Why Chattanooga? Read on.
I recently came across an article in the February 6 edition of Real Estate Weekly about the state of Multifamily Investing. In it, Jonathan Woloshin, co-head of sector research for UBS Financial Services, makes some very interesting points about what has gone on in the multifamily arena over the last few years and what that means for the future. Of course, I always hate to hear any news that could in away sour my love of multifamily investing, but his points, I believe, are right on the money. Fore warned is fore armed. Proceed with intelligence.
Point Number One – Over Paying for Property
“What’s really going to trip us up? I think it’s going to be over-paying, and we’re not going to know until it’s too late,” he told the members of New York Commercial Real Estate Women (NYCREW) at a meeting last week.
As I tell all my students and clients, the one mistake that you cannot overcome during the period of ownership of a multifamily property is paying too much for it. If you pay too much, forget it. You cannot live long enough to solve that problem. So how do you protect yourself when doing your analysis? First off, remember the old adage, if you can’t hang your head in shame when you make an offer, you’ve offered too much. The biggest lie in multifamily is the asking price. Don’t let the seller’s inflated view of his ‘baby’ impede your making an offer with a price that works for you.
Also, set your criteria for buying very conservatively and stick to it. For example, what is your minimum debt coverage ratio? Why? Why have you chosen that number? Have you ever seen those mattress commercials that talk about your sleep number? Well, the DCR is your sleep number. The lower the number, the more restless nights you will have thinking about how you are going to make your mortgage payment. The higher the number the better your night sleep will be. Set your minimum DCR and never go below it. Sticking with conservative standards will help to insure that you never offer too much for the property.
Point Number Two – Expecting the Rents to Grow Exponentially
“One of the ways you can screw it up is by pushing rents to hard,” he said of multifamily investing.
In some California markets, average rents increased nearly 20 percent. In New York, the increase was 11.4 percent. “These are sticker-shock numbers for a lot of people, and I really do worry about that,” Woloshin said.
Rents on my properties have grown consistently every year. That is a good thing. Now what if I was a seller and I showed a prospective buyer my trailing-24 financial statement and he sees the growth of my top line every single month for the last two years. Should he expect that to continue ad infinitum (that’s ‘forever’ for government employees)?
Unfortunately, that’s what I see some investors doing when they are putting together their pro forma package for their investors. The rent growth is projected at 3-5% every year of their ownership. Folks, just don’t do it. With the continued tax increases coming out of Washington, people’s incomes are coming down and that is greatly impacting their buying decisions. I was shocked when I saw one of my employees post on her facebook page the following post “Just received my first payroll check of the year – the additional taxes were significant in take home pay!!” I TOLD HER THAT WOULD HAPPEN!!!! Regardless of who won the White House.
This money grab is going to have a significant impact on rental income. Plan Acordingly.
Point Three – Over Supply of Apartments
“Less of a concern, in Woloshin’s mind, is over-building. While certain markets, notably Austin and Raleigh, are experience a buildings boom that will in some sub-markets outstrip job growth, most of the country continues to comfortable built less housing than would meet the needs of the anticipated workforce.”
I recently spoke in Seattle when an architect in my class came up and gave me some very startling information about the building boom in that town. He said that by third quarter of this year almost 14,000 new apartment units will be coming on line in that MSA (Metropolitan Statistical Area for those of you employed by the government. Is my Libertarianism coming out too strongly in this blog post?).
Think about what that will mean to the B and C class apartment owners. The B residents will pull a George Jefferson (That mans they will ‘move on up’ for those of you born in the 1980s) and the C class residents will move up to the B class properties. What would you do with this information if you were looking at buying a C-class property in Seattle? LOOK ELSEWHERE while you wait it out. The rental dynamics for Seattle are going to change drastically over the next year. When in doubt – DON’T.
Find those markets that do not have these problems and make sure you do your research before going into a particular market
CONCLUSION – Successful People Do What Everyone Else Refuses to Do
“I’ll tell you what I’ve been telling my clients, and it’s been the same story for years,” he said. “It’s multi-family in non-core, non-institutional markets.”
An aging population, people moving from high-tax states to lower-tax states, and young people in the 20s returning to college (and, thus, living in college towns,) are all trends that indicate the smart places to buy multi-family properties.
“You can go to a market like Chattanooga or Nashville where you can get a decent B or B-plus property at a seven or eight cap rate,” he said. “When you can borrow from Fannie at three and a half – and I have clients doing this with their eyes closed – that’s good business.”
I think Mr. Woloshin is right on the money with his advice here. If you are looking to get in the game, the best places for you to be looking is where the institutional investors fear to tread. Why compete against them? YOu will lose every time. Go to markets that, as he describes, are non-core, non-institutional grade markets.
I like how he chooses Chattanooga and Nashville as markets that meet those criteria. I have a client that is investing in Chattanooga and the way that Mr. Woloshin describes it is spot on. There are places like this all over the country. Even in your own backyard.
Happy Hunting!
