The main reason for owning multifamily property has changed …
Since the tax change of 1986, until recently, the top 4 reasons for buying apartments were:
- Cash Flow
- Principle Reduction
- Tax Deferral
These reasons have flipped in order. Now, they are:
- Principle Reduction
- Tax Deferral
- Cash Flow (if there is any!)
The new, overiding motivation for owning real estate is Equity Preservation!
Why the change? One reason … Artificiality
Multifamily investors know that they can borrow money at the artificially low 10-year fixed rate of 4.0%. Simultaneously, current artificial market conditions:
- Entice students into paralyzing debt,
- Pile unnecessary regulation costs onto small business owners,
- Permit tenants to be surcharged on their monthly utility bills,
- Increase multifamily property taxes beyond the rate of inflation.
- Increase medical costs for their younger tenants.
Multifamily owners see firsthand that real inflation is higher than the rate of their borrowed funds.
Therefore, large apartment owners continue to buy more apartments and lock in on a low 10-year rate, hoping that the ever-increasing costs of building new properties will indirectly pump up the market value of their existing real estate.
Do low inflation rates matter, when your customers are experiencing high price increases?
Experts insist that inflation is low, often citing the annual core inflation rate of 2%. But does that really matter when your customers:
- Pay water bills that are surcharged by companies they never knew 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,
- Are straddled with a seemingly never-ending $300 monthly payment just to pay off their degree in economics?
They look around and see hands-on evidence of real inflation:
From Builders: Over the last 4 years, builders of newly-built apartments have seen firsthand that the combined cost of bringing a new property online (land, zoning costs, impact fees, labor, lumber, asphalt, carpeting, paint, concrete, plumbing, electrical), has increased well beyond the reported core inflation rate.
From Our School Administrators: Every election season, school administrators explain to 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.
Sticks and Bricks or Stocks and Bonds?
Investors have to do something with their money. If they buy apartments at today’s inflated prices, they do not expect much cash flow. But, many fear that the artificiality of ‘quantitative easing’ has propped up the value of the stock market beyond legitimate levels. They wonder if quantitative easing can go on forever.
So, they ask themselves …
Where is the best place to PRESERVE MY EQUITY?
If my costs are actually increasing at, say 6% per year, the buying power of my current equity 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 one-quarter of 1% 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 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, they are forging ahead and are buying the sticks and bricks!
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.
Why? Because their customer base is artificially influenced.
The artificiality of lending $40,000 – $80,000 to an unemployed student has increased tuition costs and has created a pool of college graduates, so saddled with debt, that most will not qualify as first-time homebuyers, anytime soon.
Millenials, however, are tired of living with their parents (or their parents are tired of them living with their parents!). This 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 find a roommate and rent a nice place to live for $1,400/month.
Local developers oftentimes sell immediately after the last tenant takes advantage of the attractive lease-up concessions. They sell at premium prices to investors who have access to artificially cheap funding.
The large investors stand in line to 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. Their buyer’s low interest rate is fixed. Where else can they hedge their money against inflation?
Why are investors buying apartments in today’s artificial market?
Part II: Who will be the winners and losers in this artificial real estate market?
My next post will predict the future winners and losers in this artificial real estate market. To subscribe to my blog posts, and to receive a free copy of my eBook, Single Page Life Plan, click here.
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.