Navigating Unprecedented Times
“We are living in strange times.” At least that’s what we keep hearing. At this point, either every generation makes this claim or “strange” is synonymous with post-Covid.
However, many would say the real estate market now fits into the box of “strange” along with most everything else in today’s society. This I am more inclined to agree with rather than, let’s say, social media or politics. TikTok and election cycles have always been strange to me.
What we’re seeing in the real estate market truly is unlike anything we’ve seen before. The influx of capital into the alternative asset class over the past two years has been remarkable. Commercial real estate (not including single family homes or small multifamily) transaction volume hit a historic high of $846 billion in 2021! And is poised to hit north of $700 billion again this year. That’s what happens with a trillion-dollar-printing government and an uncertain stock market. But, aside from those two factors, this capital flooded commercial real estate for many other good reasons;
- EVERYONE NEEDS A PLACE TO LIVE .. I know I know, we continue to hear this. But it’s true! A roof over your head is a necessity.
- CASH FLOW .. Unlike stocks or bonds, real estate generates real cash in your pocket to be put towards anything.
- HEDGE AGAINST INFLATION .. Usually, in high inflationary times, cash flows are minimally impacted in real estate due to the ability to raise rents.
- APPRECIATION .. When we buy an asset, we seek value-add opportunities that force appreciation, even during a recession!
But none of that is strange at all. In fact, these are very normal characteristics for real estate, assuming the sponsor team does their due diligence and underwrites appropriately.
Here’s what is strange and well, unprecedented;
- COMPETITION .. As mentioned above, $846 billion! That is a lot of capital to compete against. 2022 should be a lighter in terms of transaction volume, but not by much. Not to mention, new construction is booming as well.
- RISING INTEREST RATES .. We’re all well aware here. The Fed continues to crank up interest rates to fight off inflation. We’re expecting another bump here soon. This presents challenges when seeking debt as it increases the cost of capital.
- BOOMING RENTS .. Many markets across the US have seen 10%, 15% and even 20% rent growth year-over-year. Partially due to inflation, partially due to homeownership barriers to entry.
So how are we navigating this unprecedented market? Let’s tackle each one by one;
- RELATIONSHIPS .. Building relationships are key in any line of business. Same goes for real estate. We are very intentional when it comes to our relationships with brokers. It’s crucial to stay in brokers’ back pockets when a deal is coming to market. This allows us to get our foot in the door early, underwrite the deal, make an impression on the ownership group and submit an offer before anyone else.
- CONSERVATIVE and COMPREHENSIVE UNDERWRITING .. Realistic underwriting is essential, always. We underwrite realistic and then layer in contingencies. This helps us stay conservative. But in a volatile debt environment, our underwriting must be comprehensive. What this means is we are diligent about understanding where the debt market is trending via research and, once again, relationships. Relationships with lenders and debt brokers. If rates are trending north, we underwrite higher than current rates with less than 70% loan-to-cost (this is the standard LTC). This helps us stay flexible with less leverage. If trending south, we underwrite at current rates with right around 70% loan-to-cost. This provides us the ability to “lever-up” and take advantage of a lower-cost-of-capital.
- MARKET EXPERTISE .. Strong rent growth is ultimately a good thing for CRE investors. However, we must understand the specific market and even neighborhood. Some markets are just about tapped out on the 10%+ rent growth we’ve seen over the past couple of years while others are experiencing tailwinds. Don’t get me wrong, there is still growth to be had! But underwriting the future based on record-setting historic growth is never a smart move.
Ultimately, there’s still no better asset class to invest in outside of commercial real estate, specifically multifamily. The fundamentals are STILL STRONG. And this will continue regardless of interest rate and/or overall economic trajectory. This is why we are actively seeking new investment opportunities to bring to you.
As always, we hope this is insightful. If you’re interested in learning how to invest or discussing some of our current investment opportunities, don’t hesitate to reach out!
Mitch and Kevin