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The 2020 calendar saw its last page turn and everyone, without exception, was happy to say goodbye to a year that nobody wants to remember. It’s exciting to have entered a new year and we’re all hoping that 2021 will be a complete change for the better. Many passive investors in multifamily real estate are wondering what the new year will bring, so I’ll review some current trends that will help to show what we might expect.
By way of background, I’m a multifamily syndicator, owner-operator, and investor in properties in Texas, Georgia, and Florida. We have 2,300 units, and my company is currently looking at properties in the Carolinas. Our focus is on Class B properties and we do value-add improvements to push rents and increase income.
In March of 2020, just as COVID hit the United States, there were many dire predictions about multifamily properties. It was predicted to be the “Armageddon,” with high vacancy rates and falling prices, but fortunately, those predictions never came to pass. Rather than dwelling on the past, let’s take a look at the current multifamily trends that are important to know now.
Occupancy and Prices are Stable
Occupancy is holding steady, with no huge shifts in either direction. Everyone was curious about what would happen to occupancy rates due to COVID, but their worst fears never materialized. Early negative predictions indicated that occupancy rates could fall by 10% to 20% or more. In fact, occupancy is currently running at 93% to 100%.
While many buyers were sitting on the sidelines waiting for “fire sale prices” on multifamily properties to appear, nothing happened. There hasn’t been an increase on cap rates or a decrease in prices because properties are doing well, and there’s simply no justification to lower prices. The only price declines are properties with 15% bad debt and higher or those with high vacancy rates. In those situations, the owners are unable to pay their lenders and stay current with their expenses.
When you look at how properties are performing during COVID, you’ll find that in most cases their performance is on a par with pre-COVID results. Multifamily properties have done well during recessions, and while no property is recession-proof, multifamily properties are showing that they are “recession-resistant.” That is particularly true during COVID; having the right property in a strong market is proven to be a good investment. In addition, with demand for multifamily properties still strong, there is simply no reason for sellers to reduce their prices.
Bad Debt is on the Increase, but so Are Rents
Whether you’re a passive investor or a property owner, nobody likes to hear the words “bad debt.” When tenants are behind on their rent, the rent is delinquent. After a certain amount of time, it becomes apparent that the renter won’t be able to become current, and the delinquent debt becomes bad debt since it’s not collectable.
Prior to COVID, a reasonable bad debt percentage was 1% to 2%, and in some instances, 3%. Since COVID hit, bad debt is running anywhere from 6% to 9%, but the higher percentage is found in Class C and Class D properties where the tenants are struggling with unemployment, as most of them worked in the restaurant and service industries. This impacts investors, as bad debt hurts cash flow and overall Net Operating Income (NOI), resulting in smaller monthly payments to investors.
Bad debt is hurting property owners throughout the country, as there isn’t any one region where it’s more prevalent. Remember, prior to COVID bad debt was as low as 1%, and in many cases, it was zero.
On the flip side, there are two forces that are helping to reduce the impact created by increasing bad debt: the new relief bill and the fact that rents are rising in many markets.
Congress recently passed a new COVID-19 Relief Bill that includes a second round of PPP (Paycheck Protection Program) loans which will help small businesses rehire employees with forgivable loans. It also provides a $300 weekly unemployment benefit supplement through March 21st of 2021. Most importantly for investors and owners, it includes $25 billion in rental relief for tenants, to help them pay rent and utility bills. The new Relief Bill also allows landlords to apply for rent payments on behalf of their tenants.
One interesting aspect of the timing of the increase in bad debt is the fact that we’re seeing an increase in rents, as I’ve mentioned before. Even though some markets have seen a decline on average rent, in many markets, the situation is the exact opposite. In Atlanta, for example, rents have increased, and on my properties there we have pushed rents up by 39%. Tenants are willing to pay higher rents, especially on newly renovated units, and it helps in mitigating the impact of bad debt.
New Construction is Down
The amount of new construction for multifamily properties is considerably lower than in years past. This is actually good news for Class B property owners, as there is less competition for tenants from Class A properties. Some major markets, like Dallas-Ft. Worth, are seeing a lot of new construction coming online. Overall, however, there are fewer and fewer new units being developed compared to new construction during the years 2018 - 2020.
The reason for fewer properties coming online is that there is continuing uncertainty in the multifamily real estate market, as well as in the profitability potential. Investors and developers are unwilling to take unnecessary risks until the pandemic is under control. Fewer new units online also helps to keep rents stable, as there is less competition in most markets.
Adjusted Expectations for Investors
Passive investors are experiencing lower returns since COVID appeared. Pre-COVID, investors could expect 8% to 9% cash-on-cash along with a 15% to 17% IRR (Internal Rate of Return). Now, they’re seeing 7% cash-on-cash and 13% IRR – numbers that are far lower than pre-COVID levels. Nonetheless, these are still very good returns, especially if you compare it to other asset classes and other investment vehicles.
Properties are in fact performing well, but syndicators don’t want to take the chance that new properties will perform as well as others. I’m conservative in my estimates, so on paper I show potential investors lower return numbers on properties we’re syndicating. Even though we’re getting a 39% rent increase on one of our Atlanta properties, I still like to project conservative returns. I put in my projections numbers that are as low as 0% or 1% rent increases, especially during the first year of operation.
Nobody can predict what 2021 will bring. As a conservative syndicator, I have to show potential investors that occupancy might not be as high as it was, or that bad debt might increase, so they have to assume that cash flow will be lower. By presenting, at least on paper, the “worst-case scenario,” investors are getting a realistic view of what’s possible.
Summary
Due to the global pandemic, 2020 is a year most everyone would like to forget. Fortunately for passive investors and owners of multifamily properties, the negatives that were predicted to happen never happened. There wasn’t massive vacancies and prices held steady, despite predictions to the contrary. There were some trends that evolved that should be noted as an indicator of what may happen in 2021.
Bad debt was on the increase, as many tenants lost their jobs and those behind on rent entered delinquency, and then bad debt status, when it was clear they wouldn’t be able to pay. Pre-COVID bad debt was 1% to 2%, and during the year as COVID hit that number went up to anywhere from 6% to 9%. Occupancy, however, is stable and maintaining at levels from 93% to 100%. Interestingly, while bad debt did increase, so have rents – despite the economic turmoil that hit the country.
Property prices remain stable, showing multifamily property’s remarkable ability to be “recession-resistant.” There aren’t any “fire-sale” selloffs, and buyers who waited for prices to drop missed out on some good opportunities in the marketplace. Most properties are performing well, at or near their pre-COVID levels.
New construction is down, particularly in Class A properties. This is welcomed news for Class B property owners, as there isn’t any new competition that requires rent adjustments. The decline in construction is due to ongoing uncertainty in the multifamily market, as well as the fact that developers want to avoid taking risks until COVID is under control.
Returns for investors are lower, mostly due to conservative syndicators wanting to keep increases realistic. While we’ve enjoyed rent increases of 20% to 30% and higher at some of our properties, we only project minimal rent increases on new projects, especially during the first year of operation. This provides potential investors with a more realistic look at what’s possible.
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About the Author
Ellie is the founder of Blue Lake Capital, a real estate company specialized in multifamily investing throughout the United States. At Blue Lake Capital, Ellie helps investors grow their wealth and achieve double-digit returns by investing alongside her in exclusive multifamily deals they usually don't have access to.
Ellie is the host of REady2Scale , a podcast that highlights honest, insightful, and thought-provoking discussions on the multiple approaches for 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 at www.bluelake-capital.com and learn more about Ellie at www.ellieperlman.com.