Multifamily homes have been a great investment over the past two years. While the initial shock of the pandemic caused some concern about who could pay rent and what why would do if they couldn’t pay their rent, those concerns were largely allayed by the end of 2020. Smaller and mid-sized cities saw an influx of new residents who were intent on buying property. The housing market quickly ran out of inventory, and, with house prices continuing to rise, many of those new residents found themselves priced out of buying, so they moved into rental communities.
While rent growth has continued in 2022, there is an economic headwind that has many investors pausing—the rising cost of debt. As of September, the U.S. inflation rate was 8.2 percent year over year. Federal Reserve Chair Jerome Powell has made it his mission and the mission of the Fed to decrease inflation. This mission has caused six rate increases this year, with more on the horizon. These increases are starting to cause unsteadiness in the real estate market.
Who’s in Trouble and Who’s Not
Currently, when you hear of sellers and investors that are in trouble, this predominately pertains to both builders and home flippers. This is because on a construction project or a flip, the investor has to sell the home when the remodeling or building is completed. Typically, they are sitting on construction loans or hard money, both of which have variable rates, and they need to move the home off their balance sheet because it will not generate cash flow as a rental with the high cost of the debt. Selling the homes for a profit has worked great over the last two years, with home prices increasing significantly each month; but now with rising interest rates and a stalled housing market, these homes are being sold at a loss while you have home builders and flippers trying to salvage their deals in order to not lose money. This will only become worse as rates go up and homes become more unaffordable.We haven’t yet started to see the next real estate issue, but we will in the next 12–24 months. These will be issues with syndications on multifamily buildings. For those that don’t know about this issue, syndication is raising money from other people to buy real estate. Most apartment buildings are purchased this way. Many syndicators are also in hot water. They purchased deals for the sole purpose of the property increasing in value over time. It’s essentially like a house flipper but on a much larger scale. These properties have tight cash-flow margins, and their investors are expecting an exit typically in three to five years. You will begin to see some turmoil here once the three to five years are up and the investors want their money back. This is because in that time frame the property may be worth less than they bought it for and there will be no profit, and even a potential loss to the investors.
All three of these categories—flippers, builders, short-term syndicators—will be in trouble in the coming months or years. However, certain aspects of the real estate market will do well. Currently, there’s a shortfall of five million homes that are needed to satisfy the demand amongst would-be homeowners, and that lack of supply and the increase in interest rates make renting a better option for a lot of people. This inability to afford to buy will increase the need for rental units.
Real estate investors and syndicators who have invested for the long term in cash flow-generating properties will be able to weather this storm. This is because they have fixed debt and cash flow at current rental prices. This is why at MC Companies we have always invested over the long term for cash flow and don’t get caught up in the valuation of a property. The “buy low and sell high” model has always been a risky way to invest, because a lot of gambling is involved—gambling on values and gambling on rates. Rental numbers stay consistent due to supply and demand, and units are in short supply, made even worse by a tough housing market and inflation.
As we head into this recession, I advise you to continue to look for cash flow in your investments. Don’t get caught up in declining prices or higher rates; these are just fluff that gets in the way of making a sound investment decision. Stick to the math and make sure the numbers work before moving forward with any deal.
