July 7, 2022
When a tsunami of bad news hits the economy, most investors pause and assess the short- and long-term outlook. Although multifamily investors have shown undeniable resilience over the past two years, the recent shift of inflation, labor shortages and supply chain bottlenecks have created a new reality.
First, let’s acknowledge the challenges.
On June 15, the Federal Reserve raised its benchmark interest rates by 75 basis points. This reflects the biggest hike in almost 30 years, even without acknowledging the two previous rate hikes of 25- and 50-basis points. Inflation metrics are even more worrisome: For example, the Personal Consumption Expenditures price index (for the year ending in March) just spiked by 6.6 percent, reflecting the highest inflationary measure in 40 years. Overall, the outlook for GDP growth in in 2022, which was at 2.8 percent in March, adjusted downward again to 1.7 percent. Many economists now predict a mild to moderate recession in 2023.
These shocks to the economy have roiled the commercial debt markets—lenders have tightened standards, lowered LTV limits and required larger reserves. Bridge debt, the primary method for financing value-add deals, has almost evaporated. This has caused many deals currently under contract to fall apart. Buyers who did not lock a rate before the last spike have deals that just don’t pencil out at prior pricing expectations.
What does this mean for multifamily investors? There are divergent views on how to move through these market conditions.
One multifamily investment professional believes bid pricing is generally down 5 to 10 percent, and perhaps even more in weaker markets. Bidders are down by a stunning 75 percent—a deal that would have attracted 15-plus bids just this spring will get maybe three or four today. We see this in our own business: Marketed deals are failing to meet even reduced pricing guidance, and ownership groups that we’ve been in discussion with for months have now lowered their expectations anywhere from 5 percent to 15 percent. Although some investors don’t need to sell, other groups have an immediate need to solve for an exit strategy. These groups have become much more reasonable in their pricing expectations.
Large fund groups with conservative capital have either gone pencils down for now, or become too conservative in their underwriting to realistically pursue any viable opportunities that still achieve the desired returns. They still have large pools of capital to draw on, and can afford to take a wait-and-see approach. Some mid-sized and smaller groups are excited about these market conditions, because they smell some blood in the water. These investors are looking to take advantage of less competition.
At Offerd, we are with the latter group. We see significant opportunities to capitalize on this market shift; in fact, we’ve been looking forward to just these market conditions for years.
Trends that boosted this market for the past decade have not changed. If anything, recent demographic shifts and other trends have propelled the need for more multifamily options. The country is still undersupplied for both single and multifamily housing, which will continue to support aggressive rent growth. There’s a savvy generation of millennials that doesn’t want to be tied down in one location with a high mortgage. A digital workforce that was already happy away from the office is now even more content working remotely. Smaller hubs close to university campuses and technology jobs in a variety of markets continue to draw more residents than current multifamily options can support.
In the near term, finding deals with favorable long-term and assumable debt in-place is one strategy to get deals done. Even if you need to put a supplemental loan on the property, the blended cost of capital is going to be better compared to a new loan. As we move through the next few months, there will also be groups that have floating bridge debt in place that may be problematic as their debt payments soar. Groups that have access to capital will be well positioned to take advantage of that pain.
Debt funds and other alternative forms of lending will also ascend in the current environment. Offerd just had a well-capitalized group inform us that it just went under contract for an asset with a 10-day cash close. That’s a strategy reminiscent of the single-family market.
Our core value proposition at Offerd has always featured the right combination of market intelligence, meaningful relationships and strategic timing, and we’ll build on those strengths to take advantage of the current and future market conditions. We work in partnership with some of the best operators in the industry to find targets that best suit the buy box. Every day, we leverage our proprietary technology stack to find new markets and pockets within parameters that make sense.
Our database contains over 100,000 assets around the country, and our platform allows endless experimentation with key data points. While others hover on the sidelines, we’re accelerating our efforts.
In the words of Warren Buffet, “be greedy when others are fearful, and be fearful with others are greedy.” In these strange times, those words are more valuable than ever.