Leverage Is Through the Roof!

[Ben Leybovich]

Lenders are getting more and more aggressive in their underwriting  - read this...

I am researching a project and reached out to a friend who is working for a big lender.  He confirmed - they are approving stuff that makes no sense anymore.

This bubble has more room to run, but when it bursts, it'll hurt - unless real incomes jump very significantly!

Thoughts?

[Account Closed]

I am with @Serge S. on this one.  I am little annoyed at how everyone claims to be so smart but they aren't doing deals.  I'm not that smart and I've purchased over 3,000 units the past three years on behalf of the fund I work for and every single one of my deals has been a strong performer.  Granted, I look at deals in several markets which helps, but please don't tell me it's not possible.

The last slowdown has scarred many people, for good reason.  But most "slowdowns" don't look like that.  I feel that those sitting on the sidelines and waiting for "massive discounts" may be waiting for a long time.  When overbuilding takes effect, obviously there may be some price relief and sure a little better pricing, but with demographic trends the way they are these days, don't expect to see bargain basement pricing on multifamily any time soon.

I work for a fund that is continually buying, buying, buying.  Let me see if I can explain the rational.

We offer a 7% preferred return to our investors, as well splits above that amount.  Our president is the largest investor in our fund, so we have more skin in the game that any other investor.  We believe rents will continue to grow modestly the next couple of years, most likely.  @Ben Leybovich you are a smart guy, you understand the delta between cap rate and interest rate is where the money is made.  If we buying at 6+ cap rates (and that was usually 7+ the past few years) and financing at 3.5/4% or lower, we are making a lot of money.  

Will their be a slowdown?  100% YES.  That is a certainty.  But, if we are buying deals with 10%+ cash on cash returns in stable secondary and tertiary markets, short of 2007/8 happening again, what's the likely outcome?  Things slow down in a couple of years and instead of paying our investors amazing 15% returns, we are then paying a more modest 7-9%.  Still keeps people happy and we still are able to raise money.  And so we don't make as much as a company.  But we've been making money hand over fist since 2011.

We put 10 years loans on most properties.  We are getting 2-4 years of interest only with incredible rates on nonrecourse loans.

@Ben Leybovich as an example, I put together a deal in your next of the woods last year.  Bought 204 units built in 2004 out of foreclosure just north of Dayton for about 40% less than replacement cost.  Put a bank loan on it, stabilized operations and refi'd end of 2014.  Appraisal was $2 million higher than purchase price 11 months later.  We put a long term loan on the deal and expect 11-12% annual cash on cash returns for the foreseeable future.  

Are there risks out there?  Of course.  And as @Steve Olafson said, it's very metro specific.  I totally understand why he's not buying in Phoenix right now.  He also doesn't need to buy. He's doing quite well.

If you want to keep growing today, you need to be opening to expanding your target markets a bit, or yes, you might be sitting on the sidelines.  

Maybe we will be famously wrong.  That is a possibility.  But our model has worked for 23 years, built incredible wealth for our founder and he has NEVER missed a mortgage payment on any deal in 23 years.  That includes 2007 - 2009 when the world imploded.   

My $0.02.  But remember, I'm not as smart as most of you.