Each week for the Best Ever Round Table, the three Best Ever Show hosts — Ash Patel, Slocomb Reed, and Travis Watts — come together for a deep dive into a commercial real estate investing topic.
Is now a good time to get into real estate? In response to listeners that have been requesting to hear more about current events, Ash and Travis give a detailed update on what’s happening in the real estate market right now.
They share their predictions, thoughts, and opinions on the state of inflation and interest rates, as well as their reactions to fear-inducing headlines. They also discuss their thoughts on the single-family market, how both multifamily and non-residential commercial real estate are performing, and whether now is an ideal time to get into real estate.
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TRANSCRIPT
Travis Watts: Welcome back, Best Ever, listeners to another Roundtable episode. I'm Travis Watts, full-time passive investor and now director of education with Joe Fairless at Ashcroft Capital, joined by Ash Patel here on this episode. Sad news - Slocomb Reed, our fellow host, is no longer with us on this episode, but he'll be back on the next episode; if anyone thought that he died, that's a terrible joke. But anyway, we'll see if he listens to this episode.
So we listen to your feedback, everyone, and comments you leave, emails you send, and we love it, and we appreciate it, and we encourage you to do it. Some of the feedback that we received was you guys want to hear more about current events, what's happening right now in the market, how's the Fed government and other policies affecting what it is we do. I wish we had Slocomb here on this episode to talk about the smaller multifamily sector, but we've got two contrasting points of view - we'll talk about single family/multifamily and non-residential commercial.
So I'm gonna kick it off, Ash, by just covering some high-level, macro-level, and I'm going to turn it over to you for your thoughts on that. Bottom line, as we talk about just real estate at large, or I guess specifically residential, we've been behind for years and years, almost 20 years, in building single-family homes for Americans. So we're somewhere in the ballpark of 4 million homes behind; so big supply and demand imbalance happening, and has been for a long time. Interest rates, as we all know, have nearly doubled in the last year. Inflation - 8.5% was the July read by the government; you can check that out on bls.gov for more info. That's down from 9.1%, which was in June. So Ash, with that top of mind, pull out your crystal ball if you have it, if you don't, run and get it, and tell us your predictions or just thoughts and opinions on inflation and interest rates, what you see happening and what you think might hold for the future.
Ash Patel: Yeah. Thanks, Travis. Hey, Best Ever listeners. Glad to be with you again today. Travis, here's my thoughts. I read the headlines and I see a lot of volatility. I wish I could predict what's going to happen next, but the constant reminder is what I'm seeing is very reminiscent of the dotcom bubble back in '99-2000. And there's this volatility, and that's followed by changing consumer sentiment, right? A lot of people that are invested in a specific asset class, for example stocks, equities, back in '99-2000 when these huge dips happened, they would say "Oh, don't worry, it's just a correction. We needed that correction." A lot of 401 K advisors today are doing the same thing, reassuring all of their constituents, saying, "Hey, don't worry, that's just a correction. It's healthy for the market." Well, listen, back then those corrections got bigger and bigger, and finally, we had a market collapse.
So volatility in the headlines is all over, whether it's the jobs report. Kohl's, for example - stock went through the roof when they hit their last earnings; most recent earnings - down. A lot of layoffs happening at large companies, and even though these companies are massively profitable, have a ton of cash on hand, they use this economic climate to downsize, trim their staff, become more lean. So when did we have layoffs over the last eight years, before the most recent quarter or two?
And then there's Wall Street versus Main Street, and you see how inflation has affected the middle class, and really, every class; people's decisions are being altered. Whether you're putting gas in your car or gas in your yacht, it's costing significantly more. So there's a lot of pain being felt by the middle class, and you don't often see those headlines that says, "Multifamily apartments are staying on the market longer. There's no longer the bidding wars that we used to have." Single family homes - you talked to a lot of the wholesalers, and they said, "Man, this has just dried up." Retail investors have dipped way down, the fix and flippers, the rehabbers - they're not buying as much anymore, and a lot of people are sitting on inventory. So volatility - the arrow might go up into the right after this, but my prediction is that we're in for some hard times. Fed's going to increase rates again, and what's that going to do to people wanting to sell whatever asset they have?
I'm going to add one more point - the homes that people used to be able to afford when you were window-shopping for that dream home a year ago, and you could afford a $600,000 home... Now with interest rates almost doubling from back, then you can afford a $350,000 home. So that has a huge impact on consumer sentiment.
Travis Watts: 100%. I love your points, I love that you've got a really good pulse too on other things besides what your primary focus is... So I want to dive into that a little bit with single-family. A couple thoughts real quick; I guess I'll share my thoughts on inflation and stuff like that. Hopefully I'm right, but I hope that we peaked on the government inflation numbers going from 9.1 to 8.5. They come out every month, so we'll just see, time will tell. I don't know when this episode is going to air, but we're sitting at 8.5. So hopefully that was a leading indicator, and a lot of that has to do with oil prices, right? So oil - what did it go to? $115, $120 a barrel earlier this year...
Ash Patel: North of $120.
Travis Watts: Now it's sitting around somewhere in like $90 a barrel, something like that. So obviously, transportation costs, food, essentials, your grocery trips, to your point, the gas pump, to your point - hopefully, that's going to be dwindling down or at least leveling off for a while, as you mentioned, as the Fed continues to raise rates.
The other thing I'd say is - we all know, over the past two years approximately, real estate and virtually every sector has just been on fire, and it's all been booming, it's all been good times, for the most part, nationwide. So we've been going 100 miles an hour, and I think one thing to point out is we are still uptrending depending on what we're talking about, but at a lot slower pace. I'm gonna dive into that a little bit more.
So as I mentioned, I want to dive into single family first here... So at least in my neck of the woods, I'm seeing price cuts happening, especially on the luxury, when we talk about a $2, $3 million home; I'm seeing 200k, 300k price cuts, at least in my market. But real estate is delayed. We talk about this a lot. The homes that are closing today, they may have had lower interest rates, so those prices aren't going to be a true reflection; until the Fed continues raising, people continue to get priced out, price cuts continue happening. And then six months, nine months down the road, we can really look at what effect this is having on real estate, compared to the public markets, that the Fed says whatever they say, and then it's up or down immediately, same-day reaction. We locked in 2.75%, 30-year fixed rate last September. Now I just look today they're nearing 6% for the same type of loan, with the same issuer. So double.
So to your point, Ash, you take a $500,000 home, just as an example, and that moved your payment from $1,600 a month to $2,400 a month. And the thing about single family homes - the bottom line is it just comes down to affordability. And that's your primary thing, right? So as price cuts happen and your neighbors start selling houses at lower pricing, your house just lost its value, some of it. Even if it's a rental and you have a great tenant that's paying above-market rents, it doesn't matter. That's not how they're valued. It off of comps. So with that, any additional thoughts on single family before we move over to how commercial is doing and what you focus on?
Ash Patel: Yes, and I'm glad you pointed out the fact that single family homes are a delayed metric for what's really going on in the economy. Some of the more immediate metrics are, for example, logistics. These logistics companies were absolutely killing it with inflation; gas prices took a toll on them, and right now they've had a huge dip. When you talk to the people in the front lines, things are just drying up for them. You look at luxury goods - every headline is skewed; what was trending recently... Well, sales of Rolex watches have plummeted, and all the Rolex dealers will tell you, again, "This is healthy. The prices were too high. We need these corrections."
And you look at some of these financial news sites, headline "Consumer prices rose 8.5% in July, less than expected." Hold on... If something cost 8.5% more than it did last month - "But don't worry, it's less than expected." I hope my Best Ever listeners are not putting their minds at ease reading these headlines; dive in a little bit, and really get some data, talk to people on the front lines. The used car market is slowing down big time. And again, that's a reflection of consumer sentiment. So I'm glad you pointed that out, that single family homes is a delayed metric.
Travis Watts: 100%, man. So let's dive into commercial. Let's talk about your world. Just at large, whatever you want to speak to, non-residential commercial... How's it performing? How are things going? What do you see as the forecast for it, let's say in the next year or two?
Ash Patel: Yeah, this goes back to COVID, Travis, where the millennials were eventually going to move away from city centers, out into the suburbs, just like our generation did. Gen X, man - we all wanted to live downtown, in those high-rise apartments, near the bars and restaurants... And then you get older, you evolve, you get a family, and you move out to the suburbs. I think COVID accelerated that greatly, because people didn't want to be trapped in their 800 square-foot apartment downtown when everything is closed around them. So we had this big suburban boom, and that's still going on. So investing in non-residential commercial in downtown, suburban locations is still hot. Investing in city centers or big boxes is very sketchy right now.
A lot of big boxes are under pressure. Bed Bath & Beyond, Kohl's, a lot of these big box retailers - you're gonna see them start closing doors. Walgreens I think it's closing 250 stores. But the neighborhood retail, neighborhood office is still on fire. And that's where you make most of your money. The big boxes - you're going there to park money. When JC Penney has a 20-year lease, you go there and you basically cut your coupon every month. But God forbid after 120 years they file bankruptcy and close their doors. So stay away from those big boxes. Grocery-anchored retail is still hot. And again, find those neighborhood retail office buildings.
Travis Watts: I love those points, and I also love that you're dissecting to show our listeners how niche real estate really is.
Break: [00:13:27.04] to [00:15:13.05]
Travis Watts: The headlines I hate the most, which I'll share with you in a little bit, is just when they use the term real estate and they just say "Real estate is crashing." Well, what does that even mean? What markets are we talking about? Are you talking about single family homes, are you talking about the grocery store around the corner? What does that even mean? So it's very location-specific, it's asset-type specific. You can just narrow this down to really small niches, so we'll talk about that here in a bit a little bit more.
So from my vantage point, how is multifamily performing - I would say, first and foremost, make no mistake that it is slightly down in terms of pricing. I think that we're seeing overall a decrease from that 15% to 20% shoot-up from last year, for example, to maybe a 5%, 10% discount on purchase price, depending on, again, are we talking about a 400-unit, are we talking about a duplex? That really depends. And that's, of course, mostly due to interest rates. That's been the catalyst here.
But the buying demand, to your point as well with commercial, is still very high. In fact, in Q1 of this year, 56% multifamily increased buying volume year over year, so one of the largest first quarters that we've seen in a very long time in the multifamily space. So something to keep in mind. Your national average rent so far this year has gone up about $70 per month, and that was from a first half of the year update that I was checking out here recently.
So you take an apartment, $1,400 a month rent, now $1,470; that's roughly a 5% rent bump, and that's only the first half of the year. So again, what I mentioned earlier, we're still uptrending, just at a lot slower pace than what we've seen the last couple of years, where it wasn't uncommon for rents to be popping $100 to $150 a door across the table.
So nationwide, just for perspective for everyone listening, is somewhere in the ballpark of $1,600 right now for class B multifamily rents.
So a forecast - I want to share this with our listeners. Freddie Mac forecasted that the remainder of the year in multifamily is going to be about a 3.6% gross income increase, and that vacancies will remain flat, where they are. We're hovering at about 94%, 95% occupied units nationwide. Sunbelt states have been top performers for many, many years. They continue to be top performers. Texas, Florida, Georgia, Carolinas, stuff like that. CBRE is predicting an overall 8% rate increase throughout the year of 2022. They're sticking to their guns on that, so we will see what happens.
So Ash, let's dive into those scary headlines. I know you mentioned the Rolex watches, I mentioned the real estate crash... So I want to share these that I just pulled this morning from recent headlines, from major sources, mind you. So "Should I sell my house now before prices crash?" Yahoo Finance. "U.S. facing perfect storm for 2008-like housing crash", Newsweek. "Housing market collapse - deep, fast", Forbes. So Ash, your thoughts? Anything you want to further elaborate on when some of our viewers are tuning into these major outlets and seeing headlines like that?
Ash Patel: Yeah, and I'm glad you brought that up, Travis. You had several good points that I wrote down, that I want to address. The headline issue is a big deal, right? Because people aren't diving in, fact checking. Everyone thinks there's this retail apocalypse because some of those long standing retailers have closed. However, they don't talk about how this regional optometry chain is blowing up and expanding. A lot of your smaller franchises are expanding; swim schools are expanding. You don't ever hear those positive headlines. It's more clickbait-ish to talk about XYZ retailer closing 300 stores, and that's what resonates with people. So you've got to dive in a little bit further than just the headlines.
In terms of interest rates, I also want to talk about commercial versus multifamily. Right now, commercial rates for us non-residential commercial is lower significantly than residential Freddie Fannie rates. So the tides have shifted a little bit, where we're getting better debt than the multifamily residential people. And when the Fed increases their rates again in the next quarter or so, my guess is the commercial rates, non-residential commercial will be slower to creep up, where residential will jump up immediately.
And in terms of rents - it's a double edged sword with multifamily. You people can increase rents every year, 12%, 18%. Crazy headlines, right? We're often locked into 5-10 year leases. Now, what does that do? It doesn't really impact our NOI, because we knew that going into it. We knew that for the next 10 years, this Dollar General is locked into 3% annual increases. But now let's keep in mind, they've raised their prices because of inflation. So their bottom line is increasing significantly. So when those leases come time to renew, we can raise our rents significantly, right? So imagine your residential tenants are making so much more money; you can then raise their rent to match. We'll be able to do that with commercial coming up here.
So yeah, man, headlines - take them all with a grain of salt. People with multifamily proformas - please stress-test your deals, underwrite conservatively, watch those exit caps.
Travis Watts: 100%. Gotta have a closer eye these days, as an LP especially, to your point. I think the bottom line on headlines - scary headlines and negative news always gets more views and clicks. That's why you see much more of that in comparison, rather than just saying, "Hey, multifamily remains stable." That's not very interesting, right? But to say "Housing crash around the corner, watch out!"
Ash Patel: Total clickbait, yeah. Absolutely.
Travis Watts: It gets a lot more views, yeah. So one key point that you brought up and I want to articulate in a different way is, again, when you see a headline like "Real estate this, real estate that" - very local, very asset-dependent, and the biggest difference, just to reiterate one more time - single-family homes are based off comparable sales, and it's based off affordability of those buying homes for themselves, regardless of if it's a rental and you have a great tenant, blah, blah, blah. No one really cares, unless another investor is buying it and wants to retain that tenant, which is pretty uncommon.
So when you use the Dollar General example, in multifamily - make no mistake, again, if the Fed's gonna raise rates another 1%, it's going to have a negative impact to all real estate, and all loans, across the board. But the NOI is what is key. So if multifamily rents can rise 8% throughout the year, they just added that much more revenue to their NOI to help offset that rate increase. And that's a distinction that everybody has to realize, is the difference between commercial real estate at large and individual single family homes. That's how it differs, that's the bottom line. So rents tend to go up with inflation, that's just how it is; multifamily overall total returns since 2012 have been an excess of the government stated inflation by 583 basis points, which is pretty impressive. So we'll see how that holds up in 2022. Unfortunately, I don't have the crystal ball there.
So let's wrap it up, Ash... Is now a good time to get into the real estate market, in any sense, in any asset? You can talk to commercial or residential or single family. What are your thoughts about now getting into real estate?
Ash Patel: Yeah, I'm gonna say no for multifamily, because cap rates are still ridiculously compressed. Residential - man, I don't have my pulse on that market, but I know it's had a huge run up... And you hit the nail on the head when you gave the example of NOI increasing for multifamily. But it's not increasing for commercial. And again, Best Ever listeners, bear with me - commercial to me is non-residential commercial. So take that, for example... Interest rates are going up, which means cap rates have to compress in my world; strip malls, let's say, for example. But meanwhile, your tenants are making a lot more money, so they're sitting on dry powder. We know that when those leases come up, we can significantly increase their rents. So we can right now buy at a bit of a discount, because we're going on existing NOI; interest rates are going up, so the cost of debt goes up, cap rates are going down, and historically, we've always looked for long-term leases; we wanted that stability. Now we're looking for deals that have expiring leases, because they're being sold at today's NOI. And after we get to raise rents, we get to sell at tomorrow's NOI.
Travis Watts: 100%. And anyone doing active deals, obviously be paying attention for fixed rate debt, or if you're going to do floating, then to have interest rate caps, if that's applicable to whatever you're doing. So who knows what the Fed's gonna do you, guys. They could continue raising, it looks like that's going to be the case... But then if we are in a terrible recession, to your point, Ash, they could reverse trend and they could cut rates. So also pay attention to prepayment penalties on these loans, too.
And we've been looking at more flexible loans, that have low to no prepayment penalties, in case that kind of scenario happens. But it's always either going to be with a fixed rate, or a floating with a cap. Something to keep in mind.
So my thoughts are a little bit different than yours as an LP investor in various deals. I still diversify into other assets outside of multifamily, but I still think that there's always a deal to be had that makes sense somewhere, if it's conservatively underwritten, with the right debt structure, and you're happy with the overall projections, you feel like that's good for your objectives... So I dollar-cost-average, is how I look at it. Right now, as we see that most recent deal I mentioned, 9% discount is the latest deal that we're acquiring. Well, it's a 9% discount; hopefully, the rents are going to continue rising, so you're just dollar-cost-averaging, like you would in the stock market. That's how I look at it.
I'll never forget, one of the guys that scared the pants off of me in 2015, when I was first getting into multifamily... He was a big-name operator, still is today, and he's like "Man, 2016 is going to be the biggest market meltdown you're ever going to see in your lifetime, and we are not buying any deals right now." And so he sat on the sidelines about five years; I took the counter approach and just did deals that resulted nice in my situation. I'm not saying I'm better, smarter than this guy. It's just you've got to do you, you've got to look at your own goals, objectives and philosophy on all this stuff.
So I truly appreciate you being here and sharing your thoughts. You had some great insight for our listeners. Thank you, Best Ever listeners. Thank you for the feedback, again. That's why we did this episode on a market update. You can email us, you can reach out on social, you can leave comments, like, subscribe, share, all that good stuff. So thanks for tuning in to another Roundtable episode. Slocomb will be back next week, I believe, so we will see you on the next episode. Thanks for listening.
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