This is risky business. Lenders want a down payment of at least 20-30%. Depending upon your preferences and goals, current criteria generally seek cap rates of not less than 8% and “cash-on-cash” returns of not less than 12%, loan-to-value (LTV) ratios of 70% to 80% (depending upon whether recourse or non-recourse financing is used), and debt service coverage of at least 1.25. Banks are not excited about lending for commercial property these days, so the only option is private lending. Equity share in a property may be used as a contribution for down payment with some lenders, but these deals require that all the pieces fit together well. The consultants representing the buyers add a fee, they sometimes involve other consultants and you end up with a “broker’s chain” of fees that could end up with upwards of 23% APR or more on the loan.
Okay, say a mechanical engineer just lost his or her job, and wants to buy an apartment building, fix it, flip it and make a huge profit. Engineers are smart, respected people. Multifamily RE investing is not like engineering; Real estate investing requires business savvy, and an understanding of finance, risk assessment, marketing, construction, and timing. Lenders lend to people with relevant experience. Conversely, a general contractor who knows how to renovate a building may not have the expertise to improve occupancy through management and marketing.
The combination of being able to analyze market trends, economic forecasts, and being in the right place at the right time is important. If the property is bank-owned or priced under market, there is usually a good reason. Valuation of commercial property is based on cost and income. You must know about CAP rates, NOI, and have an ability to predict the future. Having “skin in the game” as they say requires courage, backbone, guts. You need to be just like a financial gladiator, except without the lions and swords.
The Mortgage Bankers Association (MBA) released its Commercial Real Estate/Multifamily Finance Quarterly Data Book for the third quarter of 2009. The data in this report reflects a negative outlook for multifamily apartment investments. Here are highlights from the report (www.mortgagebankers.org):
- Vacancy rates rose in the third quarter for all major property types.
- For apartment properties, vacancy rates rose from 6.5 percent in the third quarter of 2008 to 8.4 percent in the third quarter of 2009.
- Industrial properties saw vacancy rates rise from 9.8 percent to 13.0 percent
- office properties saw a rise from 16.0 percent to 19.4 percent and retail vacancies rose from 12.9 percent to 18.6 percent.
- Asking rents have been falling –
- 6 percent for apartments
- 9 percent for industrial properties
- 9 percent for office properties
- 8 percent for retail properties
- Property Sales and Construction activity have seen significant declines
- Year-to-date property sales in 2009, through 3rd quarter, were 72 percent lower than the same time in 2008, which was 66 percent lower than they had been in 2007.
- Every major property type was affected
- Sales volume is so low it is hard to gauge commercial property prices but the Moody’s/REAL index showed an 11.5 percent drop over the quarter.
- New construction activity has slowed to a crawl. Nationwide construction was started on only 5,000 units in multifamily housing in October – the lowest level ever. Given market fundamentals and pricing it is unlikely we will see a significant rebound any time soon
Another analyst has a different story. The CoStar Group (www.costar.com) reports “U.S. Multifamily Market Strengthens in Third Quarter On Rising Demand, Falling Vacancy.”
- The national vacancy rate compiled from the 54 largest markets tracked by CoStar declined for the third straight quarter in 2010, falling 20 basis points to 7.7%. The national rate was a record 8.4% at the end of 2009, rising 130 basis points over the course of last year.
- The third quarter saw positive demand of around 47,000 additional units. Year to date, renters have absorbed about 140,000 units. In 2009, demand was a negative 60,000 units.
- So far in 2010, 20 metros have recouped their total demand for apartments lost due to overbuilding and other factors during the real estate downturn and recession. There’s a wide disparity across the country in demand growth. However, metros grew an average of 1.3% in the first nine months of 2010. Four of the five markets where demand is rising the fastest are Sun Belt metros, including Charlotte, NC, which saw the strongest growth at 3.5%, followed by Raleigh-Durham, NC; Phoenix and Dallas/Ft. Worth. Richmond, VA, also saw strong demand, mostly as a result of realignment of military personnel.
So where is the beef? Kiplinger (www.kiplinger.com) says the 10 best cities for prosperity, innovation, and jobs are:
- Austin, Texas
- Seattle, Washington
- Washington, DC
- Boulder, Colorado
- Salt Lake City, Utah
- Rochester, Minnesota
- Des Moines, Iowa
- Burlington, Vermont
- West Hartford, Connecticut
- Topeka, Kansas
The above cites will no doubt experience growth, but may not reflect a fertile ground for multifamily real estate investment. As local economies are declining, the foreclosure rates increase, as does the demand for rentals. At some point, when the economy improves, and the high paying job market stabilizes, renters will become home owners. The economic cycle requires understanding the demand window.