I know what you’re thinking This guy is trying to stretch the SVB headline into talking about multifamily real estate investing. Must be clickbait.
have understood. However, he would appreciate two ways in which the failure of SVB and other major banks could benefit multifamily syndicators and investors. Then determine if my headline has content.
Like all of us, I’ve seen news stories unfold at a rapid pace this past week. Silicon Valley Bank closed days after paying its bonus. No need to elaborate on the gory details here.
But when we ponder the bad news coming out of this hopefully localized but potentially more serious situation, there are two potential bright spots for multifamily syndicators and investors. I noticed Not just current players, but players eager to enter this currently overcrowded space.
I frankly admit that I could be wrong about this, as my short-term thesis is speculative. However, we believe these consequences are virtually inevitable, so we confidently flag the long-term discussion below.
Short-term implications for current syndicators and investors
Jerome Powell testified During our semi-annual visit to Capitol Hill last week, we emphasized that no decision has been made on this, but if the data overall indicates that a faster tightening is warranted, we will continue to tighten. will be ready to increase .. the pace of rate hikes.”
The conclusion for many Fed watchers was a rate hike of 0.25% to 0.5% on March 22nd. This is not surprising, as Powell is a protégé of his Fed Chairman Paul Volcker in the 1980s (who raised interest rates to his 20% on the eve of President Reagan). ) and the difficulty for the Fed to contain inflation.
Silvergate Bank collapsed at about the same time. Silicon Valley Bank next week. And Signature Bank last weekend. The water now billows across the Credit Suisse Pond.
While bystanders are right to criticize bank management’s decision, the SVB’s situation was clearly in the light of a sharp rise in interest rates. Faster than ever.
Check out this chart showing the speed of these increases compared to the previous period.
The Fed’s actions were designed to keep inflation in check, but I doubt bank failures were the intended result. The speed of these three failures and the way they have dominated the news cycle has caused widespread fear.
“Which bank is next?”
“Are my deposits safe?”
“How will this affect my line of credit and mortgage?”
how this situation will turn around in the short term
Many apartment complex deals have become a big problem. Lower floating rate debt was the drug of choice, as syndicators were looking for every possible way to close a deal to beat their overzealous competitors in the race to the bottom.
Without advance payment penalty, variable rate debt provided a more accessible vehicle for syndicators planning to sell quickly with added value. This strategy has earned investors billions of dollars in recent years.
But in this season of skyrocketing interest rates, floating debt is again plaguing syndicators and investors. A spike in interest payments erodes cash flow, stops distributions to investors, and puts investors’ stock at serious risk.
Lenders are demanding higher reserves as the expected cost of renewing interest rate caps surges. A friend of the syndicator reported that one of his deals has historically required a monthly reserve of around $2,000 for the rate cap update. His lender increased the same monthly escrow to his $70,000. (You read that right.)
Syndicators/investors with both floating and fixed rate debt will suffer additional impacts as rent growth has stalled in most markets. This has a significant impact on net operating income and value. This is a blow to operators who are looking to NOI as a remedy against value erosion due to cap rate expansion. This is a real headache for those planning to refinance or sell soon.
Every week we hear stories of syndicators discussing margin calls to reduce distributions and avoid total losses. I recently heard that a syndicator is paying $30,000 out of his pocket every month to keep his contract.
I have no way of verifying this statistic, but one knowledgeable attendee at last week’s Best Ever Conference noted in his newsletter that about 30% of multifamily contracts from conference attendees had some kind of problem. He said he thinks there is.
So the situation is serious. Where are the silver linings of the so-called banking crisis?
As I said, the Fed will definitely take bank failures into account when deciding their next move on March 22nd. Freeing overstressed multifamily syndicators and their investors.
This moratorium includes lower interest rate cap reserve requirements, less cash flow from debt repayments, less damage to valuations, greater chances of successful refinancing, potential capital calls or losing deals to lenders. may be included. (Admittedly, this may only delay the inevitable for most people.)
Some believe Powell and the Fed will move forward with their rate hike plans, while others see delays.goldman sachs professed They believe the Fed will not hike rates next week given the crisis.
It won’t take long to see if this short-term silver lining materializes. But a more solid long-term silver lining would take years.
Long-term bright spots from Fed rate hikes and bank failures
In 2016, I published a book humbly titled Multifamily Investing.perfect investment”. But I’ve been kidding myself about it since 2017 or so.
I say, “A perfect investment isn’t perfect…if you have to significantly overpay to get it.” And I would add:
Finding deals to pencil out was tough. In fact, it was quite difficult to get a contract for an apartment complex. on-market or off-market. The competition has entered a new level. If you’ve followed my sentences, you know that I believe this is due to the following.
- The relaxed rules of the JOBS Act have increased the acceptance of syndications.
- Virus visibility and popularity through social media and other online platforms.
- An explosion of gurus that appeared out of nowhere in the last decade. Someone who wasn’t in the real estate business before the Great Recession might be considered a “neurus.”
- Increased investment from Wall Street casinos and international investors.
- increased popularity of 1031 Exchanges The price of the replacement property may soar.
- The rising tide that lifted all ships for a decade until the tide receded to expose Warren Buffett’s slender Big Dipper.
Of course, the sharp rise in interest rates has significantly slowed down multifamily investment mania. But with these bank failures, lenders could definitely raise their underwriting standards.
Regional and regional banks, which provide access to credit for many real estate developers and syndicators, may be quite reluctant to initiate new lending. Bank runs and the threat of further rate hikes are looming, especially in the short term. (Note that multi-family syndicators have the option to acquire agency debt from Fannie Mae, Freddie Mac, and HUD. These debts won’t go away in a banking crisis or high interest rate environment. .)
Worse for many, these banks may stop renewing fully functioning real estate loans. A friend recently visited a local banker and was shown a thick Manila folder full of loans that he did not plan to renew this year.
So, like the short-term situation above, this situation is serious. So where are the so-called long-term bright spots from the banking crisis and Fed rate hikes?
As with any recession, the long-term impact will undoubtedly be lower multifamily supply levels to meet the still-growing demand. In 2023, a record number of multifamily homes will already be online. However, according to the National Apartment Association and the National Multifamily Housing Council, US needs to build 4.3 million more apartments By 2035 to meet demand for rental housing.
How much is it? This is approximately 20% more than the current domestic supply. If you want to think of your current supply as having been built over about a century, think of it as needing to increase by 20% over the next 12 years.
And if bank failures drive the Fed to raise rates and put the brakes on the current construction pipeline, the 12-year horizon to 2035 could quickly reach single digits (e.g., this slowdown could extend to 2026). if continued).
Silver lining? I would certainly say yes.
Fed hawks and a possibly constrained credit environment, plus many popular syndicators likely to go out of business in the next cycle, means many eager to get into the business. It can create a better environment for people.
However, you may not need to wait until the next cycle.
Many difficult multifamily deals will fail in the next year or two. This could give you the opportunity to obtain problematic deals from problematic operators and banks at prices well below your valuation.
Don’t get me wrong. I never take pleasure in someone’s failure and I hope you feel the same way. However, this is a reality in any market cycle. And this ends up creating more wealth than most ascending cycles can earn.
conclude with Quote From Howard Marks, the master of profiting from distressed assets. Now, and when the tide rises again in the next cycle, it will pay off for us to listen carefully.
“In bad times, securities are often bought at prices that underestimate their merits. And in good times, securities can be sold at prices that overestimate their potential. People are forced to buy in euphoria when the economic cycle pushes prices up and sell in panic when prices fall.”
BiggerPockets Article: The State of Real Estate Investing in 2023
After years of unprecedented growth, the housing market has changed course and entered a correction. Now is the time to take advantage of it. Download the State of Real Estate Investing 2023 report by Dave Meyer to learn the strategies and tactics that will pay off in 2023.
Note by BiggerPockets: These are opinions written by the authors and do not necessarily represent the opinions of BiggerPockets.