Why are RE Funds Paying Way Over Value in Select Markets

[Michael Tempel]

First off....I am taking a short break from the Minneapolis, MN market. Outside investors are paying beyond a premium and I am seeing long term hold investors sell like crazy. I am not talking about single family portfolios, but 100-2000 unit portfolios.

That does not even consider development! My favorite is "222 Hennepin Apartments" they created an amazing space (great job, love the leadership in that company), but quickly realized they needed to move on. The numbers are extremely tight in new construction, especially downtown Minneapolis. It is obvious they wanted to exit quickly at a premium and I believe it is a superior product that should sell at an extremely high rate.

My point is....there are tons of funds that have excess capital and nothing to do with it. THEY SIMPLY WANT PROJECTS....THE COOLER THE BETTER.....but....THEY DONT MAKE GREAT RETURNS.

I like to make 15 to 30% returns....these Chicago, NY and other fund mangers are happy to make 8% on your money. God Bless them. I cannot wait to buy back these properties, it is obvious that they are taking the easy route now, but will be in a heap pile of crap when they realize they don't understand what they bought at a premium.

[Joshua Nicholas]

I used to feel the same way about the ridiculous prices that these guys are paying for assets but now I understand it. For example, last week I sat down for 2 hours with a guy who owns 4,000 units+ in NYC. $400mm+ in holdings, personal net worth of $150mm+ easy.

He told me he borrows at 1.85%. I don't care what you're buying, when your cost of capital (They also give him 75% LTV) is 1.85%, almost any going in cap rate is gonna translate into an incredible return over a 2-5 year horizon. Particularly when compared to the option of US Treasuries yielding you zilch, which is the only real competition when it comes to an asset class being able to handle this volume of investment.

Secondly, they're massively overpaying only in select markets. NYC, Seattle, SF, LA, Boston, DC. These are tier 1 markets, more importantly they're very supply constrained and a hotbed of foreign liquidity flows. Buying a building at a 1% cap rate is something that seems like it makes zero sense. But it might be located in a market that has 5-10% annual rent growth and where there is an insatiable demand for multifamily property. 

Heck I've seen properties in NYC that I thought were EXTREMELY expensive in 2012 but now have appreciated 100% in the last two years alone. 

(And again, when you're using 75% LTV first mortgage at 1.85%, 15% mezzanine debt at 12% and putting down 10% while rents are rising 5-10%/year and interest rates are falling, it's easy to see why they're so eager to buy anything they can get their hands on.)

Third, as a poster above said, these guys are paid to put money out. Even if they think properties are overvalued, they are paid to invest so that's what they're forced to do unless they want to face massive redemptions. On top of this, they've seen this massive liquidity boom make some of their competitors obscenely rich and they don't want to miss out. Classic herd mentality.

Last point, not to be rude but I couldn't disagree more with your final point. I'm not sure about MN, but all of the investors in NYC who are paying huge prices are either family dynasties with limitless funds, or extremely successful investors like Ofer Yardeni. 

These are the guys who can negotiate loan workouts, bring in additional equity partners in order to buy their own debt at a discount during a financial crisis and more or less live in their own world. I wouldn't count on being able to ever buy assets from these guys at a steep discount.