Multifamily vs. Commercial

[Ash Patel]

A lot of Multi-family investors are feeling the pain from "unforseen" interest rate increases.  There is a perception unique to Finance and Real Estate folks that rates will be lower in Q4 of 2023.  Based on Jerome Powell's comments last week, this doesn't appear to be the case.

Large MF deals were built upon variable rate bridge loans.  These bridge loans have expirations and the result will be loss of capital due to decompressed cap rates.  Quick illustration below:

$30mm purchase at 3% cap 
NOI = $900,000 (30,000,000 / .03)
Value at a 4% cap = $22,500,000 (900,000 / .04)

Loss of $7.5mm based on a one percent cap rate rise.

My advice for multifamily investors is to look at other asset classes. Already they have pivoted to MHP's, RV parks, self storage, car washses and laundromats. The cap rates in those asset classes have already compressed and they are saturated with people looking to deploy active and passive income into.

For over 10 years, I have been screaming from the mountain tops to invest in office, retail, industrial, land development, flex, warehouse, mixed use, restaurants and conversions. We turn down deals that are 15% cash on cash all day long.

Retail Negatives 
The amazon effect will kill retail
Big Box closures (JC Penney, Toy r us, Bed Bath and Beyond etc)
Malls are closing

Retail Positives
Can't kill internet and recession resistant businesses (dog groomers, restaurants, bars, medical, QSR's, hardware, urgent cares etc)
Retail grew at 6.9% year over year
CBRE reported retail vacancy is the lowest it has been since they started recordigng that metric at 6%

Retail Play
Buy retail in suburban locations where new competition is land locked.
Stress test your deals and tenants
Stay away from areas where there are millions of sq ft of retail (think where the Costco's or Best Buys are)
Post Covid, we have become accustomed to going to suburban downtowns vs metropolitan city centers and that is where all of the growth is.

Retail Case Study
We purchased a 96k sq ft strip mall that is 18% cash on cash at purchase.  Vacancies include 10k and 6k spaces and a 31k sq ft furniture store paying 40% of market rent.  $5.025m purchase 13 months ago.  Below is what we did to add value:
Furniture store rent went up by $3.50/ft x 31k sq ft = $100k to NOI
10k sq ft leased at $8/ft = $100k to NOI
outlot (small portion of parking lot) sold to Scooters Coffee for $460k
Several other value adds.  $200k noi increase at a 8% cap = $2.5mm in increased value
This Property was listed.  18% pref to investors and 30/70 split thereafter.  We increased the pref to investors to 22% last quarter.

Office Negatives
Office space is arguably around 50%, work from home is here to stay.

Office Positives
I believe when employers regain the upper hand, people will be back into the office.  Already tech companies, Wall Street Banks and even Disney have demanded emlpoyees return to the office.  You can pick up office space for pennies on the dollar.  A once in a lifetime opportunity.

Office Play
Those of us that have owned small suburban office for years know that the demand has never been higher.  Even those that work from home are renting offices from us because they need a space to "work".  Employers are even paying for employees to rent office near their homes.  If you have excess liquidity, pick up class A office that is stabilized with a high vacancy if you can break even.

Office Case Study
All of our small suburban offices have been fully leased for years.  We picked up a turn key co-working building/business for $1.6mm.  Cash on cash day one was 35%.  Three months into ownership we marginally increased rates which are still below market.  Current cash on cash is 65%.  This was on loopnet!!!!

I can write a similar synopsis for each of the asset classes that I have mentioned here.  My point, take the blinders off and look where no one else is looking.  Our debt on these assets is always locked for 5 - 10 years even if the first couple years are interest only.  

[Ash Patel]

@Gino Barbaro - I have been in commercial for 10+ years and started with a $230k mixed use building and built up over the last decade. I started small in each asset class and learned from making a lot of mistakes. I am not advocating over leveraging or even risking other peoples money. I have always been an advocate of start within your comfort zone. The one thing I advocate to all that I mentor is to stress test deals. How much additional vacancy and rent decreases can the deal handle? It seems that some in the MF world believed the arrow always goes up and to the right. There is no doubt that a syndication bubble has been brewing for years. The fact that I hear, "we never exptected the fed to raise rates" is shocking. I think the MF space is overcrowded and it has become too easy to become a MF syndicator and put other peoples money at risk. People were bragging about OPM as if it was a badge of honor vs. the highest level of responsibility. We are seeing the fallout with paused prefs and capital calls and I think MF has a lot more carnage on the horizon. Don't get me wrong, CRE will certainly take a hit but when we buy value add at 18% coc, we have the wiggle room to absorb economic headwinds. Respectfully - Ash