I’ve been on vacation the past few days, largely ignoring the deluge of headlines and incessant barrage of market news (what a week to be away!). It’s tough at first because tracking the latest news feels a bit like sport, but over a few days I’ve begun to realize that the news is largely irrelevant and often detracts from my long-term goals.
While keeping your pulse on the general market is important, getting caught up in the “shiny new objects” as Peter Linneman calls them, is generally a waste.
The daily movements of interest rates, when inflation recedes, speculation on Fed actions, the stock market performance, whether or not we’re in a recession, the chance we see a recession in 2023 etc. are largely irrelevant to the outcome of our long-term focused multifamily investments. What happens 5 years from now will be far more impactful to the investment outcome than what happens 5 weeks from now.
Linneman uses the analogy that we should be wearing blinkers, the piece of equipment that prevents horses from seeing to the rear and, in some cases, to the side. “Many racehorse trainers believe that blinkers keep horses focused on what is in front, encouraging them to pay attention to the race rather than to distractions such as crowds.”
This is particularly apt analogy in today’s environment where every piece of news seems important, but difficult to translate into actionable insights. Whether the Fed decides to raise the benchmark rate 75 bps or 100 bps has no bearing on the success of our deals and doesn’t impact my view on investment opportunities.
The success of long-term focused multifamily investments is driven by controlling basis, downside protection (conservative leverage + reserves), value-add opportunities, market supply/demand fundamentals, and hold period.
Controlling Basis: With value-add deals, we’re hyper-focused on basis, ensuring that our total basis (acq. costs + reno budget) is well below replacement costs and in-line or below the comp set. An attractive basis enables us to use rents as a lever should demand soften in the market.
Physical Characteristics: Does the property have good egress and ingress, an appropriate unit mix, room for amenities etc.? Is there physical obsolescence risk? These are things you generally cannot change and will impact your competitiveness and market positioning long-term.
Downside Protection: Using conservative leverage (as measured by DSCR/debt yield) and holding significant reserves is critical to maintaining downside protection should cash flow be negatively impacted or an unexpected capital need arise. The main ways long-term focused multifamily operators get hurt is by over-levering and/or taking on short-term un-hedged debt and not maintaining sufficient capital reserves. You can’t win if you’re not in the game.
Supply/Demand Fundamentals: Rents and occupancy, which drive NOI/value, are a by-product of supply/demand fundamentals. Demand is driven by jobs, incomes, and household formation. Supply is driven in part by excess demand, but other factors play a part such as zoning and availability of land. Generally, we seek properties in submarkets with strong inelastic demand drivers and supply-constraints.
Long-Term Holds: I’m a firm believer that real estate is best held long-term and over a long enough time-horizon, multifamily will perform well. Maintaining hold period and debt prepayment flexibility is key to optimizing exits/refi’s.
When you look back on a deal 10 years from today, the success or failure of the deal will have nothing to do with today’s 10-year treasury yield or 2023 inflation. The success of the investment will be a direct result of your acquisition basis, ability to add value and capitalize deals appropriately, and patience.
Don’t ignore the news, but don’t get consumed by it.
As usual, EllliotttB puts it eloquently.