Does this seem "bubbly" to you?

Question

How ya feeling about the 2017 national multifamily market in view of the facts: Toppy stock market that people fear, stagnant personal incomes in many areas, 80% LTV's, rent growth rates slowing, new construction financing difficult to get, many markets overbuilt, historically low cap rates even after interest rates are up .75% since Nov. 1, multiple offers on listed deals requiring you to put down "hard" earnest money, 120+ real estate crowdfunding sites, TONS of multifamily newbies getting into their first deals, TONS of sponsors promoting multifamily deals, TONS of multifamily training courses, TONS of multifamily blogs and podcasts, several new books on apartment investing, aggressive sponsors who predict 5% rent growth and 20% IRR's because their exit cap rate is the same or lower than they are buying it at (not realistic in a period of rising rates), and I'm sure I've missed some stuff.

If you're a broker, you're telling everyone, "Sure, this will continue!" and you have numerous reasons...location, job growth, apartment performance since 2014. "It can't happen here: The vacancy rates are low, rents are climbing, folks can't get mortgages, new employers just announced x000 new jobs." I've heard this all before...in fact, I used to tell buyers the same story. And the trend did continue, until it didn't.

Is it all too good to be true?

Just remember: Rents DO go down in a recession. Cap rates DO go up. The Law of Averages is a LAW! It's a good time to be conservative in your projections.

Of course, all real estate is local, and there are deals in every market. You just have to find them (and they sure as heck aren't listed in the MLS!)

Russell Brazil · Answer

Bubbly? No. Cap rates being low are in part a factor of interest rates being low. Looking at things like cash on cash return, you need to look at them through the prism of that particular return having a spread against the risk free rate. As the risk free rate goes up, so will the cash on cash returns, and inevitably cap rates. So will prices soften in the sector in many locations? Probably, but your borrowing costs will increase as well. But I dont see anything like a bubble bursting and seeing 50% drop in values, at least not in large amounts. Im sure we will even see markets that continue to go up in the sector where there is strong rent growth.

Andy D. · Answer

I'm sure some areas are "bubbly". However, I also see regions of very strong, steady growth, even during the time the last bubble burst. Just slower. However, it's all a circle, or at least a wave: up, down, up, down, up... In that regard it's quite similar to the stock market. The majority of those people who really made money on the stock market are buy and hold, with investments into good, solid companies that preferrably give a decent dividend. Some minor adjustments here and there (Kodak, anyone?) and the obligatory bad investment but never trying to time the market. But even then it's best to buy cheap. Obviously.

Transpose that into real estate with the dividend being the rent and the solid stock being a good location with a - literally - solid building. With good selection criteria and a steady hand that doesn't tremble too much when there is some even hefty cross wind, such an investment will remain what it is: a good one. Will the ROR (temporarily) go down a bit? Maybe. But would you sell your preferred stock simply because the dividend is a bit lower in one year? I certainly wouldn't. Neither would I sell my property because of slower rent increase or even a slight rent decrease. Nor would I hold off from buying another property if I believe in the investment. It will still give me a dividend (= rental income). And at this point in time cash simply does not give me anything (at least not after fees). So unless I buy an overpriced object (and this goes for any property, not only MF) I'll have a good chance of making some money. I certainly will not if I don't invest. No risk, no reward. You just need to be smart about what you invest in. It's really that simple. ;-)

Long story short: I don't worry much about a bubble. But I also don't buy in overhyped areas, whichever type of property.

Marc C. · Answer

This is the best advice I've seen posted on BP in 2017! Thanks, Brian.

Brian Adams · Answer

I don't think "Bubbly" is the right way to think about our current market. With every real estate market cycle we always need to exercise extra levels of caution and assets need to be underwritten with scrutiny and don't just believe the "broker" and "news" hype.

You need to validate everything and form your own opinion based on the core fundamentals of each market.

I buy 100 to 400 unit deals and will be closing on deals in 2017. It takes me longer to find the really good deals as I have to sift through lots of junk.

For those just starting out, don't be discouraged and don't believe that every market is at its peak. There are many great deals available. You obviously know they won't just be handed to you, they won't fall into your lap.

You will need to work extra hard.

You need to have focus.

You need to create a strategy so you can find deals such as carving out time to speak an network with brokers, other professionals in the space that have access to deals, direct mail campaigns, BP, other investors, etc.

Be patient and work your strategy. You will look at a lot of product and inventory until you find the "ONE".

Marc C. · Answer

There isn't any! The cost of land and construction is so high, it commands premium rents, which means only Class A gets built. The only Class B stuff is Class C that has been upgraded. (Several recent articles to this effect in Multifamily Executive and other MF news sites.) And it's a legit strategy lots of investors are following here in Albuquerque. In fact, our #1 apartment lender, Washington Federal, says they really support those upgrades. "We don't want to just see lipstick on a big. We're seeking gentrification to provide an upgrade for those who now live in Class C properties." So they are willing to financing 80% of a purchase AND the rehab.

Thanks for commenting!

Jeff Kehl · Answer

@Marc C. Generally I agree with you. Frothy markets make me want to run the other way. And multifamily does certainly feel that way. But personally I'm still looking to buy. Why? Simple supply and demand. Tons and tons of apartments were built in the 60's and 70's when the baby boomers were in their 20's and 30's now their kids are the same age and demanding apartments.

While in some areas a lot of new supply is being added it's all class A high end rents. Where is the new supply of affordable working-class apartments coming from?

Bart H. · Answer

Maybe.....I think DFW may end up being a tale of two cities.  Dallas proper I think is overbuilding with generic 5 story class A apartments in Uptown/Knox Henderson/Bishop Arts/Trinity Groves etc.  There are a ton of units there.

When millennial decide to get married, they want to move to better schools and want to eventually own SFH's.  When that happens, they are moving north, ex Frisco, Denton, Plano, McKinney etc etc.

I think the prices for SFH hold up even if there is a multi family downturn because there are a lot of companies, hence workers moving to the DFW metro area.  There is a real shortage of SFH's.

Lastly I think there are some specific risks to the city of Dallas, 1) the schools for the most part are terrible.  2) there are some real issues that may force the city itself into bankruptcy with regard to the Police and fire pension, its not clear how that could play out for property owners, but I have to think its not a good sign with higher taxes/fewer services/higher fees etc. 3) there are some major issues within the city of Dallas with regard to governance, use of federal funds etc.

Account Closed · Answer

@Bart Hedgcock   I am mostly concerned about the number of apartments being built in Collin County.  I do understand our growth, but the volume of construction seems to be a little on the high side.

To be perfectly clear, I have not seen any sign of people not finding tenants for the tens of thousands of apartments being built.  It will be interesting to see the next data from the Census Bureau.  Young adults might have started leaving the next again.

Account Closed · Answer

@Marc C.    I think the Dallas market is building itself into a multifamily price correction.  Of course, that will have a trickle down effect on single family.

How long does it take to absorb 40,000 multifamily units?   I am thinking a little longer than the builders are expecting.

Account Closed · Answer

@Marc C. Overbuilt markets, increased competition and slowing rental rates seem to me to indicate more of a slowing or small correction in the market as opposed to a bubble. Some areas in the west that have experienced above average rent growth for the past few years will likely see a slow down at some point. However, as long as you are not basing your pro-forma on unrealistic rental growth this should not be a major issue.

Newbie investors will always be coming in and out of the market with many individual failures in their wake. I am skeptical of crowd funding and would not be surprised to see a number of the platforms fail. However, it is unlikely that these failures will result in a systemic devaluation of the market.

Does this seem "bubbly" to you?

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