Fortis Perspectives – February 2018

FROM THE DESK OF OUR MANAGING PARTNER, RANDY HUBSCHMIDT

Today’s Multifamily Housing Sector

In Order to Sell Right, You First Have to Buy Right

 

Key Takeaways

  • Proper market analysis is essential for success when investing in multifamily housing.
  • Multifamily housing should remain strong as new tax laws make single family ownership less attractive and as downsizing Boomers migrate to urban markets vacated by Millennials.
  • There is still plenty of upside left for properties that can be upgraded quickly and cost effectively and can be re-positioned in the market.

Recent stock market volatility has caused many to wonder if the real estate market has also hit its near-term peak. Many investors have asked me if it’s time to take some chips off the table or diversify into other sectors of the real estate market.

Real estate is notorious for its boom and bust cycles. As is the case with other asset classes, as returns continue to increase, more capital is attracted. As more capital is attracted, investors become increasingly aware that returns are on the upswing and thus, still more capital flows in that direction. At some point the music stops and you don’t want to be the one left without a chair. Sound familiar?

How real estate differs from stocks

Unlike publicly traded stocks, it takes time to deploy capital into real estate. If you are talking about a development, entitlements take time, contractor bids are collected, building commences and finally “lease up” (attracting tenants) begins. This process can take several years. By the time lease-up begins, the market may have shifted and the projected rents may be unachievable. If the projections are rosy to begin with, or if the project is over-leveraged, then returns on this investment will suffer.

If we’re talking about a “reposition” or a “value-add” project, there should be existing cash flow that can be reinvested into the property to make the required capital improvements. If the property can be quickly upgraded and repositioned in the market, then its owners will be in a better position to take advantage of the market upswing before time runs out.

Unfortunately, real estate investors often enter the market too late in the cycle and end up buying at the top of the market. This may certainly be the case when it comes to some of the multi-family assets being purchased today.

How real estate is like the stock market

Real estate and equities are in the sense that it’s very hard to financially engineer your way out of a bad investment or to rely on the “next bigger sucker” to provide your exit. If buying real estate at 5 cap or buying a tech stock at 100 P/E, how much more room is there to go?  As the old saying goes, “In order to sell right, you first have to buy right.”

  • If you buy right, you can always hold the asset for the cash flow it generates and sell when the market turns back in your favor.
  • If you buy right, you can sell when you want to, not when you have to.

According to Multifamily Executive’s (MFE) 2018 Investment Forecast, competition for attractive assets becomes tighter as valuations increase, and as a dearth of yield persists in fixed income. Thus, operational expertise becomes even more important.

The MFE report also said to expect continued outperformance in the secondary and tertiary markets despite the increased competition for high quality assets. Primary markets continue to attract the most attention driving capitalization rates down. Thus, those assets may yield lower overall returns.

Challenges will be ‘the same, but different’

MFE’s report also had an interesting take on Millennials and their propensity to rent in urban markets: “Challenges will be ‘the same, but different.’” MFE and other market observers say statistics no longer support the belief that millennials will be lifelong renters—i.e. perpetual members of the sharing economy that not only don’t buy homes in the suburbs; they don’t even commit to purchasing cars in order to get around.

Not so. Millennials are clearly delaying marriage, children and household formation later than previous generations did. But, here’s the thing: Eventually they are getting married, starting families, buying cars and migrating to the suburbs. This trend would normally be adverse news for the multi-family housing sector, but there’s another powerful trend taking place–aging Boomers are doing the reverse. Boomers are downsizing, which means they are selling their suburban homes and moving into multifamily units in urban areas. I suspect this trend to continue for the foreseeable future.

As Bendix Anderson recently explained in National Real Estate Investor (NREI), The Apartment Sector Boom (Is) Set to Continue in 2018. Anderson’s report said the new tax law changes will create an increase in overall renters as the tax benefits of home ownership have been reduced for the time being. The NREI report also said that Developers will continue to focus on the primary markets, as well as on gentrifying surrounding areas and on building luxury apartments. According to the report, these developments charge rents at the top of their respective markets and face significant competition from other luxury apartment offerings. The report also said it will be increasingly difficult for those properties to raise rents.

At Fortis, we tend to agree with Anderson’s assertion that the strongest returns can be achieved in the secondary markets—markets that are located close enough to primary markets so they can “siphon off” prospective tenants who’ve been priced out of primary markets and where competition among buyers is reduced.

Conclusion

Real estate has, and always will be, an important component for a well-balanced long term portfolio. If you or someone close to you is concerned about your lack of diversification or wealth building strategies, please don’t hesitate to contact us.

Randy Hubschmidt
Managing Partner, Fortis Wealth

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