Multifamily Apartments - Market due for major price correction?

Question

Greetings Forum members,

This is my first post but I've been reading biggerpockets for years now and have enjoyed the insight of many members who have contributed. Thank you all!

Recently, I have been searching for investment properties, primarily multifamily apartment complexes in various markets. Usually 50 to 100 units although I will consider 20+ at times.

Having taken a sabbatical from investing over the past several years and sitting tight with my portfolio, I have come to realize that the very same market places have appreciated nearly 50% in price for the same properties in let's say ten years time.

With that being said, about ten years ago was the peak of the bubble and we all realize that prices were inflated unless you acquired an REO or similar "distressed complex.

How did property values almost double from peak bubble values in almost ten years? And in your own humble opinions, do you believe the multifamily real estate market is headed for a serious downturn/correction?

Maybe that is why there is such a generous inventory of properties listed?

Do owners see it coming? Or are they struggling to meet the debt service and scared of eventual foreclosure?

For a frame of reference, a property I acquired in 2009 (66 Units) in a strong market (major metroplex), was acquired by the previous owners at around 2.5 million, they were foreclosed upon and I grabbed it for 1.1 with a 3.2 stabilized appraisal at 97% physical and economic occupancy.

This market is now asking around 3mil for 1/2 of the units (33) comparables.

I have seen the same theme in various markets that are intimately familiar across many states and cities.

Your responses and input is greatly appreciated.

Thanks,

David

Jonathan Twombly · Answer

@David Latimor

My view is that we're currently at or close to the top in most markets, and the only issue is when the correction begins and where it starts.

Though, nationally, as it's been pointed out, there is still a deficit of multifamily construction when compared to household formation and historical norms, what we have seen during this boom is an incredible concentration of construction, both in terms of asset class and location.  It's been reported that more than 75% of the construction has been Class A, and that 50% of all construction has been in about 12 submarkets.  What that means is an oversupply situation in the markets that the institutional investors care about most.  We're already seeing this in NYC, where banker friends told me two years ago that they were no longer lending on NYC development because of oversupply and pricing concerns, Tishman-Speyer (one of the leading developers in the country) fired its entire NYC development division, and just walking around town you see the number of newly constructed properties not only with "for rent" signs out, but offering concessions.  It's been years since you even saw "for rent" signs.  (Apartments are also getting hard to sell.)

When the crash happens in places like New York, the fundamentals elsewhere won't matter that much, because the correction in the favored markets will spook the lenders - who are and always have been predisposed to be wary of smaller markets, where they have now followed the investors because that's where investors have gone. But at the first sign of trouble, the lenders will pull back to the "safer" big-city coastal markets, causing the correction to spread.

In B/C class properties, there is no new supply, which is good for owners, as rents are climbing steadily. But at some point, you need to worry about whether incomes are keeping up. As prices have climbed steadily for these assets, high rent growth is necessary to justify the prices. At some point, the numbers stop working.

As you pointed out, prices are now way above previous peak.  In the most recent annual report by the Joint Center for Housing Studies at Harvard, it was mentioned that MF prices are now 30% above their previous peak.

Prices continue to rise, but a great deal of this has to do with supply on the market dropping.  It was recently reported that volume year over year was down substantially, but prices are up.  This is because of the lack of supply on the market at the moment.  What's happened is that so much of the product has been traded in this cycle that investors are now into their holding periods and are not trading what they own yet.  They also have low interest rates locked in, and because of the lack of supply the market is not liquid enough to provide enough 1031 opportunities, so they are sitting tight.  Why sell if there is nothing out there to buy, at least not at reasonable pricing?

I and many people I talk to are on the sidelines, because they are just priced out of deals.  Deals don't pencil out at the moment.  The number of people sitting on the sidelines for this reason is growing.

And just anecdotally, the press has certainly changed in sentiment.  Articles asking if the bull market is running out of steam have started to appear regularly, as have the rebuttals by the bulls who want to see it keep going.  It's been my experience that the cheerleaders only start coming out to defend the continued bull market when they start to feel threatened that it may be over . . .

David Dachtera · Answer

@David Latimor,

A little different perspective ...

We lost some 80% of developers and builders in the crash. So, there's a good back log of building to catch up on. Some economists estimate around five years.

The secondary fallout from the crash is all the refi's coming due on 10-year balloons. There will be a bunch of them approaching the refi point without enough equity to refinance without bringing cash to closing.

Just something to keep in mind ...

Michael Reilman · Answer

I find this funny since it is a 2 year old post and we are still thinking there's a bubble to pop!

Now for something current: Things are still overpriced and people are still overpaying, but deals are still out there. Just be sure to keep underwriting conservatively with healthy cashflow and you can buy in any environment.

David Latimor · Answer

I will respond to each of you who graciously answered my questions on an individual basis. Further research on my part is required.

However, if I may be so bold to share Jonathan Twombly's article link which I find to be very insightful:

http://twobridgesmgmt.com/top-of-the-market/

Thank you all for your responses and I will get back to each of you and also encourage further input from other members.

Robert C. · Answer

@David Latimor, I'm a little less data driven than some other investors on BP, and generally rely on networking and local experience to understand what's going on in the market. Just to boil things down, I tend to look at multi-family from the standpoint of mass psychology, plus the relative nature of different markets. I know people have been talking about a bubble since 2013, but it seems to the amount of voices I hear talking about "the top" has increased in intensity both in my local market as well as throughout the country. Ultimately, I see that as an "if enough people believe it, then it will happen" scenario, where the correction will come because enough people believe a crash is coming - in other words, hitting a psychological tipping point. In addition, when I look at the local market around SF, we've really been topped out in multifamily since sometime last year. Relative to the rest of the country we recovered about 2 years faster than most markets, so that makes me think other markets will also be topping out over the next year or so.

Interestingly, my non-scientific opinion intersects quite nicely with @Jonathan Twombly's data.

To be clear, it's not that I don't look at statistics. I just spend equal or more time keeping my ear to the ground, so to speak. I think Jonathan already gave the more important observation - the numbers just don't make a lot of sense anymore in places like NYC and SF.

James Kandasamy · Answer

Hi @David Latimor . In general, most markets are in expansion mode. We have been one of the longest time in this mode. This is the mode just before hypersupply comes in. We continue to see differences between market performance based on demand and supply of a particular market. To dive deeper into a market that you are interested in you can visit the blog page on my site. I recently did a webinar on how to analyze multifamily markets.  There is a replay available.

Account Closed · Answer

Others have said it better about feelings and numbers, but I'll add my two cents.  Most multifamily deals are not done for cash.  This makes interest rates a key factor in looking at pricing because cheaper loans = higher prices.  To Jonathan's point, as interest rates rise, some deals will just become less attractive.  The Federal Reserve is being very careful as they raise interest rates so far, expect more of that to continue.  A sudden spike in rates is highly unlikely - the more likely scenario is that rates increase slowly and over longer periods of time.

Evan Polaski · Answer

@Roni Elias I do like how you reinvigorated a 2 yr old thread.  But I think it is telling that 2 yrs ago we had a healthy discussion of being at top of market, and yet, here we are in early 2020 and still not seeing that correction.

Roni E. · Answer

Yes prices are very expensive right now. I think you should look at deals and creat your investment box. I need a yearly Cash on Cash of  blank percent and a 5 year IRR of blank percent. I would budget if you bought at 5.5 cap rate plan to sell in 5 years at 6.2 cap rate. Interest rates are great now. If you stay prudent and do your homework deals can be found but you have to look at a lot of bad deals till you find one that works.

Will Poon · Answer

The supply of money is a factor investors need to take into consideration. Money supply within an economy and the fiscal policy/monetary policies influence prices. The fed will go through balance sheet reduction and rate increases in the near future. I do not believe there will be peaks and valleys of the past. My opinion is there will be plateaus for long stretches. All the capital restrictions put on banks will not allow to over investment or under investment.

Multifamily Apartments - Market due for major price correction?

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