the rise. Obviously, when inflation happens, things get more expensive, people start demanding more money, we're in a big labor shortage as a country. If our maintenance personnel goes from $25 an hour to $40 an hour, that's going to matter.
If that happened, that means that our onsite property managers probably want to raise too, that means any contractors we've worked with want to raise too. If you're not properly underwriting and anticipating this kind of thing, then you might be in some real trouble. It's important to work with groups as an investor who are very conservative in their underwriting. If you're doing your own deals, remember that real estate is a people business, it is a team sport. Anytime you're working with people, you need to think about people problems. One of those being wages.
Here's a few final thoughts to wrap up this episode. If you're going to invest in multifamily apartments in 2022, here's what I suggest. Number one, start by identifying your goals. What is it both short-term and long-term that you're trying to achieve? Is it net worth, is it passive income, is it send my kids to college is it retire early? You need to get clear on what you're really doing before you even get started. This is just aside from multifamily, this is just becoming an investor, get clear on your why first.
Number two, get educated. Read books, listen to podcasts, find mentors, get a coach, paid or unpaid, just attend events, attend meetups, launch a meetup, get out there, get on forums like BiggerPockets. You need to be educated, at least from a fundamental perspective so that you can grow and launch from there and that you understand, again, your goals, your mission, and what you're trying to accomplish.
Number three, only work with operators in the space that match and meet your criteria. This is a big problem that people get into is this analysis by paralysis. They get out there and they get on 100 list for all these syndication deals and are being sent deals left and right, and they don't know which ones to pick or what to do. You got to start with steps one and two to get to step three. I'm in the business these days of unsubscribing, quite frankly.
I don't know how my email has been circulated out there to literally hundreds of groups. I'm constantly unsubscribing when I see something that doesn't match my criteria. Like new development, or maybe it's some crypto thing. Again, I'm not saying that new developments bad or that crypto is bad. They don't help me meet my goals and they don't match my criteria for someone who lives on monthly cash flow and passive income, those, generally speaking, are not going to help me accomplish that.
Number four, do your due diligence mostly on the operator themselves, their background, their track record, who it is they are as people, then focus on the deal in the market second. Because again, one of the biggest risks is that they can't actually execute the business plan. If that can't occur, nothing else really matters. If you've got a terrible operator in a great market, you're likely going to break even or lose money.
Last but not least, my whole philosophy on life and the reason I do these shows and try to help inspire you and other listeners, is start building your passive income stream so that you can focus more on the things that you love doing and you can spend less time on the things you do not enjoy.
Thank you so much for tuning in to another episode of The Actively Passive Investing Show. I'm Travis Watts, let's connect on social media. I'm on bigger pockets, I'm on LinkedIn, I'm on Facebook, I'm on Instagram, I'm on joefairless.com, I'm on ashroftcapital.com Let's connect, let me help in any way that I can. I appreciate your feedback, comments, likes, subscribes. We'll see you next time on another episode of The Actively Passive Investing Show.
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