Where is Baltimore on the Cycle of Reason?

Question

I am a Baltimore, MD native and I invest in my own backyard. Fortunately, the numbers make sense here. From what I've observed, the market for 1-4 unit rentals is great! However, I've begun to set my sights on larger multifamily deals (20 - 50 units).

One of the resources that I've recently picked up to help educate myself on the apartment game is the "The Apartment Consultant eBook" by Peter Harris. In it he stresses the importance of knowing where your market is in the cycle.

I'd like to get a consensus from other Baltimore investors. Where do you think Baltimore City currently falls on Peter's "Real Estate Cycle of Reason" (pictured below)?

Ned Carey · Answer

@Sam Henry Dave Lindahl the apartment guru talks about market cycles. Market cycles can make you a fortune in just about any business if you understand them.

Keep in mind, market cycles are not perfect sine waves.

We are at the point on the bottom of the cycle right above where it says "BUY."  The problem is, cycles are not perfect. Are we going to go sideways for 5 years? Will we see the second shoe drop and have further declines ? Will it surprise us and go almost straight up? No one knows.

What we do know is we are below the long term average. This means the odds are it will start climbing towards that long term average.

On the other hand, anytime you are above the long term trend line, the odds are it will start moving down towards the long term average.

I have not been following the multi family market closely becuase I am currently priced out of it. But I'll thow my 2 cents in anyway. Multi family in Baltimore is priced at cap rates well below SFHs. I also believe given the risk of Baltimore City the high prices (low cap rates) are not justified. It is my understanding that there is significant multi family building in Baltimore. I don't know where they expect the demand to come from.

Personally I believe the multi family market is grossly overpriced nationally. I don't think multi family investors recognize the tremendous risk they are taking by buying at low cap rates. Further artificially low interest rates are propping up cash flow in a way that is unsustainable.

Financial collapse in the Multi family market was averted because of higher demand and rents due to foreclosures and home ownership declines. Also the policy of extend and pretend helped. The point being investors just got plain lucky when the grossly overpaid in the boom times of the mid 2000s.  consequently I believe investors continue to overpay and not understand the risks they are taking.  @Joel Owens  do you care to comment?

Paul Khazansky · Answer

As someone who's done a bit of development in the downtown Baltimore area, here is my two cents on the subject.

According to Downtown Partnership (a Baltimore think tank that gathers and analyzes data on various real estate asset classes), Baltimore has a demand capacity for 5,800 new apartments between 2012 and 2017.  That number is largely driven by new jobs being created in downtown, and a trend known as urbanization or "manhattanization" where across the country we see more and more people who prefer to live in dense, urban areas. All in all, based on number of apartments in the pipeline and what's already been introduced to the market since 2012, we believe there is about 18 more months where there will be strong demand for apartments. Come 2016, demand will likely soften, given a huge number of new apartment projects that are to be delivered in the next few years.

For investors interested in the multifamily space this means that there should be more emphasis where multifamily acquisitions/development should be taking place, with a focus on a more desirable neighborhoods, such as Federal Hill, Fells Point, Upper Fells Point, etc., areas that are likely to be more resilient to rent reductions once the city will become more saturated with apartments in the market.

As far as heated cap rates go, I agree, they've fallen A LOT in the last 18 months alone, so it makes it that much more important to be prudent in your underwriting.  For example, in our recent deal in south of Federal Hill we projected rents per square foot lower than what's currently in nearby class-A buildings by ~15-20%, which gave a level of comfort to investors that decided to participate in that transaction.  So keep a close eye on supply vs. demand of apartments in Baltimore, and stick to stringent underwriting criteria when vetting potential acquisitions, and you should be ok in the long term.

Paul Khazansky

www.poverni.com

Sam Henry · Answer

Very insightful responses. Thank you all.

Account Closed · Answer

@Paul Khazansky

"a trend known as urbanization or "manhattanization" where across the country we see more and more people who prefer to live in dense, urban areas."

This why Pittsbugh is Hot

Joel Owens · Answer

Plenty of deals still in multifamily.

It's all about what you plan on doing with the property. Are you trying for strong forced appreciation and turn around or great cash flow with leverage??

I think there are some good properties and then there is overpriced trash but that's in any cycle. If the cycle is peaking and you are buying overpriced then it really can get you.

How an investor views opportunity is different based on how much wealth they already have. At least this is from my experience. An investor I talk to with 100,000 cash has a different outlook on growth and risk versus someone nearing retirement and has 1,500,000. The 100,000 investor might say not enough cash flow for a deal to me. The other investor with more wealth might say I don't need the money much more than outpacing inflation and tax write offs and leaving a quality property legacy for my family to inherit etc. Investing is like taxes in that everyone's situation is different.

Where is Baltimore on the Cycle of Reason?

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