Is "Stupid" Money Chasing Millennials in Your Market?

[Michael Ealy]

Have you heard of the expression "stupid money"? It is when a herd of investors or speculators seem to be overpaying for an asset.

In my market in Cincinnati and I guess almost everywhere in the country, "stupid money" seems to be overpaying for apartment buildings. We've seen cap rates drop several basis points in a short span of time.

At first, I thought "stupid money" is really dumb - overpaying for buildings but...it seems that it's not "stupid" at all. Money is flowing into apartment buildings because it seems Millennials across the country are now preferring to rent long term vs. buy. 

In my local market, I've seen movement of people from the suburbs back into the city as well.

Keep in mind some of that "stupid money" is from institutional investors and private equity firms with full time acquisition analysts and market experts (not newbies like here on BP). For example, a lot of them paid 9% cap for buildings in C areas in Cincinnati less than 5 years ago and the cap rates are now 6-7%. 

Crazy!

Have you seen this in your local market as well? "Stupid money" chasing the Millennials' trend to rent apartments as a long term housing solution vs. buying?

If so, share it here. Also, if you are, share how you are making money from apartment buildings today.

If I get quite a few responses, I might share how I make money with apartment buildings today...even if I seem to be "overpaying" for them.

[Greg Dickerson]

@Michael Ealy yes CAP rates are compressed all across the board for every asset type and class.

A couple things are happening. More and more institutional capital is pouring into real estate as you mentioned and are they happy with returns equivalent to Bonds or Treasuries. However they are also focusing on the higher end Class A-B- product.

Second thing are the interest rates. Just like the housing boom and crash back in 2009 it's all about low rates and interest only loans. This is the only way to get cashflow at 4,5 and 6 CAP's

[Paul Sian]

Investors in search of a yield is what is driving this along with cheap Fed money.  Definitely harder to buyer for the investor in Cincinnati who is looking for a good cap rate.

[Bjorn Ahlblad]

@Michael Ealy I am a buy and hold guy. I'm not overpaying if there is a better utilization of the property that I can accomplish. If I find a distressed property that I can rehab and attract a whole new tenant class paying more rent, and it meets my goals, I have not overpaid. Cap rate becomes less important going in if I can see a new equation for that property. 

In most cases the building is rented near market, and overpriced, in that event there is no point in chasing it-for me anyway. Today it seems buyers are willing to pay 'crazy money' just to get in. That's how overhyped MF is.

[Michael Ealy]

Originally posted by @Greg Dickerson:

@Michael Ealy yes CAP rates are compressed all across the board for every asset type and class.

A couple things are happening. More and more institutional capital is pouring into real estate as you mentioned and are they happy with returns equivalent to Bonds or Treasuries. However they are also focusing on the higher end Class A-B- product.

Second thing are the interest rates. Just like the housing boom and crash back in 2009 it's all about low rates and interest only loans. This is the only way to get cashflow at 4,5 and 6 CAP's

I agree on institutional buyers focusing on higher end class A-B product. This is why with hotels that's my strategy. Buy a performing hotel in A or B locations, further improve its NOI and then sell to instutional buyers (if I get a crazy offer) or keep for the long term.

For apartments though, is there more to it than just cheap money? I know cheap money is one factor but is it the only one that accounts for crazy low cap rates?

[Greg Dickerson]

Originally posted by @Michael Ealy:

Originally posted by @Greg Dickerson:

@Michael Ealy yes CAP rates are compressed all across the board for every asset type and class.

A couple things are happening. More and more institutional capital is pouring into real estate as you mentioned and are they happy with returns equivalent to Bonds or Treasuries. However they are also focusing on the higher end Class A-B- product.

Second thing are the interest rates. Just like the housing boom and crash back in 2009 it's all about low rates and interest only loans. This is the only way to get cashflow at 4,5 and 6 CAP's

I agree on institutional buyers focusing on higher end class A-B product. This is why with hotels that's my strategy. Buy a performing hotel in A or B locations, further improve its NOI and then sell to institutional buyers (if I get a crazy offer) or keep for the long term.

For apartments though, is there more to it than just cheap money? I know cheap money is one factor but is it the only one that accounts for crazy low cap rates?

Yes its the low rates that make the deals work but also demand that helps keep CAP rates low. You may not be able to raise rents to accommodate interest rate hikes fast enough if at all. If rates shoot up the only buyers would be the big guns as that would eliminate all the smaller syndicators that have to raise the capital and get a certain return for the deal to work. The average investor in a syndication will not take the risk below a certain level. Right now they are all hoping for and being told they will get 18-24% IRR on most deals. For now the FED seems set on lowering rates in the near term so i think we will see even more pressure on CAP rates.

I love Hotels. They are way more profitable than multi family and you can adjust room rates daily to capitalize on special events or be more competitive during slower of peak times. REITS are fickle and can change course very quickly so I wouldn't count on them as an exit or safe haven. Stick with Hyatt and Marriott and you stand a much better chance of exit as they are the Darlings of Wall Street. 

If FEDS drop rates tomorrow you will see REITs go on a shopping spree all across the board confirming what I am talking about here. It will be interesting to see how the rest of the years plays out.

[Michael Ealy]

Originally posted by @Bjorn Ahlblad:

@Michael Ealy I am a buy and hold guy. I'm not overpaying if there is a better utilization of the property that I can accomplish. If I find a distressed property that I can rehab and attract a whole new tenant class paying more rent, and it meets my goals, I have not overpaid. Cap rate becomes less important going in if I can see a new equation for that property. 

In most cases the building is rented near market, and overpriced, in that event there is no point in chasing it-for me anyway. Today it seems buyers are willing to pay 'crazy money' just to get in. That's how overhyped MF is.

 Exactly my strategy - buy buildings with problems and below market rents, fix the problems, increase the income and increase the value significantly.

I also buy in areas that are about to turn around because of a development, investment by the city, etc., hence, there is a cap rate depression.

With these strategies for example, in one of my buildings (41 units), the NOI improved and the cap decreased at the same time such that I am able to increase the value by over $500k in just 12 months.

[Russell Brazil]

Low interest rate enviorment forces people to chase yield. As long as rates are low, expect cap rates to be low correspondingly. When rates finally do rise, then that will be because of inflation, then rates will rise then alomg w cap rates.

[Marc Winter]

IDK, I read this 'crazy money' and low cap rate stuff and I gotta say, it's all about the total number of staws.  It's not the first one, not the last one, it's the total of the straws that will break that poor camel's back.

Example:  I have been blessed with two of the most beautiful Millenial daughters a proud papa could ever hope for.  They both earn over 6 figures.  Both added a middle name: Independent.  They both live in their own apartments in a Millenial ghetto in Brooklyn--chic is more than just an adjective to those living that lifestyle.  Rent for a 450 sq ' apt runs about $2,500 plus utilities.  Bargain, right?

Savings?  Nah, nothing more than a month's rent.  Party?  Hell yeah, bring it on!

Until, a few months ago, when #1 got married and told me she wanted to have a baby and, oh yeah, "we want to move out of Brooklyn.  Too urban, we want something more (wait for it) -- SUBURBAN. A nice place to raise a kid".  She wanted better schools, room to run and play and all the stuff that my parents wanted.   

The moral of this little tale is that this stuff goes in cycles.  Life, Real Estate, stocks, world views, love and marriage, youth and older age.  It's all cyclical.  Figure out the cycle as best ya can.  If and when that happens, we'll know which straw we are really looking at.

Cheers!

[Dennis M.]

@Michael Ealy

Sometimes it seems like every dollar I spend is stupid money these days !

[Brandon C Johnson]

@Michael Ealy I have a great broker in your area with great returns. I'm just not interested in your market. Pm me if you want his info.

[Jim K.]

@Michael Ealy

You know my strategy, Michael, poking around ugly places to find the pocket solid C'class neighborhoods in borderline D'class areas, buying SFR at D'class price, renovating to solid C'class standard, renting for low market rates to very-well-screened tenants looking for long-term housing.

For various tax reasons, the entire area I'm investing in is getting a significant increase in its public budgets, municipality and school district. The pocket neighborhoods I'm talking about are coming back and appreciating quickly -- a couple of big local flip teams are concentrating hard on those pocket hoods, because they know their business. Since I got there first, God bless the sweet hearts of the flippers.

The stupid money is going into what I call "the high hood."

I really get the sense that there are dozens of realtors out there taking the comps off the flipped houses in the pocket neighborhoods and applying them to EVERY house in the area for OOS investors. To give you an example: in the same municipality, I own a house on Peach Street, I would own every house on that street if I could expand fast enough. I own a house on Judy Street, that one's much more of a questionable buy, but I believe it has potential. But I will not buy a house on Diana Street, I don't care how cheap it is. Because all the locals all know the triangle of Diana Street, Joanna Street, and Barbara Street is a place to avoid, the worst nexus of the high hood where the local drug trade lives and breathes.

Yet Diana, Joanna, Barbara Street houses are still getting sold to OOS and institutional investors.

The other thing that's happening is that people are buying cheap-construction properties in the same hoods for inflated prices, stuff that's obviously heading for a teardown. My strategy is simple: pre-1945, I want brick and only brick. If I can get it, I want first-quality brick. I want steel beams and lally columns in the basement. I want as little major renovation by third parties in these buildings by others since construction as I can get.

But the same OOS investors are buying the dogcrap, saggy beams and rebuilt columns, dirt cellars, houses that have been flipped a dozen times since 1980, really, really dumb investments to turn into rentals.

[Bill F.]

Originally posted by @Michael Ealy:

At first, I thought "stupid money" is really dumb - overpaying for buildings but...it seems that it's not "stupid" at all. Money is flowing into apartment buildings because it seems Millennials across the country are now preferring to rent long term vs. buy. 

Could you point me to the research or data has lead you to this idea? All of the data I have seen points in the opposite direction so I'd like to see someone who has reached a different conclusion.

Also being an institutional investor and stupid are not mutually exclusive... Portfolio Insurance, Long Term Capital Management, Pets.com...

[Caleb Heimsoth]

@Michael Ealy. Why would someone who overpays need to be a millennial? I think it was unnecessary to put that part in the title. That seems like an unfair assumption.

[Michael Ealy]

Originally posted by @Caleb Heimsoth:

@Michael Ealy. Why would someone who overpays need to be a millennial? I think it was unnecessary to put that part in the title. That seems like an unfair assumption.

 You didn't really read what I wrote. Here's a 1-sentence summary:

Institutional investors are paying low caps in part because they believe that millennials would rather rent long term than buy - and they prefer apartments vs. houses.

[Michael Ealy]

Originally posted by @Greg Dickerson:

Originally posted by @Michael Ealy:

Originally posted by @Greg Dickerson:

@Michael Ealy yes CAP rates are compressed all across the board for every asset type and class.

A couple things are happening. More and more institutional capital is pouring into real estate as you mentioned and are they happy with returns equivalent to Bonds or Treasuries. However they are also focusing on the higher end Class A-B- product.

Second thing are the interest rates. Just like the housing boom and crash back in 2009 it's all about low rates and interest only loans. This is the only way to get cashflow at 4,5 and 6 CAP's

I agree on institutional buyers focusing on higher end class A-B product. This is why with hotels that's my strategy. Buy a performing hotel in A or B locations, further improve its NOI and then sell to institutional buyers (if I get a crazy offer) or keep for the long term.

For apartments though, is there more to it than just cheap money? I know cheap money is one factor but is it the only one that accounts for crazy low cap rates?

Yes its the low rates that make the deals work but also demand that helps keep CAP rates low. You may not be able to raise rents to accommodate interest rate hikes fast enough if at all. If rates shoot up the only buyers would be the big guns as that would eliminate all the smaller syndicators that have to raise the capital and get a certain return for the deal to work. The average investor in a syndication will not take the risk below a certain level. Right now they are all hoping for and being told they will get 18-24% IRR on most deals. For now the FED seems set on lowering rates in the near term so i think we will see even more pressure on CAP rates.

I love Hotels. They are way more profitable than multi family and you can adjust room rates daily to capitalize on special events or be more competitive during slower of peak times. REITS are fickle and can change course very quickly so I wouldn't count on them as an exit or safe haven. Stick with Hyatt and Marriott and you stand a much better chance of exit as they are the Darlings of Wall Street. 

If FEDS drop rates tomorrow you will see REITs go on a shopping spree all across the board confirming what I am talking about here. It will be interesting to see how the rest of the years plays out.

 I love hotels too my friend!

I am closing on a hotel in Columbus and that is a Marriott.

Great minds think alike ;)

[Michael Ealy]

Originally posted by @Russell Brazil:

Low interest rate enviorment forces people to chase yield. As long as rates are low, expect cap rates to be low correspondingly. When rates finally do rise, then that will be because of inflation, then rates will rise then alomg w cap rates.

 Rates have stopped decreasing though yet cap rates continue to drop. So, it's not just interest rates fueling this craziness or this "stupid money".

[Account Closed]

@Michael Ealy what makes that money truly "stupid" though? Are people paying way above appraised value and getting 7 caps in exchange? What if that is something they're aware of and totally ok with?

I'm a CA investor who buys and sells in high cash flow markets out of state, and have gotten to experience both sides of the coin: what the CA buyers think, and what the local investors think. I've heard "why would anyone pay this much for that property in that market, I would never!" from local guys and gals... when the CA buyer says "11.5 cap? Low vacancy rates? That's crazy, I'm in and I don't care what it appraises for." Who gets to decide what's legitimate? 

Now if someone is overpaying for a property that is likely not to perform and result in negative cash flow/foreclosure... sure, dumb buy. But if someone out there has a lot of cash that isn't yielding them a return at all, and they exercise capitalism upon something they are willing to earn a smaller profit on than the local investors, that's a good buy for them where they can be competitive!

The virtualization of businesses has made this all more accessible as well. Customers and service providers alike are utilizing tools that allow them to operate remotely, and this concept is far less stigmatized than it was 12 years ago in our last peak market. 

Yes, it drives your prices up as a Cinci local... but that money was going to be places somewhere to compress returns if not in your market. The net, general result is same. The localized result is different.

[Russell Brazil]

@Michael Ealy

Interest rates are not fueling it, but are a function of i a low yielding enviorment.

If the risk free rate is low, then with it any yielding product will then in turn follow that same pattern as risk premiums adjust to any enviorment. For instance lets say the risk free rate was 10%. Now any other yielding investments yield would need to adjust the risk premium to compensate for where the risk free rate is at any given moment. Sonif risk free was 10%, then wed see treasuries at 12-14%, dividends at 15%, real eatate at 20%, etc. (This is a hypothetical risk free rate).

In step with that is rates are a function of inflation. As inflation stays low, so will rates. If rates rise, thats primarily a function of inflation rising.

[George Gammon]

@Michael Ealy Interesting question, "Is stupid money chasing millennials in your market." 

There are some really solid answers on this thread @Russell Brazil @Greg Dickerson, but I'd like to expand on their points slightly.  

The Fed has created an environment of artificially low interest rates which starves several groups of yield.  As we all know, it makes it much more difficult for managers of large pooled groups of money to provide an acceptable return to their investors.

These groups include hedge funds and private equity funds.  Most would respond with "boo hoo," the poor billionaires, what will they do.  But the further you dissect the problem you see it's not just billionaire run hedge funds, but public/private pension funds, insurance companies, teachers unions etc.  

All of these groups, and more, are starving for yield and they'll do almost anything to get it...including going out much further on the risk curve than is prudent.  

Adding fuel to the risk curve fire are the funds in Europe and Japan where rates are not just artificially low, they're negative.  That's right, believe it or not, there's 13 trillion dollars of negative yielding sovereign debt (and recently European corporate debt), floating around the world wide financial system, formerly the bedrock of most funds portfolios.  

In other words, there's upwards of 13 trillion no longer able to buy bonds. See chart

So what do you do if you're a fund manager?  Go to cash?  Do you think your investors will continue to pay you 2% and 20% management fees to be in cash?  They really have no choice but to be fully invested.  

Bonds are not an option so do you go into stocks?  Maybe, but where?  US market is at all time highs and in the longest period without a recession in US history.  European banking (Deutsche Bank) is shaky at best and Australia/Canada are on the verge of having their housing bubbles pop.  

My point is, all things considered, if you have to put large amounts of money to work, multifamily with a 6% cap looks pretty darn good.

Which by no means implies there's little risk, or all the "professionals" working for them know something you don't.  It simply means they have no choice but to go further and further out the risk curve.  

Just because they go further out the risk curve doesn't mean it's less risky! ;) 

IMO this may have something to do with Millennial housing preferences but it has much more to do with interest rates being at 5000 year lows and 13 trillion in negative yielding sovereign debt.  

My suggestion would be don't compete with them, there's far greater downside than upside.  If you have to buy US assets, buy them with 30 year fixed rate debt.  It's cheap and not available to the hedge funds and private equity.  

30 year fixed rate mortgages are by far, the biggest edge small investors have based on current market conditions.  

George 

[Jay Hinrichs]

Originally posted by @Michael Ealy:

Originally posted by @Caleb Heimsoth:

@Michael Ealy. Why would someone who overpays need to be a millennial? I think it was unnecessary to put that part in the title. That seems like an unfair assumption.

 You didn't really read what I wrote. Here's a 1-sentence summary:

Institutional investors are paying low caps in part because they believe that millennials would rather rent long term than buy - and they prefer apartments vs. houses.

 I don't know I would say over 50% of my new homes sales are to millennials seems like once they get married and have kids they exit apartments especially in our area were rents are what a payment would be on a 450k new build..     

[Tj Hines]

@Michael Ealy I agree totally with @Greg Dickerson    Institutional money will continue to flow in and buy at compressed comp rates. Millennial's won't be buying any time soon. To much student debt. And baby boomers are down sizing. Fact of the matter is, we live in a nation of renters. It will continue to be this way for quite some time to come.

[Mike Dymski]

[Ian Walsh]

Many times we don't really know if dumb money is dumb until the bubble pops.  Sometimes it's pretty clear though.

[Josh C.]

@Bill F.

I’ll echo this statement that big buyers know everything. It’s flawed thinking to believe hedge funds and other big “smart” buyers can’t make mistakes. Mount helix bought around 1000 homes in Indianapolis. They never had the crews to rehab them. Got more fines more unsafe or high weeds or whatever than anyone ever had before. Then fire saled everything. Didn’t even check what it was worth. Just low low prices. I bought one such house they listed for $17k I paid $36k and was worth 80k. Even after I offered them 50k about 6 months prior. They still listed it out 17k. Just silly.

[Bill F.]

Originally posted by @Josh C.:

@Bill F.

I’ll echo this statement that big buyers know everything. It’s flawed thinking to believe hedge funds and other big “smart” buyers can’t make mistakes. Mount helix bought around 1000 homes in Indianapolis. They never had the crews to rehab them. Got more fines more unsafe or high weeds or whatever than anyone ever had before. Then fire saled everything. Didn’t even check what it was worth. Just low low prices. I bought one such house they listed for $17k I paid $36k and was worth 80k. Even after I offered them 50k about 6 months prior. They still listed it out 17k. Just silly.

“In some corner of the world they are probably still holding regular meetings of the Flat Earth Society. We derive no comfort because important people, vocal people, or great numbers of people agree with us. Nor do we derive comfort if they don't.”- Warren Buffet

The entire idea of the smaller investor following the lead of the "smart money" big investor is laughable. Having $10m in AUM is a separate world than $100m or $1b AUM; different universes with vastly different constraints and restraints. Each can do things the other would never dream of and still find success. Why people invoke this appeal to authority in order to justify their investment choices is beyond me.

I also think the idea that Millennials aren't buying house is simply a story investors tell to make themselves feel good about purchasing apartment they know are marginal investments. I have yet to see any data to support the claim, that's why I asked OP for his, but its been crickets from him so far...

The Millennial generation runs from 1981-1997, or 38-22 year olds. The median home buying age is 31 (in 1970 it was 30.6 if anyone cares). Assuming a uniform distribution, half of the generation is below the median age.

It is a lot like saying you need 10 years of experiences to work at a company and then comparing that you don't have anyone in their 20's working with you. Is it a surprise that 25-28 year olds are living in apartments? Would this even be a discussion 15 years ago?

This article from 2015-16 time frame has some great data to support its conclusions  that "a majority of millennials would prefer owning to renting, but they appear to be postponing homeownership because of real and perceived difficulties in affording it."

Millennials want to own homes, but for the reason listed in the articles plus some other( boomers aging in place, changes to household formation times, ect) the timeline is delayed. All of this is a far cry from millennials aren't buying homes.