Why Buy Apartments in An Artificial Market?

Cover of the book Walking and Talking - 57 Stories of Success and Humor in the Real Estate World of Business. Walking and talking was an early lesson I learned in commercial real estate.

Equity Preservation!

Since the tax change of 1986, until recently, the top 4 reasons for buying apartments were:

  • Cash Flow
  • Appreciation
  • Principle Reduction
  • Tax Deferral

These reasons have flipped in order. Now, they are:

  • Appreciation
  • Principle Reduction
  • Tax Deferral
  • Cash Flow (if there is any!)

Why the Stampede to Preserve Equity? Artificiality.

Everywhere they look, there is … Artificiality

Real estate investors know that artificially low interest rates let them borrow money at a 10-year fixed rate of 4.0%. They suspect that other artificial actions include:

  • Loaning students into paralyzing debt,
  • Forcing new regulations onto small businesses,
  • Changing the way tenants are charged for utilities,
  • Increasing property taxes, and
  • Increasing medical costs for their younger tenants.

They believe these artificial actions are causing overall inflation to increase at a rate that is far beyond the rate of interest on their borrowed funds.

So, they lock into a 10-year rate, hoping that the ever-increasing costs of building new properties will pump up the market value of their existing real estate.

Do low inflation rates matter, when your customers are experiencing higher prices?

The experts tell us that inflation is low, often citing the annual core inflation rate of 2%. But does that really matter when your customers:

  • Are surcharged for utilities by companies they didn’t even know existed.
  • See the filet mignon on their dinner menu is now priced at $49.00,
  • Spend more money for less at their local grocery store,
  • Pay $318 every month, for 13 years, just to pay off their degree in economics?

Real Evidence of Real Inflation

From Multifamily Builders:

Over the last 4 years, builders of newly constructed apartments have seen firsthand that the combined cost of bringing a new property online (land, zoning costs, impact fees, labor, lumber, asphalt, carpeting, painting, concrete, plumbing, electrical, etc.) has increased well beyond the reported core inflation rate.

From Our School Administrators:

Every election season, school administrators tell us that the cost of educating our kids far exceeds the rate of inflation. In turn, apartment owners increase rents just to stay even with the sharp increases in property taxes.

In News Reports:

Recently, data from real estate analyst RealtyTrac, reported by Columbus Business First, revealed that single family home prices in Columbus, Ohio increased 12.5% in the last 2 years, nine times faster than did wages in the same period of time.

But, they have to do something with their money! So, what is it? Sticks & Bricks or Stocks & Bonds?

If they buy multifamily real estate at today’s inflated prices, there is not much cash flow at all. But, they also suspect that the artificiality of ‘quantitative easing’ has propped up the value of their alternative investment, the stock market, beyond legitimate levels.

So, they ask themselves …

  • Where is the best place to PRESERVE MY EQUITY? If my costs are actually increasing at, say 6% per year, my buying power will be reduced by roughly one-third over the next 7 years. This, of course, is unacceptable. So where can I preserve the value of my equity?

In the bank? Will .25% will keep pace with inflation?

In the stock market? Is it due for a major ‘correction’?

Sticks and bricks? Will real estate keep pace with inflation?

Gold and silver? What’s that all about?

Then they ask themselves,

  • “What is within my control?”

Rising costs and expenses? No

The Fed’s policy on quantitative easing? No.

The rental/leasing market? No, not really.

The stock market? No

The overall economy? No

The price of gold and silver? No

The fixed interest rate I can lock into for the next 10 years? Yes!

The ONE thing they do control …

The one significant and substantial thing they have airtight control over is their 10 year fixed rate! It transcends time! 10 years is an eternity in this market! The 10-year rate is their only market certainty.

So investors are buying the sticks and bricks!

The demand for multifamily property at lower cap rates and higher prices is extraordinary.

Developers flip the properties as soon as they can!

Make no mistake. Local builders have little interest in keeping these apartments. They know that, in every direction, these conditions are artificial. They realize their local market is being flooded with new apartments. If not for the artificially low, long-term interest rates, they would never build apartments in such high numbers.

Developers know that their customer base is artificial.

The artificiality of lending $40,000 – $80,000 to an unemployed student has resulted in increased tuition costs and has created a pool of college graduates, so saddled with debt, that they will not likely qualify as first-time homebuyers, anytime soon.

The alternative to renting is moving in with their parents, which explains why builders are flooding the market with thousands of brand new apartments in Columbus (over 12,000 in the hopper!). Builders fill them with young, transient, overextended tenants who will rent for $1,400 per month for a nice place to live.

Most developers sell immediately after the last tenant takes advantage of the attractive lease-up concessions.

They sell at inflated prices to investors who have access to cheap funding.

The large investors gobble them up!

Investors wait in line to purchase the apartments at historically low cap rates. Auctions of apartment communties go to the highest bidder. Where else can they hedge their money against inflation?

Why buy apartments in today’s artificial market? EQUITY PRESERVATION

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Part II: Who will be the winners and losers in this artificial real estate market?

Future posts will predict the future winners and losers in this artificial real estate market. Hit the follow me button to receive these posts!

Here are some other posts you might find interesting:

Single Page Checklist for Buying Apartments: My book, Single Page Life Plan explains how you can extend single page planning to all of your important projects and ventures. Single Page Checklists are a ‘catch-all’ for special projects that you can review regularly to stay focused.

Podcast: What is a Cap Rate?  Cap Rates. You hear about them all the time, from people who specialize in investment real estate. They’ll says things like, “That property sold for a 6 cap,” or, “We’re looking for properties priced in the 9 to 10 cap range.” Today’s Walking and Talking podcast is all about Cap Rates!

I Wish I Had Smoked More Cigarettes: When I speak to 8th grade students, freshman, and sophomores, I make them this promise: Nobody ever looks back on their high school or college years and says …

Where is Your Rancho del Cielo? He called it his “Cathedral in the Sky” (Rancho del Cielo is Spanish for Sky’s Ranch, or Heaven’s Ranch). It is where President Reagan could sort out problems while riding his favorite seventeen-hands-high thoroughbred for hours at a time. He could enjoy Mother Nature in all her glory.

Please note: I reserve the right to delete comments that are offensive or off-topic.

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