When To Make A Multifamily Real Estate Investment: Expansion, part 3

Expansion in the multifamily market is creating an excellent real estate investment opportunity.

I liken the Expansion phase of the investment cycle to an analog in Nature: Summer.  If Recovery (Spring) is characterized by the creation of potential, Expansion is all about unleashing that.  A market that is in Expansion mode has a palpable energy: hiring is at the highest pace of any point in the cycle.  So are occupancy rates, rent growth and absorption.  Units that have been in the planning stage since Recovery come on line and more are planned.  Debt is readily available to finance acquisitions.  Debt Service Coverage Ratios (Net Operating Income/Monthly Loan Costs) tend to fall.  That makes deals possible that banks wouldn’t look at previously.  The rapid rise in rents spurs some to opt for buying a home.  As home prices go up condominiums become more attractive.  The possibility of making a fortune makes developers convert existing apartment products into condos.  This further exacerbates shortages of rental units causing rolling waves of rent increases.

The Expansion cycle sees a sharp increase in the number of units sold and a dramatic increase in the prices per units accompanied by a consolidation of Cap Rates.  The REIT I worked for in Las Vegas bought a nice institutional size property during the last Expansion cycle .  It was a B asset in a B location.  We bought well…we always did.  Our acquisition strategy was “Buy and hold” with a “mild lipstick refurb”.  By the time we got it painted we received a “Brando”.  A firm offered us a $13,000,000 premium over what we had paid for it less than a year before.  That worked out to a million bucks a month net profit to the investors.  Before I move on its important I acknowledge that while I was damn proud to be a valued member of that team I was not the Principal Broker.

Just as Nature transitions from warm June days at the start of Summer to blistering hot days in August…so does the Recovery cycle.  Eventually even people who don’t have a background in development jump in.  After all, “What could possibly go wrong?!”

The fundamentals present that characterize an Expansion cycle market include:

  • Decreasing vacancy rates
  • Moderate to high new construction
  • Moderate to high employment growth
  • Medium to high rental rate growth

Acquistion strategies that work effecively in an Expansion market are similar to Recovery markets, but with additional caveats on timing. Towards the transitional phase from Expansion to Hypersupply (Summer to Fall) it is much more important when making a flip play that you can complete the full deal before the end of the season.  Investors who “Buy and hold for the long term ” will be fine.  Where I have no problems with an agressive leverage strategy during Recession or Recovery,  you can’t afford to buy with minimum down towards the end of the Expansion season.  Where I might be fine with a 75 to 80% LTV (Loan to value) play during Recovery I want to position the asset to have adequate DSCR (Debt Service Coverage Ratios) should the property suffer from some lower revenues during a downturn. 65 to 70% LTV loans make sense during Expansion.  Ironically, this is when the bank is likely to offer even better terms than you should accept.  Over leveraging at the wrong time is how you can inadvertently turn your lovely Cash Cow into an profit hungry Alligator.

Leverage note:  The LTV levels I have discussed are my opinions based on the economic cycle that work for me.  Lowering the LTV has the effect of increasing the equity stake required and lowering risk, along with a commensurate lowering of profit potential.  Like risk, each investor must set their own level in accordance with their personal comfort.

In our next post: When to Make Multifamily Investments-Hypersupply-Part 4 of a series.

More posts in our Timing Your Multifamily Investment Series:

 

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