Answer: Yes! (Maybe the better question, what *don’t* you have an opinion on)
I had a reader ask me specifically about my opinion on “multifamily syndicates” and any advice I might have about them. He had been hearing that these investments have recently been providing a 6%-8% cash on cash return then providing 1.5x to 2x the equity contributed at exit in three to five years.
In full disclosure, these investments *have* been providing this level of return. They have been outstanding for many investors who entered them three or more years ago. The market conditions have been ideal to make good money in these deals. In fact, it may be looked back on as a generational opportunity for commercial real estate.
So why have these projects been so good?
Declining Capitalization Rates
“Cap Rate” is real estate lingo for Capitalization Rate. The capitalization rate is the net cash flow after expenses a property produces divided by price. If you are buying a stock or a bond, this same ratio is quoted as the investment’s yield. Here is a quick look at Cap Rates in some major US Markets over the last fifteen years.
In 2010-2011, Cap Rates were roughly 8% and have slowly declined to 6%. This happened during a time period with improving trends in commercial real estate. Occupancy rates have been improving and landlords have been able to get rent increases at or greater than the rate of inflation. This has been the perfect combination of economic events to make buy and hold (or buy/improve/sell) investors a heck of a lot of money.
Rising Rents/Rising Occupancy:
Many property types have been able to receive rent increases higher than inflation since 2010. This is especially true in multifamily properties. Home ownership rates begin to decline in 2008 with the residential real estate collapse and those families need somewhere to live. There were almost no new single family properties (and few commercial) that were built between 2009 and 2012, but the country’s population continued to grow.
There are lots of other factors causing a lack of supply in housing units. Wage growth wasn’t great through 2016 but rents continued to rise. High density housing units cause “Not In My Backyard” political fights. (Not surprisingly, the cities that need affordable housing the most also carry the most red tape for new development). Many people were burned by home ownership in the last decade and aren’t necessarily willing to sign up for a six fugue mortgage again. Add all of that in plus the fact our country’s immigration challenge has starved the construction industry for talent and the country just isn’t building as many housing units and the population demands.
There is some early evidence that rental rates are finally seeing some cracks, but the data through this summer was still trending higher.
All Equity Example:
A team of real estate investors purchase a moderate quality apartment building for $5,000,000 in 2011. At an 8% Cap Rate, this investment generates $400,000 per year in net cash flow. Over the next four years, the apartment complex is able to increase rents at the pace of inflation, roughly 3% per year. Five years later with appropriate management, the apartment complex now has net operating income of $450,203 per year. At an 8% Cap Rate, the investment would now be worth $5,627,537….
Except the market’s Cap Rate hasn’t stayed at 8%….it’s now dropped to 6%. This is where the real money was made: That property is now worth its new stream of cash flow ($450,203) divided by the new cap rate (6%), or $7,503,383. The real estate investors received their 8% return on their cash invested per year, then exit the property for 1.5x the initial investment. This drives the underlying return on investment into the mid to upper teens.
The recent economics driving rents higher have shot these returns higher. These numbers can be increased further through riskier strategies, such as using a combination of debt plus equity or investing in a project with a plan to improve cash flow through additional investment.
Management Talent & Availability of Deals:
I had this exchange on Twitter around a month ago when RealtyShares announced it would stop having new offerings.
The smart money doesn’t need the big IT infrastructure. Find the deal then raising the capital is *easy*
— Stop(ped) Ironing Shirts (@StIroningShirts) November 7, 2018
It's interesting when you talk to the crowdfunders. They claim to be rejecting 95%+ of deals brought to them. Where are those deals going?
— White Coat Investor (@WCInvestor) November 7, 2018
I don't know that there are fewer projects, but as the number of projects expanded, there was no doubt they couldn't all be equally good deals for the investors.
— White Coat Investor (@WCInvestor) November 7, 2018
The exchange gets to my biggest issue with crowdfunded real estate: Availability of deals. There are tens of thousands of properties available for sale at any given time with professional buyers and professional sellers looking at deals.
A typical crowdfunder has to put a contract under an extended purchase arrangement due to the time it takes for them to raise equity. This results in a higher price being exchanged for a longer closing contract. Compare this with some of the competitors for the property:
A publicly traded REIT carries a large revolving credit facility and cash. They will acquire properties through their credit commitment then place permanent financing or do an equity raise in arrears. The REIT investor buys into the entire REIT portfolio and not the specific transaction.
The private/local real estate professional should be able to put together a deal quicker than a crowdfunding site. This professional has a track record of successful projects and have rewarded a close circle of equity investors. The professional puts the property under contract like a crowd funder, then creates a limited liability company (or limited partnership), and go to a small group of investors with an offering. If the deal is strong, there is more investor interest than available equity and funds are quickly raised. This professional also has relationships with local banks and can put a combination of debt plus equity on the project.
The best private investors in this business with find a deal, present a limited package to their loyal investors, then “pass the hat”. The better the reputation of the investor, the less questions asked and quicker the deal is closed. If you’ve heard of the old saying of you “Need money to make money”. That applies for these investment circles.
The underlying risk in a Commercial Real Estate Investment:
The generational positive trends in both occupancy improvement and rent growth can reverse. If occupancy starts going down, the rental rates start being cut to attract new tenants and the property’s cash flow quickly declines! If you’re in an all-equity project, this is a nuisance that creates a lower return. If you’re in a project with debt, your total investment can vanish all together.
What real estate would you invest in?
Today: REITs. I am currently an investor in two publically traded Real Estate Investment Trusts. I do not want to invest in VNQ or any other REIT index because of the wide variable of REIT investment options and risks inside these stocks. My preference is to stick with a REIT that specialists in one type of property and has strict equity to debt guidance and tenant diversity.
This removes most of the cash flow risk and I earn the initial yield purchased plus inflation style increases in the dividend payments. Over time a well operated REIT should return a slightly better than bond style return with a dividend that keeps up with inflation.
The other advantage of a REITs is liquidity: You can sell your shares at any minute and have an instant quote on your equity’s value. This brings me to the most absurd argument I’ve ever heard for crowdfunding or a syndicate: “They don’t fall in value like a REIT!” – Oh my. There is actually a market value for your investment, lack of information is not an acceptable argument.
Future: Buy and Hold Syndicate, Direct Ownership of Real Estate. I would consider investing in a buy and hold real estate transaction. The ideal investment would be in conjunction with other experienced investors directly into an property specific deal with minimal debt. This investment would need to generate reliable cash flow from the property and its returns can not be based on a future sale or refinance. Relying on the increase in value in a property is more speculation than investing.
Disclaimer: My current employer requires prior approval of these investments, which would be difficult given the concentration of commercial real estate lending and potential for conflict of interest
Have you invested in crowdfunded real estate or a direct syndication? Please share your thoughts!