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TRANSCRIPTION
Theo Hicks: Hello Best Ever listeners and welcome to another edition of the Actively Passive Investing Show. As always, I am your co-host, along with Travis Watts. Travis, how are you doing today?
Travis Watts: Theo, doing great. Thrilled to be here.
Theo Hicks: Yeah, thanks for joining me, as always. And we’re going to talk about markets today. So we’re going to talk about, as you can see by the title, we’re going to talk about a blog post that we wrote called the Top 10 Markets To Buy Multifamily In In 2021. And if you’re watching this on YouTube, we’ve got Vanna White over there giving us a presentation of a beautiful map, the infographic we have that highlights those top 10 markets.
So this is going to be based off of a PwC and Urban Land Institute report. We’ll have a link to that in the blog post we’re referencing and also in the show notes of this episode. And we’re going to highlight some of the other takeaways from this report today. So before we dive into that, Travis, do you have anything else you want to say about why what we’re going to talk about is relevant to someone who’s a passive investor?
Travis Watts: Yeah. I think this topic is relevant to active and passive investors. It is titled Top 10 Multifamily Markets, but real estate markets are real estate markets, right? No matter what asset type you’re in, or whether you’re active or passive, it all goes hand in hand. And as we talked about a couple of episodes ago, a lot of these episodes that we do, especially this year in 2021, come from questions that I get asked frequently by investors when I’m on calls week after week as part of my investor relations role. Which market should I be looking at? Which reports are good? Which ones are bad? That’s why we’re showing you guys this; it’s a very popular and common topic that I think everyone can benefit from.
Theo Hicks: Yeah. So in that blog post – and if you’re watching this on YouTube, which we highly recommend – Travis has an image behind him that shows the top 10 markets. We’re not necessarily going to list those out today in full. As I mentioned, this is a very long report. We’re going to go into some of the takeaways from this report. And obviously, this has been a show focus on passive investing, and we’re going to talk about why each of these takeaways are relevant to you as a passive investor. So Travis, you could start off by talking about some of the issues that were highlighted in this report.
Travis Watts: Yeah. And one thing before I get rolling here… As you pointed out, Theo, this is like a hundred-page report, again.
Theo Hicks: A big one.
Travis Watts: PwC and the Urban Land Institute, it’s kind of a combination of the two. Very, very much in-depth, in detail. We could literally talk for hours on this report. We’re just going to skim it, hit some high-level topics and things to think about. Check out the blog post, because there’s a link to the actual PDF that I’m referencing, and I’ll point out what pages I’m on too if you want to kind of follow along and if that blog post is something that you want to take a look at.
So to your point, let’s get started. So what these are, are the issues that could potentially arise this year, and then how much importance is weighted on those particular issues. So I’m on pages four and five of this report. And I’ll just kind of start from the top; I’m not going to go over all of them, there’s 10 in every category. But as far as economic and financial issues that could potentially have an impact on multifamily and real estate in general, at the very top is job and income growth. As we all know, we’re in the midst of COVID, everyone’s concern is jobs and unemployment. And you get into these deals as an investor, and you’re looking at these projections of ‘We’re going to be raising rents $200 a door per month over a few years”, well, it’s really dependent on your renters and the fact that they have a job, number one, and then number two, that their income can support those rent hikes. So you’re trying to kind of read between the lines, and we need an economy that’s stabilized to support that. It’s a one to five scale, if you’re not following along, on the chart. So they ranked that as number five, meaning the most important.
And I’ll scale quickly to the bottom. They’ve got inflation and currency strength as still very important in the top 10, but the least of the top 10 of importance. There’s a lot of talk with all this money printing that we’re doing, with the Fed coming out with this proposed $2 trillion stimulus package possibly around the corner… My gosh, it’s crazy. So you’ll see a lot of headlines about inflation, and are we going to see it, and is it going to go into hyperinflation, or are we going to collapse the value of the US dollar? I personally would rank those a little higher on the list myself. That’s a concern to me. But they’ve got them there at the bottom, so take it as you will. Those are the economic and financial potential issues.
Moving on to social and political at the top of the list of most importance. They’ve got epidemics and pandemics in a category; obviously, in the midst of COVID. That makes a lot of sense. That’s still a concern of most people, especially this year. The political landscape – as Theo and I pointed out several episodes ago on the proposed Biden tax plan… If you haven’t checked out that episode, I would. It’s getting more outdated by the day, so stay up with the news. But the political landscape – we just had the inauguration, but now what Biden’s essentially proposed is to repeal the Trump tax reform that was set forth in 2017, which was the Tax Cuts and Jobs Act of 2017. And it’s not a political statement, whether you’re pro Biden or Trump, it’s just that that particular policy was really to the advantage of real estate investors. So if that gets repealed, that’s obviously of most importance.
At the bottom of this list on social and political is terrorism and rising education costs. So obviously, terrorism is hard to predict and determine. That’s kind of an unknown factor that’s always there. And then rising education costs – yeah, obviously, of importance, but may not affect the majority of our tenants and our renters. So it’s up there, but at the bottom of the list.
Last but not least, real estate and development. This is more about new construction in multi-family. The top two being the labor costs and the cost of materials being of utmost importance. At the bottom of the list being the risk of extreme weather, which is global warming and climate change and things like this, and environmental sustainability requirements. A lot of talk about this Green New Deal, and everyone’s going solar, and electric cars… Well, what if some policies come forth that says, “All multifamily units have to be solar by 2030” or something crazy like that. It could happen; perhaps unlikely, but who knows? So that’s why it’s at the bottom of the list, but it could happen as we go into this new change of hands here under the Biden administration.
So I’ll cut it there; take a look on page four and five of the report if you have it. There’s a lot more detail, I just highlighted and skimmed that. But those are some of the issues that could potentially have factors here in 2021.
Theo Hicks: And the key to keep in mind here is that these are based off of surveys of people who are real estate investors. So they’re asking them how do they think these things are going to affect real estate in particular. So these aren’t what they think high-level, but just specifically to real estate, right? And these are based off of surveys. So yeah, all of these different things we’re going to be talking about, you can see how these active real estate professionals replied. So they are people who are actually doing it, and what they think is going to happen based off of their experience and their research.
The next thing that we’re going to talk about is going to be the statistics for working from home. So don’t need to spend much time here; it’s pretty obvious that a lot more people are working from home now. So the question is, as it relates to real estate, is this going to continue? Or is this going to end? And when it does end, is it going to go back to normal, or are more people going to work from home? And so the question that was asked was, in the future, more companies will choose to allow employees to work remotely, at least part of the time. Do you agree, strongly agree, or disagree? The majority of people strongly agree, and then another 42% agree. So basically, every single person either agrees or strongly agrees that this trend of working from home is going to continue in the future. So as a passive investor, that’s obviously going to impact the locations where multi-family is going to be in demand, which I’ll talk about in just a second… But also the type of multifamily that’s going to be in demand. If people are working from home, they’re going to want a different type of experience than if they’re not working from home.
So we actually have a blog post on our website about the top amenities for multi-family for 2020 or 2021 as it relates to COVID. We kind of go through, okay, if people continue to work from home, what types of things are going to be in demand? What size of units? What are the opportunities in the units? What type of amenities at the property are going to be in demand? So definitely check that out. And then the second thing is going to be the locations that are in demand, right? So U-Haul has a really good report… We actually have a blog post that posted — it’ll be live when this goes live; it’s called 10 States With The Most Net Migration in 2020. So U-Haul tracks all their one-way trips to see where people are renting vehicles and going one-way, with the assumption that they did it to move to that location. So they rank the markets with the greatest positive net migration, and then the markets that have the most people leaving them.
So the South, in general — there are obviously exceptions, but the South, in general, are full of in-migration markets. You’ve got Texas, Florida, Georgia, the Carolinas, and Tennessee. And then you’ve also got some of the mountain areas, so Idaho, Utah, and Arizona. Whereas you’ve got the coasts, specifically the West Coast is in general, as well as the Northeast, people are moving out of those places. So this report is just based off of the states. But in addition to this, you’ve got to keep in mind that within each of these states it doesn’t mean that every single investment you see in Florida and Texas is going to be great. Or every single market in Texas and Florida is going to be great. Again, because of this move, which Travis is going to talk about here in a second, there has been a large movement out of the large urban areas to suburban and even rural areas, which is kind of what Travis will be talking about next. So a natural transition.
Travis Watts: Yeah, that’s a great point, Theo. Actually, I probably should have brought that up at the beginning of this. Just because we’re showing you this map, just because PwC and the Urban Land Institute have come out with this data and this particular survey, there’s going to be differing opinions, whether you tune into CBRE, Marcus & Millichap, CoStar… There are different data sources out there, there are different economists, there are different opinions. Just because you live in Ada, Oklahoma, it doesn’t mean you shouldn’t do a deal there. If your neighbor is short selling their home or there’s a foreclosure in your town, maybe that’s a good opportunity for you. So it’s not to suggest these are the only markets to look at. And again, it’s titled Top 10 Multi-family Markets, but it’s just real estate in general, right? We’re really talking about migration trends, which is what we talk about a lot on this show.
So to your point Theo, my topic here is the age migration and what’s happening. I thought this was really interesting. I’m on page 10 of the report, anybody following along… And what they’re looking at is the forecast from 2020 to 2030. So they’re looking at a full decade of all different age groups and what’s likely going to happen as a progression here. So start out with folks in their 20s – this demographic is shrinking in size, number one, and these groups tend to live a more urban lifestyle. So obviously your studios, your one-bedrooms, your downtown stuff, the city life. Keep in mind, as they point out, this is a shrinking group. So urban will be shrinking, basically, is what they’re saying.
So groups in the family formation years, maybe your latter half of the millennials, folks in their 30s, and maybe up to age 40 – I don’t know exactly where the cutoff is there… But these groups are tending to look for a more suburban lifestyle. And this is a growing group. So this is going to be a big migration here that’s happening to support the suburban lifestyle.
The next one over is empty nesters. So parents where their kids have gone off to school and kind of moved [unintelligible [00:15:39].29] from the house. They’re actually – this was a surprise to me – looking at going more urban. But again, this is a group that is shrinking in size. So it’s not going to be a huge migration here. But that one kind of surprised me, that empty nesters are looking for a more urban setting and lifestyle.
And last but not least, as we all know, the retirement age groups are going to surge. We all know about the silver tsunami. I hope that’s not offensive to anybody. But they’re looking for more of the suburban lifestyle, which kind of surprises me in a sense… But yet, I really think about reality, and folks in my family and just my own parents, and that’s true. They really like the suburban lifestyle, at least in my bubble of the world. So I guess, overall, in general, to your point, Theo, it’s looking like suburban is likely going to take a wind here for the next 10 years as far as the forecast goes, as far as this source of data suggests, and the urban perhaps could be shrinking in popularity. So that’s that on page 10 of the report.
Theo Hicks: Yeah. And it is definitely tied to the working from home statistics too, right? Because most of the people that live in the city live there because it’s so hard to get to work. For example, my wife works in a big company and a lot of people that live in the city have moved out to their parents or moved back home out of the country because they don’t need to be downtown. And so if you don’t need to be downtown and it’s cheaper to live further out in the suburbs… It’s cheaper, it’s safer, you get more space… So all these things are definitely connected.
I remember reading an article right when COVID started, about how many people left New York City for the suburbs and also places like Connecticut, and stuff. It was a crazy amount of people. In addition to people have been leaving these urban areas for a while now, and so it has only been expedited. So again, the point here is that if you’re looking at deals in the large urban areas, take a look at what the explanation is for why they’re doing it. Are they getting a really, really good deal? Or are they claiming that making predictions about “Oh, well, this is not going to last forever. Eventually, they’ll come back.” Sure, maybe that’s the case. But again, there’s additional risk when it comes to that.
So the next thing which I think is really fascinating is going to be about the debt and equity underwriting standards. So as a passive investor, most likely you’re not going to have a highly custom multi-tab Excel underwriting calculator where you pull the P&Ls, and you make all these predictions yourself, underwrite the deal, right? You’re gonna be relying a lot on the information that’s provided by the sponsor who did their own underwriting.
Now, obviously, it’s important to trust that person. We’ve talked about that before, how to qualify the GP. But another really good way to gauge how aggressive or conservative their underwriting is is how banks and then these large equity firms are also underwriting deals. So when we talk about debt, we’re talking about Fannie and Freddie Mac, their traditional fancy banks, commercial banks, insurance companies, debt funds, things like that. When it comes to equity, we’re talking about, obviously, private investors, but these big public equity REITs, hedge funds, private REITs, pension funds, things like that.
So how are they underwriting deals right now, compared to previous years? There’s actually a huge difference. So this is 2021 data, and they asked them – so for debt and equity, how do you expect the underwriting standards to be? And the options were less rigorous, or remain the same as the previous year, or more rigorous. And so historically, since 2014, basically most people said it would remain the same, especially from 2017 and on. A very small percentage of people said that it would be less rigorous or more rigorous. But bring us to 2021 and 73% of the respondents think that the debt underwriting standards are going to get more rigorous. The previous high was 47% in 2017, and then last year was 34%. So double, basically. And it’s the same trend for equity – 67% said that the underwriting standards are getting more rigorous, and again, the previous high was in 2017, at 34%. I’m assuming that’s because that was after the election, but still double what has been every year since 2014, with this graph.
So if you’re coming across deals that are underwriting the exact same as they did in the past few years, then that’s something to think about. That is definitely a red flag. And Travis kind of already mentioned this – the rent growth assumptions, we’re talking about just the revenue growth assumptions in general, maybe how quickly they’re going to accomplish these value-add renovations or the renovations they’re doing… Essentially, anything that’s changing from how it’s currently being operated to how it’s going to be operated after them should be very conservative, and not be super aggressive.
Travis Watts: Yup. 100%. This next section really piggybacks off of that, which is great. This is the one I was actually most excited to share with folks, because I would say probably – let me put it in top three category of questions that I get asked by investors always… Is it the right time to start investing in multifamily or continue investing in multifamily? Something to this nature. So I think this kind of sums it up. And this is a great graph I’m going to be sharing with people, because this is a great data to have, as far as a survey goes.
So what this is, is the availability of capital for real estate, 2020 versus 2021. So there are two categories – there’s lending, so getting financing for your deals, and then there’s the equity, which is people wanting to buy and own equity in this real estate. So on the lending, to your point Theo, about more rigorous underwriting and lending… So naturally, there’s a slight pullback; it’s not a major shift, but there is a slight negative impact on lending from non-bank financial institutions, government-sponsored enterprises, debt funds, insurance companies, REITs, banks, collateralized mortgage-backed securities, all that good stuff, has a slight pullback. So a little more conservative approach. But this is the part that really paints the picture. There’s a massive increase in demand from publicly-traded REITs, from private local investors like myself, private equity, hedge funds, pension funds, REITs, foreign investors… Actually, foreign investors has a slight pullback. But everything else has a large margin of more demand through 2021. And I think that really says a lot.
And here are my final thoughts on this, as a conclusion to wrap that up. I’ve talked about this before, maybe on this show, maybe on other podcasts, but right now there is a huge demand for yield. We’re not finding yield, cash flow, and interest and dividends in bonds, and CDs, and money markets, and treasuries. So both Main Street investors and Wall Street are needing and wanting yield. And the biggest margin here is REITs that are increasing exposure here. Obviously real estate investment trust. But this is huge. I hear this all the time about “Well, what do you think about cap rates?” Or “I don’t know about buying something out in Texas at a five cap. That seems crazy.” Well, think about it like this, if an institution’s coming in to buy that asset, and they’re going to pay all cash, they’re not even going to use lending or debt, they’re still getting a five cap, a 5% yield off that property. Well, how much risk are they really taking with no debt and no leverage, compared to bonds and other things that are paying 2% or 1%? So that’s still a very healthy yield for an institution to have by using no leverage and no debt.
So I still think if you’re in the space, this is again, part of my personal criteria that I’ll share. But I like investing as a limited partner in these syndications, in the unit size of 200 to 600 units. To me, that’s kind of a good sweet spot. Because as we go to the exit, we’re often going to exit to institutional capital, who’s needing this type of yield. We could also sell to another syndication group, we could also sell to wealthy individuals, family offices, stuff like that. But it gives us a lot of exit potential strategies to use.
So at the end of the day, I think the demand is for yield, and I think that people have seen through this pandemic, that B and C class value-add products have really held up. Yes, it’s been impacted, I’m not trying to sugarcoat it, but it’s not been to the effect of office, retail, other asset types in real estate. So that’s my final thought on it. And I know we’re getting short on time.
Theo Hicks: Yeah. We actually have the Best Ever conference coming up in about a month, and the first webinar they did, I think it was somewhere along the lines of should you buy or should you sell in 2021, and one of the speakers was a tax expert. And, as we mentioned before, about the impacts of the new tax plan, I kind of really like what she said, and it kind of goes along the line of what you’re talking about. It’s like, look, [unintelligible [00:24:37].20] he taxes, sure, it might impact other industries more than others, but it’s going to be an across the board thing, right? It’s going to affect everything, more or less equally.
The same thing with the pandemic, or any kind [unintelligible [00:24:48].27] in the economy, it’s going to affect things more or less equally. So when you’re thinking about whether to invest or not, or what to invest in, you can’t really compare it to the yields that you were getting five years ago, or these massive IRRs and cash and cash returns. It’s more of like, what are your options right now? What’s your best option in investing right now? You have to do something with your money, so what are you going to do with it? Are you going to keep it in your savings account? Or are you going to invest it in something? And if you invest it in something, what are you going to invest it in that has the least risk with the highest returns? Which are more important to you?
So that’s why all these equity sources are so interested in real estate; it’s not necessarily because they’re going to make the most money they never made before, its’ because this is the best option right now. So that’s what I thought about when you were talking about yields. It’s not the best yield ever, but if the best yield of the options right now.
Travis Watts: Yup, a hundred percent. Times change. Before the 2008, 2009 collapse, you could have bought US bonds at 6%, relatively taking no risk. So that would be a hell of an option today, if you could…
Theo Hicks: Exactly.
Travis Watts: But instead, you’re getting half a percent or something, or one percent. So to your point, you’ve gotta go with the current environment. And a lot of folks hang on to the old ideals of things, and where that phrase was hot in multifamily, you have, “Double your money in five years.” Well, perhaps it’s still possible in some aspects, but maybe don’t count on that in today’s environment. But yes, it’s put a lot of pressure, this low yield environment we’re in with interest rates, and everything else – it put a lot of pressure on the stock market, which is why we’ve seen these huge crazy rallies in the midst of a pandemic. And then also onto real estate. So just like you said, you’ve got to make the choice for you. Where are you going to park your money? Clip a 0% coupon in the bank, or go into some kind of asset with a moderate yield?
Theo Hicks: Exactly. All right Travis. Well, thanks again for joining us. I really enjoy these conversations and getting your perspective on these things. You’re deep in the trenches every day looking at this information. And Best Ever listeners, as always, we appreciate you for tuning in.
As we mentioned in the beginning, this is going to be based off of the blog post called Top 10 markets To Buy Multifamily In In 2020, so check that out to actually get the top 10 markets. We also have a link to this 100 plus page report. But if you just want to read the report yourself, we’ll have that in the show notes as well.
So again, thank you for joining me, Travis. Best Ever listeners, thank you for listening. Have a Best Ever day and we’ll talk to you tomorrow.
Travis Watts: Thanks, Theo. Thanks, everybody.
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