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When is the next deal coming?
This is a question I get a lot from our investors, so I wanted to share our view on how the current economy is affecting real estate deal flow.
We all know that interest rates and rents have been going up across the country, but what’s the impact been on real estate acquisitions? In terms of the deal flow specifically, there’s definitely been a slow down since the Fed first declared its intention to increase rates.
Since then, a lot of sellers have pulled deals out of the market or they've been hesitant to put their deals in the market because they run a quick calculation and think: “If I had put the deal in the market three months ago, six months ago, a year ago, I could have gotten millions of dollars more”.
It's painful for some sellers to accept that they’ll get less now than what they could have gotten a few months ago. However, some sellers don't have a choice; perhaps their loan is due, they may have issues with a partnership, or they may want to move away from a certain market or asset class.
Regardless, many sellers still want to test the market and see if they can get the price they want. If they can’t, they’ll quickly pull it off and either: 1) plan on putting it back on when they feel the time is right or 2) engage with buyers who they know can close deals. As a result, we’re seeing a pickup in the number of off market deals right now, creating more opportunities.
In addition to market conditions, we’re starting to experience seasonal cyclicality. We typically see fewer deals towards the end the end of the year and into the new year. A lot of sellers don't like to sell during the winter months.
This in turn creates a seasonal slowdown. A lot of people are traveling and spending time with family at this time of year, so deals are put on hold, creating a backlog. Starting in mid-February, volume typically picks up again; deal flow increases, and we see more and more deals hitting the market.
What does this mean for multifamily real estate prices?
Generally speaking, the pricing of multifamily assets has stabilized, but occasionally we’ll see deals where prices have gone down a bit. Right now, that's primarily due to economic forces; interest rates are increasing and inflation remains high, so cap rates have increased.
When cap rates increase, real estate prices generally go down, and a lot of buyers have begun to adjust their expectations in terms of the yields that they're expecting.
That's why, even with a cap rate that is higher by 50 or 75 basis points, some groups are still making very competitive, aggressive offers. Instead of getting 6% or 7% cash on cash, they’ve adjusted their expectations and are okay with getting 3% or 4%.
Again, this relates to the deal flow because, especially now, a lot of groups know the end of the year is coming, they know they need to deploy capital and they're willing to pay a premium because they need to do it this year.
What can you do to get more deals?
As a buyer, what do you do when you understand that economy is now in a state where it's affecting real estate deal flow?
This is what I want to share with you as a sponsor of multifamily properties.
What we do at Blue Lake Capital, first and foremost, is rely on brokers to bring us deals. Brokers are key gatekeepers; they are the ones who are recommending to the seller which buyer to go with. Ultimately, it's the seller's decision, but brokers are a very, very important piece of the whole process.
We focus on strengthening our broker relationships to make sure that we’re getting the phone calls when there's an off-market deal and that the brokers are helping to promote our brand and putting our group at the head of the pack.
Essentially, we’re hoping they’ll tell sellers: “We've transacted with these guys, they’re good buyers. We enjoy working with them. Even if their offer isn’t the highest, you want to award the deal to them because they’re more likely to close and they're a good group to work with.”
It’s imperative that our brand & reputation are intact, and our relationships with the brokers are very strong, as strong as we can have them.
Another way to ensure there are enough deals coming your way is to develop relationships with owners and ownership groups. Make sure you can tap into your relationships with the groups you’re calling on to bid on deals now and you may see more off market opportunities come your way down the road.
Just remember; with everything that is happening in the economy today, it's becoming more “interesting” to win deals. There are some adjustments you’ll need to make to ensure a slowdown in deal flow is not going to bring your individual deal flow to a complete halt.
How to select the “right” properties
When considering properties, the main thing I advise anyone to focus on is the tenant base, which is a function of the location.
You should focus in areas where the tenant base is strong and solid, where they're going to keep up with rents so that delinquency and bad debt are not going to be an issue.
My favorite tenant base is usually centered around the medical and tech industries; that's why we're looking into areas like the Research Triangle in North Carolina, the Raleigh-Durham area.
There’s a strong tech base there with a healthy delta between income and the cost of living, so tenants are able to pay rent and are willing to pay premiums for nicer apartments. In an environment where there's a slowdown in deal flow, you want to make sure that the deals you win have a potential tenant base that’s as strong as possible.
Adjusting Expectations
In terms of financing, it's interesting because loan to value used to be 65% to 75% just 3-5 months ago, and now we're talking about 50% to 60%. It's a very important piece of the puzzle, because the lower the dollar amount coming from the lender, the higher the dollar amount from equity, and that impacts returns.
A key point here, again, is to adjust expectations. When you underwrite a deal, I wouldn't recommend making assumptions of 20% rent increases or even 7 or 10%, even if this is what you’ve been getting now on other deals in the market. Be conservative.
This could all end tomorrow, so you want to plan for the worst and hope for the best. Basically, adjust expectations in the underwriting and with projections. It’s important that we invest with our eyes wide open and understand, for instance, maybe 3-5% cash on cash is a more reasonable expectation today for assets in strong markets.
Key Takeaways
In summary, here’s how the current economy is affecting multifamily real estate deal flow:
• There has been a slowdown, but prices are generally stable and we are seeing more off market deals.
• Developing strong relationships and a strong brand are key to keeping your deal flow active and filling your funnel.
• Returns are not what they were before; that's partially because the loan to value is lower and you need more equity to close deals.
• The main thing is to adjust expectations and understand that, while returns may not be as high as they were before, they’ll still be solid.
• Operationally, it’s important to understand the forces impacting your yields. If it’s financing and pricing, you should know up front. If expenses increase due to inflation, you should make adjustments. It’s different from how things were just six months ago.
Is multifamily still a very strong asset class to invest in? Absolutely. Is it a “bulletproof” asset in a recession? There's no such thing.
While you can’t say multifamily is “recession proof”, it is more “recession resistant”. When you ultimately sell the asset, there will be a nice bonus check at the end along with tax benefits, so multifamily still makes a great investment.
Understand all the different parts your investments, the returns with the debt structure and your operations. As long as you invest in the right markets with a strong tenant base, you should be fine.
Be well, be strong and keep pushing forward!
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About the Author
Ellie Perlman is the founder of Blue Lake Capital, a commercial real estate investment firm specializing in multifamily investing throughout the United States. At Blue Lake Capital, Ellie partners with both institutional and individual investors to grow their wealth by achieving double-digit returns by investing alongside her in exclusive multifamily deals they usually don't have access to.
A defining factor of Blue Lake Capital’s strategy is founded in utilizing machine learning/artificial intelligence throughout the course of all acquisitions and asset management. This advanced technology enables the company to produce accurate and data-driven forecasting for all assets on a market, property, and even tenant basis. In doing so, Blue Lake is able to lead commercial investments with the full capabilities of today’s technology.
Ellie is the host of REady2Scale, a podcast that highlights the assets, processes, and strategies for the multiple approaches to successful real estate investing.
She started her career as a commercial real estate lawyer, leading real estate transactions for one of Israel’s leading development companies. Later, as a property manager for Israel’s largest energy company, she oversaw properties worth over $100MM. Additionally, Ellie is an experienced entrepreneur who helped build and scale companies by improving their business operations.
Ellie holds a Masters in Law from Bar-Ilan University in Israel and an MBA from MIT Sloan School of Management.
You can read more about Blue Lake Capital and Ellie Perlman at www.bluelake-capital.com.