Having looked at several multifamily deals in secondary markets, and the taking prices and the projections, I am left to wonder who other than a REIT can make good sense of buying some of these properties. While the assets are decent, they are often older, in need of material renovation, and have some but limited rent upside due to the markets they are in and their age. In the current debt market, one can make good sense of a decent current return in the teens levered, but assuming a 5 year hold and the ten year rising to 4% or more likely 5% over the term of investment, it is hard to understand where the capital gain will be on an asset in a secondary city that is now maybe 30-45 years old. There is no real upside to the next buyer as the renovation will have been completed, the rents raised and wages and demand will not likely have increased a lot to justify material increases in rents for pretty ordinary suburban located apartments. In the meantime operating costs will have increased.
This appears to have resulted in REITs being able to swoop in and pay unrealistically high prices to get a nice asset that will yield a decent cash flow to the REIT. An individual investor has a very different outlook in most cases and is in for cash flow plus an upside and possibly the management fees. For the passive investor in these assets it is fine if all they seek is a higher yielding asset to provide a relatively safe cash flow for a period of time, but there Is no real capital gain.
When comparing investment alternatives for thje passive investor, it depends on their goals, but one could reasonably argue that a securities portfolio of mainly good quality equities traded on public markets is a better investment over the next five years for someone who does not need to access the cash. It is a reasonable assumption that over the same five year hold period the economy will eventually improve, and stocks will be higher an average over that period at the long term increase of 7.5%-9%. In the interim there are dividends of on average for good stocks of 2% more or less. While there is far more risk that the stock will gyrate in value in that period, compared to the multifamily asset, it is also far more likely that the portfolio of stocks will generate a much better levered return with capital gains over the same term and the investor will have daily liquidity if needed.
I am not suggesting that multifamily is a bad deal. It is not bad if bought right, and there is renovation upside. Instead I am suggesting that cap rates and REIT competition is now at the point where public equities markets are probably a better investment alternative for many passive investors over a five year hold period where rates will almost surely rise maybe by 100% if they go from the current 2.5% to 5% which is in line with long term rates on the ten year in a well performing economy. Cap rates on real estate have to go up over the next five years as the ten year rises, and if the economy does not improve and push up rates, then we all have a much bigger problem. Equities may be fully priced right now, and maybe it is not a wonderful time to invest given the geopolitical situation and the complete lack of leadership and ability in this administration, but buying on dips is likely good if you are an investor to hold and not a short term investor. It all depends on the investor, his goals, his risk tolerance and his desire for current yield or long term gain.
It is getting much harder to justify passive investment in multi when faced with the competition from the REITs which have a very different hurdle and hold goal than non REIT investors.
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Joel Ross
Joel Ross began his career in Wall St as an investment banker in 1965, handling corporate advisory matters for a variety of clients. During the seventies he was CEO of North American operations for a UK based conglomerate, and sat on the parent company board. In 1981, he began his own firm handling leveraged buyouts, investment banking and real estate financing. In 1984 Ross began providing investment banking services and arranging financing for real estate transactions with his own firm, Ross Properties, Inc. In 1993 Ross and a partner, Lexington Mortgage, created the first Wall St hotel CMBS program in conjunction with Nomura. They went on to develop a similar CMBS program for another major Wall St investment bank and for five leading hotel companies. Lexington, in partnership with Mr. Ross established a hotel mortgage bank table funded by an investment bank, and making all CMBS hotel loans on their behalf. In 1999 he formed Citadel Realty Advisors as a successor to Ross Properties Corp., focusing on real estate investment banking in the US, UK and Paris. He has closed over $3.0 billion of financings for office, hotel, retail, land and multifamily projects. Ross is also a founder of Market Street Investors, a brownfield land development company, and has been involved in the acquisition of notes on defaulted loans and various REO assets in conjunction with several major investors. Ross was an adjunct professor in the graduate program at the NYU Hotel School. He is a member of Urban Land Institute and was a member of the leadership of his ULI council. In 1999, he conceived and co-authored with PricewaterhouseCoopers, the Hotel Mortgage Performance Report, a major study of hotel mortgage default rates.
