As you know, we recently launched Jacobson Equities Multifamily Fund, a $300,000,000 vehicle with which we intend to purchase well located core plus and value add communities in the Western United States. A unique set of market factors are conspiring to create what we believe is an extraordinary moment to buy high quality apartments at a substantial discount to replacement cost, with correspondingly lower risk.
What makes us so confident?
The Federal Reserve has raised interest rates by over 500 basis points since March of 2022—the most aggressive scope and speed in four decades—resulting in both cap rate expansion and asset devaluation across all commercial real estate classes. At the same time, over $1 trillion in multifamily loans are set to mature between now and 2028. Much of this debt consists of high leverage, floating rate loans which cannot be refinanced at today’s higher interest rates and lower valuations. Absent a lenient lender, many sponsors will be forced to bring well performing assets to market despite high occupancies and high rents.
Astute multifamily buyers are recognizing that the tide is turning, and this spells opportunity. They will organize around identifying potential acquisitions in their preferred markets and put capital to work as good deals become available.
Some buyers though will fail to capitalize on the moment and miss out. These people are looking for a huge flashing green light, usually defined as a clear herd they can follow. They see conflicting data in the morning papers and choose to sit on the sidelines.
Two quotes, one from 1979 and one from last month come to mind. In 1979, Warren Buffett said “The future is never clear; you pay a very high price…for a cheery consensus. Uncertainty is actually the friend of the buyer of long-term values”. More recently, in connection with Blackstone’s $10b purchase of AIR Communities, Blackstone President Jonathan Gray commented “we can see the pillars of a real estate recovery coming into place. We are, of course, not waiting for the all-clear sign and believe the best investments are made during times of uncertainty”.
With that in mind, let me lay out what we see as the compelling data points that indicate to us that the time to buy multifamily is upon us.
1. Multifamily Demand Growing
- The U.S. is expected to have a multifamily shortage of 769,000 units by 2025, with a widening deficit each year thereafter through 2028.
- The housing affordability gap is at an all-time high for first time homeowners. As of May, 2024, home mortgage rates are over 7% and home prices have remained well above pre-pandemic pricing.
- Since 2019, household formation has averaged 2 million per year according to the U.S. Census Bureau.
2. Supply Shortfall
- New construction deliveries in the U.S., currently elevated, are expected to taper from 460,000 in 2024 to approximately 262,000 in 2026. Elevated labor and material costs, high interest rates on construction financing and lack of available liquidity are conspiring to slow new deliveries dramatically.
- Current new supply is being rapidly absorbed due to increased immigration and strong job and wage growth.
3. Favorable Pricing
- Not only have the Fed’s aggressive rate increases impacted property values nationwide, but this is occurring at the same time as rental rates are flattening across the country (due to the near-term spike in supply). Higher cap rates plus lower Net Operating Income means even more favorable pricing for buyers.
- Of the $1t plus in multifamily loans maturing by 2028, approximately $600b will come due by 2026. Again, many of these loans will not be able to be refinanced, forcing these properties to market.
4. Reduced Risk
- The last decade’s sustained period of low interest rates resulted in asset price inflation. Many sponsors promised investors high double digit returns which were only achievable through high leverage, floating rate debt, aggressive rent growth projections and unrealistically short renovation timelines. That formula only works as long as interest rates stay low. Those times are over, forever.
- Today, as asset prices revert to reality, outstanding properties can be acquired for excellent prices without the risk that accompanied many of the past decades’ deals.
Some readers will note that the drop in inflation recently stalled, calling into question when (or perhaps if) the Fed will start lowering interest rates. Some may question whether it is premature to begin buying apartments again. Not only do we believe the answer is no, but we would argue that this pause in the march to lower rates works to the advantage of the multifamily buyer.
First, higher for longer means more pain for many overleveraged owners and lenders. This should hasten the time when these lenders and their borrowers throw in the towel and either foreclose or sell prior to foreclosure according to a May 7, 2024 Wall Street Journal article entitled “Property’s Waiting Game Gets Harder”. The article closes by saying that, as owners move to sell their properties, the flood of assets hitting the market will further depress values. We are already beginning to see nascent signs of sellers capitulating and bringing properties to market rather than waiting for interest rates to drop further.
Second, many institutional real estate buyers are on the sidelines still (Blackstone being a notable exception). That gives private buyers a leg up in acquiring assets at better prices than will be the case when the institutions decide the water is warm enough to jump back in. The Wall Street Journal ran an article on March 28, 2024, entitled “Fortune Favors Early Movers in America’s Property Crunch”. Private buyers, the article asserts, “…are under less pressure to time their purchases perfectly. They tend to own assets for longer and are more focused on creating generational wealth…” The article goes on to point out that real estate buyers who bought in 2009 or 2010 made literally twice what was made by more cautious players who waited until 2013 to buy.
Real estate investment is not a competition in which one is graded on whether they bought at the absolute bottom of the market. In fact, given the sheer difficulty, if not impossibility, of knowing exactly when a market has bottomed, waiting for an illusory market bottom proves to be a more costly strategy to the multifamily buyer, because they miss opportunities to buy excellent assets at a good basis.
People ask us what types of properties we buy, and the answer is always the same: we buy properties we want to own. That means well located properties in cities and states where people want to live, businesses want to operate, with a reasonable cost of living and a high quality of life. Our objective is to buy at a reasonable price, without excessive leverage, and to apply our operating competencies to ensure we execute our business plan. If we can make cash distributions, enjoy meaningful rent growth and appreciation without undertaking undue risk (read: too much leverage), we believe we’ve done our job.
As you know, Warren Buffett’s business partner, Charlie Munger, recently passed. Mr. Munger was renowned for his many colorful expressions of business wisdom but perhaps none was more quoteworthy than his advice to Mr. Buffett early in their relationship. Rather than focusing on “…buying fair businesses at wonderful prices…”, Mr. Munger said, try instead to buy “…wonderful businesses at fair prices”.
We are entering a period of tremendous opportunity. Moments like these do not come along often. Wonderful properties at fair prices (and, likely, some at outstanding prices) can be obtained. Proactive, thoughtful operators (and their investors) should be well rewarded.
