\n<\/p>\n
Multifamily real estate<\/strong><\/a> is by no means an easy asset class to buy into. What most people mistook as simple investments in 2020 are now turning out to be cash-hemorrhaging, high-interest, soon-to-go-bust investments<\/strong>. Everyone and their grandma was trying to buy the biggest apartment building they could, bidding well over asking without checking the fundamentals of the deal. Now, these buyers have to reap what they sowed by selling a solid asset at a low price <\/strong>or falling into foreclosure<\/strong>.<\/p>\n But how did we get here?<\/strong> Wasn\u2019t multifamily the hottest asset class <\/strong>of the past two years? This was supposed to be a foolproof way to <\/strong>build wealth<\/strong><\/a>, so what happened? Brian Burke <\/strong>knows, and that\u2019s why he sat patiently on the sidelines, watching inexperienced <\/strong>syndicators<\/strong><\/a> bite off more than they could chew, refusing to listen to long-term investors. Brian has successfully predicted multiple crashes<\/strong>, not because he has a crystal ball, but because he knows when to take profits. He smelled something fishy happening in the multifamily space<\/strong> in 2019, and this same feeling saved him in 2022.<\/p>\n So, what\u2019s next for the multifamily housing market?<\/strong> Are the nation\u2019s multifamily investments set to crash and burn? Not quite, but this could be the opportunity of a lifetime for the new investors looking for their next deal. But when should you hop in, start analyzing deals, and make bids? Stick around for this multifamily deep dive<\/strong>, as Brian will give you everything you need to know about the multifamily real estate market.<\/p>\n Dave: Kathy: Dave: Kathy: Dave: Brian: Dave: Brian: Dave: Brian: Dave: Brian: Kathy: Brian: Kathy: Brian: Dave: Brian: Kathy: Brian: Kathy: Brian: Kathy: Brian: Dave: Brian: Kathy: Brian: Kathy: Brian: Dave: Brian: Dave: Brian: Kathy: Brian: Kathy: Brian: Dave: Brian: Kathy: Brian: Dave: Brian: Kathy: Brian: Kathy: Brian: Kathy: Brian: Kathy: Brian: Dave: Brian: Dave: Brian: Dave: Brian: Kathy: Brian: Dave: Brian: Kathy: Dave: Brian: Dave: Kathy: Brian: Kathy: Dave: Kathy: Dave: Kathy: Dave: Kathy: Dave: Kathy: Dave: Kathy: Dave: Kathy: Dave: \u00a0<\/p>\n \u00a0<\/p>\n<\/div>\n Interested in learning more about today\u2019s sponsors or becoming a BiggerPockets partner yourself? Check out our <\/i>sponsor page<\/a><\/i>!<\/i><\/p>\n Note By BiggerPockets:<\/b> These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.<\/p>\n
Hey everyone, welcome to On the Market. My name\u2019s Dave Meyer and I am your host, joined with Kathy Fettke today. Kathy, what\u2019s new with you?<\/p>\n
Oh, well, I am just so excited to hear what Brian has to say. He is just a brilliant investor and I think a lot of people are going to learn so much from this interview.<\/p>\n
Yeah, I\u2019ve gotten to meet Brian a few times now, luckily, but he\u2019s like one of my original people I looked up to when I joined BiggerPockets. He\u2019s just been around for so long and has been so smart and for so long. It\u2019s a treat to be able to talk to him<\/p>\n
And he speaks in a way you can understand. He boils it down into basics. His voice needs to be out there more helping protect investors and syndicators because it\u2019s rough waters.<\/p>\n
Yeah, absolutely. And just so everyone knows, we are going to be talking today mostly about multi-family investing, and that does have implications for the whole real estate investing industry. But just to be clear, what we talk about, Kathy, Brian and I in this episode, is not the residential market. There are differences between multi-family and commercial markets and the residential markets. Brian does a great job of explaining that, but just want to make that clear before we jump into this. But it\u2019s super, super interesting and if you want to just build out your knowledge as an investor, the concepts that Brian talks about that form and inform his opinion about the multi-family market are applicable to investors of all types. Definitely pay attention and as Kathy said, he makes these really important complex topics super easy. We\u2019ve got an excellent, excellent episode for you. We\u2019re going to jump into it in just a second, but first we\u2019re going to take a quick break.
Brian Burke, welcome to On the Market. Thanks so much for being here.<\/p>\n
Thanks for having me here, Dave.<\/p>\n
Well, it\u2019s a pleasure to have you on. For those of our listeners who don\u2019t know who you are, could you provide a brief introduction?<\/p>\n
Yeah, absolutely. I\u2019m Brian Burke, President and CEO of Praxis Capital, longtime BiggerPockets member. I think going on 10 or so years now. My company invests in multi-family housing across the US. I\u2019ve been doing this for in the multi-family side, about 20 years. Started out as a single family house flipper, did about 725 or 750 house flips. But now our core business is multi-family. Our portfolio topped out about 4,000 units.<\/p>\n
Wow. Well, yeah, when I started working at BiggerPockets, you were one of the OG forum members that I remember really looking up to and you were too modest to also mention your book, The Hands-Off Investor, which is one of my favorite books. Really great introduction to investing in syndications. If anyone\u2019s interested in that, you can check that out from Brian as well. But we\u2019re here obviously to talk about the tumultuous economy and state of the multi-family market. You have a pretty interesting opinion about what\u2019s going on here. Can you give us a brief synopsis of what you think is going on in the multi-family space as we head into 2023?<\/p>\n
Well, I think we\u2019re in for quite a change in the market from what people have become accustomed to. The prices and rents in multi-family space have really only gone in one direction for about the last 12 or 13 years. And I think a lot of people thought that that was the way it always is and was always going to continue. But I\u2019ve seen this movie before and it\u2019s kind of back in like \u201905-\u201906, right before the big housing crash. I just remember people talking about how, \u201cOh, my plumber bought a house and made a hundred grand in one year, and so I\u2019ve got to go buy a house.\u201d The whole thing subsequently came crashing down and it\u2019s like when everybody is doing it then you know that there\u2019s probably a problem soon to follow. This also happened in the dotcom bust, the 2000, when everybody was investing in stocks.
Next thing you know it came crashing down in a ball of flames. And what I\u2019ve noticed over the last three or four years we\u2019re getting into this everybody\u2019s a multi-family investor. Everybody\u2019s a syndicator, and the space was becoming overcrowded and overheated and I thought that we\u2019d probably see quite a different looking market coming in not too distant future. Well, that got pushed even sooner thanks to recent actions by The Fed and of course the bond markets that have driven interest rates up. That\u2019s been kind of the spark that lit the fuse, and I think the bomb is starting to go off.<\/p>\n
Wow, bomb going off. That\u2019s a little bit scary. Can you say a little bit more about that, just generally \u2026 Maybe actually, let\u2019s take a step back and just provide our listeners with a little bit of foundational knowledge here. Why is it that you think \u2026 Well, first, do you think that the commercial multi-family market is different from the residential market and what are some of the key differences you see?<\/p>\n
Yeah, they\u2019re completely different and they can be entirely disconnected. And I get this question all the time about, \u201cOh, you\u2019re a real estate investor, what\u2019s going on in the market?\u201d And it\u2019s like, what the heck is the market? There\u2019s really no such thing as the market. Multi-family trades on a different cycle at different amplitudes than single family, than hotels, than commercial. Even within itself. You could have multi-family doing great in Tampa, Florida, but doing absolutely terrible in San Francisco. That actually might ring true now as a matter of fact. Single-family prices can be falling while multi-family prices are increasing. They\u2019re completely unrelated and it\u2019s really impossible to try to put a nexus between them that\u2019s going to stand the test of time.<\/p>\n
Brian, you\u2019ve been really cautious and you have really timed things well. It\u2019s been really incredible to watch you and watch your company grow. I know we would run into each other in events and I would always pull you aside and say, \u201cBrian, what are you, are you working on? What are you doing?\u201d And we would both be extremely concerned about the underwriting that was happening over the past few years and the deals people were doing. They\u2019d come across my desk and I was like, \u201cThis doesn\u2019t make sense.\u201d And I would go to you and say, \u201cIs it me? Am I just not seeing the opportunity?\u201d But how have you been able to navigate, let\u2019s just say the last decade and time things so well?<\/p>\n
Kathy, it\u2019s not you, it\u2019s me. Just always know that. Yeah, I don\u2019t know, maybe I have a sixth sense about these market cycles. I don\u2019t know. But I\u2019ve managed to navigate them fairly well over the years. I basically stopped buying real estate in about \u201904 and a half, and then by \u201905-\u201906, the market completely catapulted and it went in the toilet. I managed to avoid the worst of that, managed to somehow be lucky enough to acquire a rental pool of about 120 rental houses in the San Francisco Bay Area in 2009 and \u201910 right as it was bottoming out, rode that up until those prices doubled and a half, and sold the whole portfolio as the housing market was starting to slow just a little bit. I\u2019ve managed to figure out the timing more often than not.
Of course I\u2019ve certainly been wrong my share of times, but I think it\u2019s just a matter of staying in tune to what\u2019s going on, recognizing the signals around you. And sometimes it\u2019s not like you can point to one specific data point and say, \u201cOh, I read it an article that this or that is happening or this is going to be 0.7 and then I\u2019ll sell when it\u2019s 0.8.\u201d That kind of stuff. It\u2019s not like that. It\u2019s just a matter of a kinetic sense of what\u2019s going on around you, being aware of your surroundings. I think maybe this came from my background in law enforcement before I was really a full-time real estate investor, always wondering what\u2019s the next bad guy hiding behind the corner ready to attack you as you come around. I look at a lot of news and information and articles and data points and also just a sense of when things are just getting too overheated or too cooled down.<\/p>\n
What was the bad guy this time around, like over the past couple years? What were you seeing around the corner?<\/p>\n
What I was seeing was two things. A massive interest in acquiring multi-family coupled with high leverage, risky debt. To put that into practical example, when we would go to acquire property, let\u2019s say we\u2019re putting in a bid on a 200 unit apartment building and we crank on it as hard as we can and come up with the highest price that we can and we submit an offer only to find out that there\u2019s 35 other offers, half of them with hard non-refundable earnest money deposits, some of them over a million dollars and asking the broker about the financing structure that the other buyers are doing, finding out, \u201cWell, they\u2019re all using bridge debt, which is high leverage and short term.\u201d And when you see that kind of stuff happening that it\u2019s time to sell and things are topping out. And that\u2019s exactly what we did. And when we put our first property on the market and we had, I don\u2019t know, 17 or 18 offers, we knew that our thesis was more than just a casual observation.<\/p>\n
You obviously have seen a lot of demand, but that was even according to your timeline, that was even before The Fed started raising interest rates. Is that right?<\/p>\n
Oh yeah. This all started, early 2020 is really when it started. Then COVID hit in early 2020 and it kind of instantly shut the market off. For about four or five months we just sat on the sideline. We didn\u2019t really want to buy anything, we didn\u2019t really want to sell anything. It just didn\u2019t seem the time was right and then things started to really take off. And it was interesting to watch because come third quarter to fourth quarter of 2020, market activity was way hotter than it was even pre COVID. Rent growth took off a lightning storm. We kind of were able to recognize some of those patterns of what was causing it and how we could benefit from it. And that was the final nail in the coffin, so to speak, for us. And that\u2019s when we made the decision to essentially sell everything that we could, keeping only our highest quality best properties remaining behind in the portfolio.<\/p>\n
It seems like multi-family or at least a lot of multi-family deals are sitting on quicksand today just sinking. I mean, what are you seeing out there from people you talk to and what are the challenges that some of these operators are facing?<\/p>\n
Well, some of the operators who financed conservatively and bought, let\u2019s say any time before 2022, even in early 2021, I\u2019m not really hearing much about challenge. Occupancies are holding very steady. For our portfolio, for example, we\u2019re getting our proforma rents, the rents that we expected to get when we initially underwrote the property we\u2019re getting, in some cases we\u2019re getting more. Occupancies are holding in the mid 90s just like we expected them to do. We\u2019re not seeing really any stress in that regard. And I don\u2019t think any of our fellow owners that are in a similar situation are either. The ones we\u2019re seeing the most challenge is coming from basically two sources. People that bought early this year, call it Q1, Q2 of 2022, paying 2021 prices, but ending up getting stuck with 2022 interest rates, seeing some stress there. Then owners that bought a little bit before this year, maybe one year ago, two years ago, that used high leverage financing and they didn\u2019t get a chance for the rent growth to catch up or their renovations to really reach a critical mass to increase their income enough to cover far higher interest rates.
And one characteristic of that bridge debt is the interest rates are floating and they\u2019re generally floating at a pretty wide margin over the index. SOFR index at the beginning of 2022 was five hundredths of 1%. 0.05 of 1%. And now SOFR is, I think it was like in the mid twos or mid threes even. It\u2019s gone up a lot. If your loan is 300 or 400 basis points over SOFR, you\u2019re now looking at close to 8% interest rates when they probably underwrote to a four or maybe a four and a half and they don\u2019t have the cash flow to cover it. I\u2019ve been hearing a few stories about some operators requesting loan modifications, some requesting forbearance to stay out of foreclosure, only just now beginning to hear talk about people who are reaching maturities or needing to refinance and are finding that to be difficult. I think we\u2019ve only barely cracked the door open on that scenario. That\u2019s going to be the next shoe that drops in my opinion.<\/p>\n
I mean, and what does that look like? I mean, are banks being lenient? Are they offering the forbearances?<\/p>\n
I don\u2019t know. I think so to a certain degree. One thing a lot of people don\u2019t know is I had started a bridge lending company five years ago and we did $2 billion with a B, in loans in that five years, one billion of which was in 2021. I sold that company as well.<\/p>\n
Geeze, Brian. You are a baller.<\/p>\n
But I\u2019ve been talking to some of the people I know in the industry and finding out that, well, first of all in the loans that we made are still doing quite well thankfully, but our lending was quite a bit different than some of this larger CRE bridge product that we\u2019re seeing. But I was just having a conversation a couple days ago with a warehouse lender. These are the folks that do the loans to the people who do the loans. And I am hearing a little bit of talk about a little bit of patience for borrowers who may be running up against a maturity be yet are still paying, but if they\u2019re not paying there\u2019s likely not to be much leniency.
Now the challenge that we have is some of these borrowers aren\u2019t going to be able to pay and as rates have gone up so much, if the cashflow isn\u2019t there, they\u2019re going to have problems. I mean, we had two of the properties, actually three properties that we sold in 2021. We had brokers unknowingly come to us this year trying to sell us those properties because the sellers were trying to get out because they used high leverage financing and they\u2019re having trouble. It\u2019s definitely, I think the cracks are only starting to appear right now.<\/p>\n
A couple of weeks ago for the people who listened to this show, you might have heard a show where Ben Miller, who\u2019s the CEO of Fundrise was on, James and I interviewed him and he has a similar take as you do Brian about the state of multi-family. And he said he was fearful that there\u2019s just going to be a lack of liquidity and for not just the two cohorts you describe, but also people whose commercial balloons are coming due and who also people who bought five or seven years ago and that people are facing not just banks who are not wanting to extend loans, but there\u2019s just not enough money out there to cover some of the needed liquidity. Are you seeing that at all?<\/p>\n
I haven\u2019t seen that yet. It certainly could become an issue. I would say that lenders are becoming more conservative and whenever lenders become more conservative, that means that there\u2019s less capital flow, right? This could become an issue. Now I think you\u2019re going to see this issue materialize more in other sectors outside of multi-family to a greater extent. If you have a portfolio of shopping centers or office buildings and you\u2019ve got a commercial maturity coming, yeah, maybe there could be a liquidity issue to refi because values haven\u2019t really gone up. In fact, arguably, you could say that office maybe has become a little bit stressed and capital may be difficult to obtain there. But in performing multi-family assets, Fannie Mae and Freddie Mac are the backstops for the biggest finance years out there in that space. They\u2019re always going to be there. Now to what extent we don\u2019t know.
I mean, they do have lending caps every year. They\u2019re not even going to come close to it this year after two or three years of constantly hitting it. Where it used to be if you wanted to get a multi-family loan from Fannie or Freddie, you better not try to do it in October or in November and December because they were reaching their cap and you\u2019re probably going to have a challenge, but now they\u2019re not even going to hit their cap. If you bought seven years ago, man, you\u2019re going to be fine because values in multi have gone up so much in seven years that assuming you hadn\u2019t previously refinanced and stripped out all your equity, you should have a ton of equity to be able to qualify for very low leverage, probably 40 or 50 LTV takeouts. I don\u2019t see any issue there. Now, if you bought two years ago using 85% to cost bridge debt and maybe it\u2019s a class C property and you\u2019re suffering from delinquent collections and that sort of stuff, then your takeouts could be a little more challenging.<\/p>\n
It seems like you\u2019ve been very disciplined in your buy box and obviously, so what are those fundamentals that you follow that have worked so well for you?<\/p>\n
Well, now the fundamental is a flight to quality. I haven\u2019t always had that as a element of our portfolio. We certainly had our phase of doing class C, maybe even C minus type stuff. I think the experience has taught me to think a little bit counterintuitively from what some people believe is they say, \u201cWell, I want to invest in class C because when the economy goes south, class C does the best because the class B people can\u2019t afford the class B, so they move into class C and class A moves to class B and class A suffers.\u201d That\u2019s the thesis that you\u2019ll hear. You\u2019ll hear, \u201cOh, it\u2019s workforce housing and everybody needs a place to live.\u201d And I just don\u2019t buy into either of those two theses. On the class part, I feel like in my experience, the class C tend to perform the worst in the downturn because the resident profile is generally the one most impacted by layoffs and wage cuts and other things.
Then what ends up happening is they stop paying rent and then they have really nowhere else to go, so they don\u2019t leave. You have to wait all the way through an eviction and that can take months. And now when they leave, they don\u2019t leave it in the best condition. And now you got all this turnover cost and it just eats you alive. Whereas your class A, they\u2019ll discount their rents and do some concessions, but they\u2019ll stay relatively full. In my experience, class A tends to do better in a downturn. Our buy box has been more of a shift to a flight to quality. I think just looking at things like crime statistics, school ratings, income, all these different factors help guide us to sub-markets where we feel we have the highest likelihood of actually collecting our rent. And that really does make a difference.<\/p>\n
And how will you know that it\u2019s time for you to jump back in again?<\/p>\n
I\u2019ll start to see signals. When you start to see more distressed sales, you start to see a couple REOs coming out, these are bank owned properties, you\u2019ll know it\u2019s really time to hit it. But to get a little bit earlier, I think when you see more and more people talking negatively about the business, that\u2019s probably about a pretty good time. I remember in \u201909 when the market was just in the toilet, the residential market was terrible. And I was at a family office conference and I had just given a presentation about what we were going to do next, which was we were going to be buying single family homes to rent out. We\u2019d been flipping like 120 houses a year. And it was great business while there were all these foreclosures. But I said, \u201cWe\u2019re shifting to a buy and hold model at least for some of our portfolio.\u201d
This guy comes up to me and he goes, \u201cYou got it all wrong.\u201d He\u2019s like, \u201cYou don\u2019t know what you\u2019re talking about. This is not the time to buy rentals. This is the time to be flipping. It\u2019s crazy. You\u2019re catching a falling knife. What are you even thinking?\u201d And this guy was supposedly this sophisticated, this guy, family office guy, and it\u2019s like, \u201cOh yeah, whatever.\u201d Well, I said, \u201cLook, I think houses are going to double in value in the next five years.\u201d \u201cOh, that\u2019s just ridiculous.\u201d Well, I was wrong. They didn\u2019t double in value in five years. They doubled and a half in value in five years. And that really was confirmation it was the time to do it. When people were telling you it\u2019s the absolute wrong thing to do, that\u2019s when I figure it\u2019s the right thing to do.<\/p>\n
We\u2019ve talked a little bit about performance in terms of cash flow and whether people are going to default. Where do you see valuations for multi-family properties going right now? Because the data, I\u2019m not involved in the day-to-day in the way you are, but I look at the aggregate data that every commercial real estate investor looks at, the cap rates haven\u2019t really expanded to the point I would expect them to at this point in the cycle. Is that what you\u2019re seeing as well?<\/p>\n
Yes and no. It\u2019s an interesting, there\u2019s like two parallel universes right now. There\u2019s like reality and then there\u2019s dreamland and there\u2019s just enough people that still live in dreamland to obscure what\u2019s really going on in reality. Here\u2019s what I mean by that. I had a broker in the Phoenix area call me about six months ago. This was just as the market was starting to turn and he said, \u201cWell, what are your thoughts on the market?\u201d And I said, \u201cWell, the mere fact that I haven\u2019t heard from you for in two years and now you\u2019re calling me tells you everything you need to know about what\u2019s going on in the market. Obviously buyers have vaporized or you wouldn\u2019t be calling me\u201d because he\u2019s trying to say, \u201cHey, are you a buyer, right?\u201d I asked him, I said, \u201cI cannot justify paying 300 a door for 1980s value add product. That\u2019s just not making any sense.\u201d
And he\u2019s like, \u201cWell, now we\u2019re starting to take that same stuff out for 250 a door.\u201d The same stuff they were taking out three months prior for 300 a door they\u2019re taking out for 250 a door. Right there, there\u2019s a 10 to 15% price cut and that was overnight. It was like a light switch. And people may not realize that that happened if they aren\u2019t paying really close attention to the market. Now, the interesting part about that was even though prices fell from where they were in January, February, March, they were still up from where they were in say August or July or August of 2021. There was this really rapid ramp up here in the third and fourth quarter of \u201921 and first quarter of 2022. Then second quarter is when everything kind of fell off a cliff.
Well, now you start getting brokers calling and you\u2019re saying, \u201cLook, three cap isn\u2019t a thing anymore.\u201d And, \u201cWell, we\u2019re getting offers and this and that.\u201d And what\u2019s happening is there\u2019s just enough people out there that have a 1031 that they have to close out or they raised $500 million and they got to get the money out because it\u2019s sitting there burning a hole in their pocket. There\u2019s just enough of them. There\u2019s so few sellers that there\u2019s this little minutiae of transaction volume that\u2019s taking place and is still taking place at these ultra compressed cap rates. Well, guess what? As soon as those buyers spend their money and then they go away or more sellers need to sell because they need to sell, then the real pricing is going to get discovered. We\u2019re in this little phase of price discovery where there\u2019s a wide bid ask spread resulting in almost no transactions that transactions that are taking place are just, as you said Dave, they\u2019re still kind of in that high threes, low fours and that\u2019s not going to stick.
It\u2019s just not going to stick. The thing that people got to think about is if a cap rate was 4% and it goes to 5%, you go, \u201cOh, cap rate\u2019s moved 1%, no big deal.\u201d But guess what? From four to five is a 25% decline in asset value. It is actually quite significant. And I think you\u2019re not only going to see that. I think there\u2019s a really good chance that you see multi-family even in good markets, could be in the high fives or touching in sixes and maybe even go a little higher than that.<\/p>\n
Thank you for explaining that. I still am just I guess the 1031 money and these institutions that have money to spend, but I just don\u2019t understand the bull case here. Do either of you know a coherent argument about why multi-family values would go up in the next couple years, which would justify buying at a cap rate that\u2019s about what bond yields are right now?<\/p>\n
Well, the argument I usually hear is, well, everybody needs a place to live argument. That\u2019s one of them, which by the way is BS because just because everybody needs a place to live doesn\u2019t mean they\u2019re going to rent your apartment. They could live with their parents, they could move in with their friends, they could double up. It\u2019s about household formation. Not everybody needs a place to live. I think that plays a part in it. But the other theory that I hear is interest rates are going up, which is going to cause house payments to go up, which is going to cause more people to stay in the renter pool or enter the renter pool, which is going to place more demand on rentals, which is going to force rents up and rents going up is going to force up values. That\u2019s the thesis that I hear.
And certainly one could argue there\u2019s merit to that thesis, that could in fact take place, but it\u2019s going to be difficult because the rents have already gone up. And this is the part that people tend to want to dismiss is that there was a massive increase in rents over the last two or three years. Some markets, I just read Phoenix was up like 80% in five years or something like that.<\/p>\n
Wow.<\/p>\n
And I know that some people say like, oh, that can never continue. And some people say, \u201cOh yes it can.\u201d I\u2019ve seen both happen and it probably will continue, but it\u2019s going to take a while and there\u2019s going to have to be this leveling off and kind of a chance for everybody. Okay, cool off, just let this set for a minute and then we\u2019ll get back to rent growth later. That period could be six months, it could be six years. I mean, that\u2019s the part that nobody knows right now.<\/p>\n
Yeah, I mean, Dave, to answer your question, I also hear inflation and lack of supply and there\u2019s just not enough out there, so we got to get it now. And I could tell you I spoke, I did that debate at the Best Ever Conference in, I think it was February or March, and the debate was are there going to be more sales, commercial sales this year or less than last year? And I was on the side of it\u2019ll be less. The audience voted that it would be more before the debate and I had to just pound it. I\u2019m pounding the podium saying, \u201cAre you not listening to The Fed? Do you not see what\u2019s coming?\u201d The fact of the matter is they didn\u2019t, they had no idea. And we just talked about it earlier, people now know who The Fed is and maybe they\u2019ll pay attention. But just in March I looked at a group of thousands of multi-family investors who had no idea what was about to happen.<\/p>\n
And it did happen. The sales in the first half of 2022 were greater than the sales in the first half of 2021. However, sales in the fourth quarter of 2022 are going to round out at around 30 billion or \u2026 Yeah, 30 billion. Compare that to last year\u2019s fourth quarter was 130 billion. It\u2019s down, I don\u2019t know, what\u2019s that? I\u2019m not that good at math. 70%? It\u2019s a down a lot, right? It\u2019s happening already. And that\u2019s going to continue. I think you\u2019re going to see very light transaction velocity for at least the next couple quarters.<\/p>\n
Brian, what do you make of the increase in multi-family construction of late? We\u2019ve seen it go up a lot. I actually saw something today that said it\u2019s at the highest rate since 1973, and there seems to be a good deal of inventory that\u2019s going to come online over the next year, I think particularly in Q2. How do you think that\u2019s going to add to this complex market that you\u2019re sharing with us?<\/p>\n
Well, it\u2019s going to change things only very regionally. There are some areas that really have no development. Case in point, late last year, I bought a three property portfolio of multi-family assets, which you think, \u201cOh my God, late last year, a terrible time.\u201d Well, but it was a kind of a distressed sale. We really got a good deal on it. But really one of the things that really drove me to it was it\u2019s located in a county that has had a moratorium on multi-family construction for like 15 years, and they\u2019re the newest properties in the county, and there\u2019s only 11 properties over a hundred units in the whole county. And it\u2019s a very populous county, a suburb of Atlanta. I didn\u2019t have to worry about multi-family development coming in and overrunning us. And that was an important consideration. You go to Phoenix, Arizona and they\u2019re building left and right, but that isn\u2019t necessarily a wrong choice.
I mean, there\u2019s people moving there left. What really matters most is looking at construction to absorption ratios, how much is being constructed versus how much is being absorbed and how many people are moving to that area? And this is one of the reasons why I constantly preach buy in markets where people are moving to and avoid markets where people are moving from. It\u2019s kind of almost as simple as that. And Kathy asked about my buy box earlier. That\u2019s criteria number one. But you\u2019re going to see some markets that may suffer from additional inventory. Your question as to why, it\u2019s kind of like, okay, the multi-family market\u2019s starting to suffer. Why are all these builders building stuff? Well, don\u2019t forget that in order to build something, it takes two or three years, or if you\u2019re in California, two or three decades of preparation to get a property to the point where you\u2019re pounding nails.
When things are going great post COVID, you\u2019re like, \u201cOh my gosh, there\u2019s demand everywhere. There\u2019s rent growth everywhere. We got to build, build, build. It\u2019s becoming too expensive to buy. It\u2019s cheaper to build than it is to buy. Let\u2019s do that.\u201d They start going down that road. You get past the point of no return. And inevitably, and this is why I hate development, by the time you actually finally start hanging windows, the market goes to crap. That\u2019s what we\u2019re seeing. You\u2019re going to have some of this inventory coming online at the worst possible time. That\u2019s going to create some stress in some markets. But you also have a lot of projects that maybe they\u2019re approved and they were about to start, but they haven\u2019t actually started running tractors yet. And those guys might not get financing. And you might see a lot of those properties pushed back or canceled entirely. The jury is still out on how that\u2019s going to affect things, but it\u2019s only going to affect things regionally. I wouldn\u2019t try to put a national opinion on how that\u2019s going to change things.<\/p>\n
Would you invest in new construction multi-family?<\/p>\n
Oh heck no.<\/p>\n
I love somebody who just gives a straight answer. No, no caveats.<\/p>\n
Yeah, no. Well, actually, okay, here\u2019s a caveat. When you say, would I invest in new construction, if a project was completed and we had the opportunity to acquire it, yes, and we\u2019ve certainly been in the running on doing this before. We actually had one in contract. Then is kind of a funny story. We had a property in contract, great market, just about to complete construction. We would\u2019ve had to do all the lease up and everything. The seller defaulted on the purchase agreement because they decided they wanted to keep the property because they thought they could sell it for more. And that was middle of 2021. I wouldn\u2019t want to be them and having to explain that decision to their investors today. But I guess maybe I dodged a bullet. I do like high quality assets, new properties have less maintenance requirements, and so I would like to buy newly constructed properties that are done. Would I want to go in and build one? No.<\/p>\n
Yeah, too much risk.<\/p>\n
Been there, done that. Not in the multi-family side, but I\u2019ve built a self-storage facility and it was one of the worst experiences of my life. And it has nothing to do with self-storage. All your self-storage guys, you don\u2019t have to defend your industry. I still believe in it. But what happens is you get past the point of no return, and then everything kind of goes against you. And that\u2019s what happened to me is once I started building, steel prices doubled and that doubled my construction cost. There\u2019s nothing you can do about it. You have to finish and you have to press on. And that\u2019s the problem with development. Things change during the process, and it doesn\u2019t always change in your favor. Sometimes it does.<\/p>\n
Investors just really need to understand that new construction is probably the riskiest investment.<\/p>\n
That\u2019s right. It has to match your risk profile, and you have to be willing to wait. It\u2019s nice to start getting your cash flow returns quickly in development projects. And Kathy, I know you do these. I know this.<\/p>\n
And it\u2019s not been easy.<\/p>\n
It is not easy. It\u2019s hard. It\u2019s stressful. It\u2019s a lot of work. And it\u2019s not instant gratification. I mean, it\u2019s nice to see beautiful buildings being built, but from a financial perspective, it takes a long time to realize the result if it\u2019s realized at all. And I\u2019m too old for that.<\/p>\n
I know. I mean, our early projects, we were getting land for 10 cents on the dollar and you could make it work. But I just don\u2019t know how people pay high land costs and high construction costs and high debt costs and make it work today. No.<\/p>\n
I don\u2019t either. I don\u2019t either.<\/p>\n
Brian, this has been great, and we do have to get out of here soon, but I have a large multi-part question for you. This is going to be a big one.<\/p>\n
Hit me, Dave.<\/p>\n
All right. We\u2019re in the beginning of 2023 and everyone listening is learning a lot from you, but what they really want to know is what they\u2019re supposed to do. I\u2019m going to ask you a two-part question. What should people who want to sponsor multi-family investments do, or what advice would you give them in 2023? Then for people who invest passively, in syndications or in multi-family deals, what advice would you give to them?<\/p>\n
Okay, so for the first group that wants to be the active participant and sponsor multi-family investments, I will tell you a couple of things. One, it is so much easier to lose a million dollars than to make a million dollars. Always keep that in mind because your primary job, you really only have one job. There\u2019s the old saying, you only have one job. Well, you really only have one job. Don\u2019t lose your client\u2019s money. Keep that forefront in your mind and make sure that when you\u2019re preparing to acquire a property and launch an offering, that you have a very high degree of confidence that you\u2019re going to have a successful outcome and that you\u2019re not going to lose your client\u2019s money.
Because if you do, if you get in too early, it could be the end of your career and you don\u2019t want that to happen. If you want to do this and you want to do this for the long haul, it\u2019s okay to wait until you\u2019re comfortable that you\u2019re going to have the best odds of producing a successful outcome. That\u2019s preferable than to start too early, screw it up, lose your clients, and then now you\u2019re out of business and you\u2019re never going to make a comeback, right?<\/p>\n
And Brian, is that to you, would that be waiting through what you called the pricing exercise that we\u2019re in right now?<\/p>\n
Yes. Get through the price discovery. Let other buyers figure out price discovery, start to get some direction to the game. The way I put it is I\u2019m watching this game from the grandstands. I\u2019m not playing on the field right now, but I\u2019m going to place a bet on the outcome of the game, but I\u2019m going to wait until I can see some kind of trend in the score. Who do I really think is going to win this game? Then I\u2019ll place my bets. I\u2019d rather do that than to bet beforehand, before I even know who the players in the game are going to be. I think it\u2019s okay to sit back and watch. For the passive investors out there who are looking to invest in passive syndications, I would say look very closely at offerings that are being launched right now and listen to what the promoters are saying.
And if it doesn\u2019t pass the smell test and you feel like those folks are losing credibility because they\u2019re promoting something that you feel is not appropriate for the time, pass on it and make a note of who those groups are and watch them and see what happens. There\u2019s no reason you have to make a quick decision, watch and wait, and you\u2019ll start to see some of these groups may vanish in the wind. You want to invest with the groups that survive through whatever it is that\u2019s going on right now. Those are the people you want to invest with. Don\u2019t be the test case. Don\u2019t feel like you need to let them learn on your dime. Go with proven skilled operators that have been through a market cycle or that survived this one before you place any bets. This is a time for caution and it\u2019s a time for diversification. Whatever you do, don\u2019t put all your money in one offering with one sponsor and hope and pray because that\u2019s about the worst strategy you can come up with right now.<\/p>\n
And to just add to that, Brian, if you\u2019re an accredited investor, take the time and spend the money on having your CPA review the documents and your attorney review the documents. Because a lot of times these documents aren\u2019t well written, that\u2019ll tell you right off the bat that maybe something\u2019s wrong.<\/p>\n
Yeah, I love the offering documents that are riddled with spelling errors and grammatical mistakes, and these sponsors are going to put their best foot forward while they\u2019re trying to raise money. And if that\u2019s their best foot, just what happens after they get your money could be kind of scary. Yes, review carefully and certainly there\u2019s a whole bunch of red flags. If you want to know what they are, you could read The Hands-Off Investor because they\u2019re all listed in there. I mean, I took 30 years of experience in this business and rolled it up into 350 pages so that people wouldn\u2019t have to make these mistakes on their own. They could see where all the hidden skeletons were in the closets. It\u2019s all listed in there.<\/p>\n
Great. And Brian, is there anything else you think our audience should know about the multi-family or broader commercial market in the next year that you think they should pay attention to?<\/p>\n
Well, one thing to pay attention to is what\u2019s happening at other sectors of real estate. For example, net lease, commercial, industrial, office, don\u2019t discount that stuff as either A, not a place to invest because perhaps it could be or B, unrelated to multi-family because they are in some respect related. If those assets start throwing off really attractive returns, capital is going to flow to those assets, and that\u2019s going to mean a longer recovery period for multi-family, it\u2019s going to mean that cost of capital for multi-family projects is going to change. When you start seeing cap rates in say office or retail or whatever, starting to climb into the sevens or eights, you can\u2019t think that multi can hold at a four and not be impacted by the competition of those dollars getting shifted to other asset classes.<\/p>\n
Woo. Mic drop.<\/p>\n
All right. Well, I guess if that was the mic drop, we got to go. All right. Well, thank you so much, Brian. This has been insightful and we really appreciate this. Everyone listening to this and Kathy and myself included, I\u2019m sure appreciate sort of the sober look and a real realistic understanding and you lending your knowledge to us about what might be on the horizon here on the multi-family market. If people want to learn more from you, we mentioned your book or want to connect with you, where should they do that?<\/p>\n
Yeah, just one thing before I get to that is I do want to say I\u2019m not all negative Nancy. There is going to be a positive side to this. Don\u2019t look at this as this is doom and gloom. This happens. This is a market cycle. We\u2019re in it. It will bottom out. Things will get better and there will be some massive opportunities coming down the line, and those opportunities will be much better than they would\u2019ve been had this not happened. There is a positive side to this. To learn more about the positivity side of it, you can learn more about me on my website for Praxis Capital. It\u2019s PraxCap.com. It\u2019s P-R-A-X-C-A-P, .com. Of course, you can find me on BiggerPockets in the forums answering questions. And I\u2019ve got an article, I think it\u2019s going to be published on the blog soon. That\u2019s going to be along the lines of this conversation. Also check out Instagram, @InvestorBrianBurke, and the book is at BiggerPockets.com\/syndicationbook.<\/p>\n
All right, great. Well, thanks again, Brian. We really appreciate it and hopefully we\u2019ll have you back in a couple months and you can give us an update on the multi-family market.<\/p>\n
Yeah, we expect the alert when it\u2019s time to dive in.<\/p>\n
There you go. I\u2019ll bring it.<\/p>\n
All right.<\/p>\n
We got to get Brian on here once a week.<\/p>\n
I want him to be my personal mentor.<\/p>\n
I know. I invest a lot in multi-family. I know you do too. Having him on is selfishly very just to hear from him.<\/p>\n
Absolutely.<\/p>\n
What do you think about all this? He\u2019s saying there\u2019s this pricing exercise or price discovery going on. What do you think? What\u2019s your gut tell you about the state of housing? A year from now, where will multi-family be?<\/p>\n
Well, I mean, I don\u2019t want to even laugh. It\u2019s not funny. I think there will be blood in the streets, and a lot of us could see that. I know a lot of people felt FOMO. I know people who did 20 acquisitions this year, and I would just kind of scratch my head. Again, it me, am I not seeing it? But I think Brian, I\u2019ve just followed him for years and he has so much wisdom and insight that unfortunately I think he\u2019s going to be right, that there\u2019s the positive and negative. The positive is a year from now it will be a good time to buy, and the negative is there will be a lot of loss.<\/p>\n
Yeah, I think that\u2019s true. I asked that question about what case someone who\u2019s bearish about multi-family right now can make, and I guess what you and Brian shared makes some sense, but to me it doesn\u2019t pass the sniff test. I just think the evidence that valuation, that cap rates are going to expand, I just don\u2019t see how that doesn\u2019t happen and valuation doesn\u2019t fall 15, 20% in multi-family. It just seems like we\u2019re heading for that in the next couple of months.<\/p>\n
Market shifts are really a great opportunity to study psychology, honestly, because there\u2019s just people grasping to what they\u2019re hoping will be the case or what has been over the last few years and just able to read the market. It is just an incredible skill to be able to do that. And it\u2019s actually imperative if you\u2019re going \u2026 Especially if you\u2019re going to be managing other people\u2019s money. Now in some cases, obviously there\u2019s things you can\u2019t see. We couldn\u2019t have predicted a pandemic and then the supply chain issues and all of that, but sloppy underwriting, that\u2019s more predictable.<\/p>\n
Totally. Yeah. And it\u2019s interesting what he said, and we\u2019ve had a few other guests on here say the same thing, that they were already starting to feel like the market was frothy in 2019. You can\u2019t predict COVID and can\u2019t predict Russia invading Ukraine, but if they were already seeing the tea leaves as frothy and then you get this frenzy and pandemic, I can see why someone like Brian is like, \u201cNah, I don\u2019t want any of this.\u201d<\/p>\n
\u201cI\u2019m out.\u201d Yep.<\/p>\n
Well, yeah, I mean, I never root for anyone to lose their shirt, so I hope that there is, that people don\u2019t suffer any significant losses from this, but at the same time, if smart people like Brian and you believe that multi-family valuations are going down, we should discuss that and be honest about that and warn people that to be cautious over the next couple of months and potentially wait until this uncertainty has sorted itself out and there\u2019s more clarity and stability in the market.<\/p>\n
Yeah, I love what he said about let other people do the repricing. Wait until it lands and you know what the real values are.<\/p>\n
Absolutely. All right. Well, Kathy, thank you so much for joining us and thank you all for listening. We do have something for you today. We forgot to mention this up top, but next week, Kathy, James, Jamil, Henry and I are going to be debating a document I wrote called The 2023 State of Real Estate Investing. It\u2019s just a analysis of what happened in 2022, and I lay out a couple potential different scenarios for 2023, and we\u2019re going to debate it. If you want to download that ahead of the debate so you can follow along and maybe form your own opinions ahead of the debate, you can do that on BiggerPockets. It\u2019s for free. It\u2019s BiggerPockets.com\/report. Go check that out ahead of next week\u2019s episode. Again, thank you all so much for listening. We\u2019ll see you next time for On The Market.
On The Market is created by me, Dave Meyer and Kailyn Bennett. Produced by Kailyn Bennett, editing by Joel Esparza and Onyx Media, researched by Pooja Jindal, and a big thanks to the entire BiggerPockets team. The content on the show On The Market are opinions only. All listeners should independently verify data points, opinions, and investment strategies.<\/p>\n