All Forum Posts by: Dan DiFilippo

@JR C. It's unfair, to be sure. But it should be a lesson to landlords to maintain a prudent reserve. And this isn't to pick on landlords. The entire lesson of this pandemic to everyone is that they should maintain a prudent reserve. Individuals and businesses alike. Now, the tenants very commonly don't have the financial responsibility to maintain their day to day finances let alone have rent money in a time of crisis. Unfortunately, that's just an occupational hazard we have to deal with.

@Ella Alpina Thank you! I do my best to make my analyses as thorough as possible. I don't want my fatal mistake to be something I could've avoided by drilling down another few feet. But regarding SFH and MFH, I agree that cashflow is the difference, but cashflow can change. Thankfully, most costs in real estate are stable. Mortgage is set, of course, when it is written, so that's good. Roughly 50% of our cost. Taxes/insurance don't tend to fluctuate tremendously. Repairs can usually be underwritten at about 5% of rent. Can be 10% if you have a problem unit. And can spike if you get a really bad tenant. But those only come once in a while, so you just eat the expense and move on. Management fees are extremely stable and you only owe them when you're getting paid anyway. So certainly the cost side is okay. And, definitely, part of the appeal of multi is that your overall costs usually get cobbled together in one way or another (lower per unit taxes, insurance, etc.) and you end up saving money on them. Although I will always raise a fuss about individual HVACs being absurdly expensive and all too often overlooked by investors. Compounded by the fact that $600 tenants are less likely to be changing filters than $900 tenants and suddenly your HVACs become a tremendous liability. It's just not one that's evident at purchase because capex is inherently a future expense and one that is less tangible. On those fundamentals, it is a better value for sure.

But the revenue side is the concern to me. We might underwrite a $400 monthly cash flow for a 4-unit (gross rent, say, $3,000) in present market conditions. Which means we have an exposure to the rate of rent, right? If market rents go from $750/unit down to $700/unit, this is a relatively small change in rent, but it halves our cash flow. And that's what I'm suspicious of in MFH. They make good margins because they are fundamentally cost efficient. That's good. So investors start buying them. As investors buy them, their prices go up. Monthly mortgage payments go higher. Rents continue to increase as they've been doing over the last decade. This drives more investors to buy. And this will happen until the last sucker buys a multifamily with 0% down with their VA loan, without the foresight to underwrite for capex, underwriting for only 2% repairs and still only having a small margin. So what happens if something happens that reverses this strange trend of renters appearing to pile in multi-family homes? Causing multi-family rents to fall? Well, our VA buyer is already levered to the hilt and their cash-flow is already strained because they didn't account for the possibility of an HVAC breaking or tenant trashing one of their units. So if rents fall, they are waaaaaay offsides all of the sudden.

And, to be clear, I think this is happening across most of the American real estate market.  I just think it's especially weird to see it happening in multis.  People with $1.7M mansions in Connecticut understand that their home might lose half a million in value in a crash.  It's a less liquid market and it's a consumer market.  They likely bought the house for the purpose of hanging on to it for 15 years or longer.  They probably expect to have the money to ride out any struggles.

My nervous suspicion is that MFH is in the final stages of putting in its top.  Aside from mobile homes, it's the bottom of the stack.  So if they're going to survive, the renters market needs to stay depressed into it.  And the SFH's need to essentially disappear.  It just seems like a strange inversion on the economy.

Never. Never do this. In fact, make it abundantly clear when they move in that you will not do that. In fact, when I did leasing, I included a fee of about $200 if there was any rent balance remaining at the time of move out.

I'm a broker in the Fort Bragg area in North Carolina.  It's an opportune area for investing and we've seen out of state owners bringing more money in over the last few years.  Particularly, people go crazy over multi-family deals.  I can understand why these deals work well in some ways.  It's priced right for a value-add?  Go for it!  House-hacking?  No doubt!  In fact, let me preface with a quick list of pro's and cons for a multi-family as compared to a single family.

Pros:
Proportionally lower taxes/insurance
Ease of management(locationwise)
Lower roof capital expenditures
Higher rent to price ratio
Rarely fully vacant - can reno-rotate too
Low price volatility

Cons:
May pay minimum management fees due to lower unit rents
Greater potential for delinquency/damage
(Much) higher HVAC capital expenditures
Low price appreciation

Overall, it's a somewhat bizarre phenomenon to me to watch the money rushing into multis.  We're aware of bubbles.  Anyone old enough to be an investor has 2007 in living memory.  We all know that the market can turn on us.  More than that, we know that we can ruin our own markets.

I can understand a euphoric rush into single families.  That would make sense.  In economic terms, single family is a normal good, whereas multi-family is an inferior good.  What I would think we would *want* to see is this kind of a rush into single family.  That kind of a move would seem to indicate strength in the economy.  With the partial exception luxury apartments in popular cosmopolitan areas, single family homes are supposed to be the ideal living situation for the American family.  Throw in some pointy pieces of white-painted wood and you've got the American dream.  And while the American dream doesn't mean what it did half a century ago or earlier, I don't think that the apparent shift to multi-family is a function of any sort of romanticization of the lifestyle.  I think we can rule out a change in tastes as being a primary driver -frankly a driver in any capacity- of the multi-family buy-up.  Right off the bat, we should be regarding this as a bad thing from a social perspective.  This by and large, is more people living in ways that they probably don't want to.

And at first it's not a particularly difficult concept to understand "it's sad, but Americans just don't have the money, so they're living in multi-families now".  That makes perfect sense.  Until you think about it.  If your household income drops because you or your spouse loses your job, you'll just manage your budget and make some changes and not much will happen.  If a recession comes into town, maybe the local steakhouse ends up closing because everyone stops spending money there.  Fair enough.  The steakhouse produces steaks which are consumed every night and then one day it just stops because it's no longer economically viable.  Because nobody is buying.  But this isn't how houses work.  A house is built and then it produces shelter for years.  With its upkeep costs being extremely low relative to its price.  There shouldn't be a slew of vacancies in homes if those homes are desirable.  Those single-family homes are all still there.  They don't get destroyed, condemned, or somehow cancelled when people move out of them.  Who is living in them?  Why are their supposed former residents huddling up in 950sqft apartments when single-family homes are theoretically *sitting vacant*?  Theoretically the market would use the price mechanism to clear, but that doesn't appear to be happening.  What are some of the variables that could be contributing to this?

1) Divorce - divorce is a housing multiplier. But divorces, in absolute terms have been declining.  This wouldn't explain an increase in multi-family living.  On an unrelated note, declining divorce is not indicative of Americans beginning to take marriage more seriously, etc..  It's a sign of Americans not even marrying in the first place anymore.

2) Short term rentals - Where are my Vancouverians at?  We know that if the tourism market can support it, a short term rental property will do pretty well.  Some will argue that in urban areas, short term rentals all tend to be apartments.  In the more investor friendly areas, they may more commonly be single family homes.  At the end of the day, it doesn't really matter which it is.  Conversions of *any* residence into a short term rental indiscriminately depletes the housing stock, causing the rest of the demand side of the market to squeeze into a smaller supply.

3) More households - Along the same lines as the divorce argument, I suspect that following the crisis of 2007-2008 we saw more young adults (say, in their 20's) remaining home with their parents.  Either after finishing highschool and not finding work or after finishing college and not finding work in their field.  Of course, we did eventually grind our way out of that economic mud.  And although our method for calculating the unemployment rate is terribly flawed, it does perhaps mean something that it was at fifty year lows going into the COVID crisis.  And while consumer debt levels over the last five years tells a different story, perhaps the American young consumer was feeling stable enough to move out.

4) Demographics - Yes, I know that 1 and 3 would appear to be "demographics", but let's specifically look at these two components.  Population growth and net immigration.  Net immigration has been relatively stable over the last decade at about 0.35% per year.  While this may not sound like a lot, it actually is going to require a constant increase in new constructions to accommodate on any sustained basis.  Probably not a driver, but definitely a contributor.  And then there's population growth itself.  Endogenous, that is.  Births is pretty small - and also stable throughout the 21st century, while deaths have been steady and with a slight push upwards.  Not much of a culprit.

5) Replacement - There is a question of the capital stock and whether it's being replaced on a sufficient basis.  Permitting data does indicate a slowdown of new constructions.  Being houses don't, on average live as long as people, this variable, which is found wanting, will actually have a heavier weighting than the demographics variable.

Overall, I think it is difficult to tell which direction things "should" be moving.  This is only a snapshot review of the major variables.  I'm sure there are other variables and as well there are probably intricacies that I am missing to what I've already discussed.  Overall, however, I think that a bet on multi-families is inherently a bet against the American consumer.  For the multi-family investment to work, one needs there to be sustained population growth set against a degradation of the capital stock.  For it to work, we need to see new permits suppress to lows and remain at those lows as more and more of the population funnels into multi-family residences.  On the opposite side, if we see the American consumer do well and we start building the homes we want, multi-families will be left vacant.  They will essentially be forced to choose between remaining competitive and remaining viable.

And none of this is to say that its "a patriot's duty" or any such thing to invest in single family homes.  I simply want to point out that housing manias are frightening enough when they're surging manias - luxury manias.  They're darkly scary when the mania is a race to the bottom.  A different set of rules applies.  I've been trying my best to anticipate what's around the corner and would love your guys thoughts on this.