Q1 2024: Michael Becker's "Beyond the Horizon"
Q1'24 State of the Market: "Beyond the Horizon"
Written by Michael Becker
Q1 2024 Newsletter
Hi, Michael Becker Here...
In this newsletter, I’d like to speak on my current view of the market, particularly regarding investment sales activity. So far this year, I’ve attended several conferences, meeting primarily with potential private equity and family office investors. Between late Q4 of last year and today, I’ve had approximately 50 meetings, and below are my major takeaways.
Throughout 2023 to date, there has been a dramatic decline in both properties listed for sale as well as actual transactions in the multifamily space. Sales volume is off at least 70% compared to 2022. Values have dropped approximately 20-25% from the peak in Q1 2022 for Class A and A- deals, and even more for workforce housing deals, ranging from 25-35% depending on the asset’s location, vintage, and physical characteristics.
Currently, anything for sale on the market is receiving considerable attention, with high tour counts (40-50 tours being common compared to the typical 20-30) and 20+ offers in many cases. Current listings have skewed more towards the newer vintage side with less workforce housing on the market. Recent pricing isn’t consistently meeting seller expectations or requirements to transact, but there are deals closing on a regular basis. I would say today’s cap rates (Q1 2024) have somewhat of a scarcity premium priced in due to the lack of inventory. As more inventory hits the market, this scarcity premium should get priced out to some extent. However, property operations may also improve over the spring and summer as a result of higher income and lower property taxes boosting Net Operating Incomes ("NOIs") Time will tell how that plays out exactly and results will vary by market and ownership group.
Based on my numerous conversations with equity investors, owners, and sales brokers, here are my takeaways on current market demand:
- There is some money looking for Core and Core-Plus projects (new construction in downtown or suburbs), with sufficient liquidity to transact to the extent that you can capture an owner or developer’s attention at today’s values, which are below current replacement cost.
- Some investors are seeking 1980s vintage 8-foot ceiling value-add properties in decent submarkets, and an even larger subset is interested in 1990s 9-foot ceiling assets. However, there’s far less available apartment stock of the 90s vintage than the 80s because there simply wasn’t much built in Texas from 1987 to about 1995 following the building boom that took place in the first half of the 1980s.
- As for the 1960s and 1970s vintage deals, I won’t say "No Bid," but to clear the market with that vintage, generally speaking, the disparity between the price a buyer is currently willing to pay is still too far from what a seller can or is willing to accept. To me, this segment feels largely frozen with just a few trades recently. The most challenging (if not next to impossible) assets to sell in this subset today are larger unit count properties with unattractive characteristics like being located in unfavorable, high-crime neighborhoods and having a chiller system, or aluminum wiring, for example. Moreover, smaller assets tend to be more liquid than larger properties since the equity check required on smaller deals is more attainable today compared to a few years ago.
- The segment most sought-after is the 2000 to, say, 2016 vintage properties – Class A/A- with 9-foot ceilings and a first- or second-generation value-add opportunity available. This subset is the meat of the bell curve and attracts an abundance of capital because it allows a buyer to execute some level of renovations to justify pushing rents while avoiding undesirable physical (or structural) attributes that older buildings have. This segment is currently seeing the highest level of “Scarcity Premium” attached to it with the tightest cap rates in the multifamily space. I see cap rates starting with a 4 in some cases. It is the most liquid subset of the multifamily space today, as most everyone wants this.
My read of the current market is that:
- 10-15% of capital is targeting the Core/Core+ segments and the 1980s segment.
- 70%+ is focused on the 2000s and newer Class A/A- with a light value-add play.
- <10% of equity is interested in the 1970s segment or older.
To me, it seems like private and family office money is ready to invest and take advantage of today’s relatively attractive values compared to 2+ years ago to some extent, but most are likely to be cautious in the deployment of that capital since the market hasn't flashed the "all-clear" just yet. Essentially, a deal has to “check” most of the proverbial boxes to get them to buy today.
Institutional capital remains largely sidelined but is getting ready to deploy. This should be closer to the typical herd mentality – when the first one goes, the rest will follow suit. My crystal ball says that, upon the first rate cut by the Federal Reserve, they will feel the coast is clear and start to deploy capital.
With all that said, SPI Advisory was among the largest buyers in Texas in 2023 with 5 Acquisitions (I believe we were Top 3 or 4 in the state). Although every situation and deal is unique, and certain circumstances may warrant focus on de-risking a deal via refinance, returning capital through disposition, or otherwise, for 2024 we unequivocally plan to be net Buyers. We will continue to selectively lean in and buy assets that align with our investment criteria at today’s values. As soon as the institutions see the "all-clear" sign flashing, we believe values should increase 5-10% effectively overnight and proceed higher from there. In our estimation, now is the time to buy ahead of the curve. Especially when coupled with the dramatic drop in supply relative to forecasted demand in 2025-onward in Texas, I think tactical buyers in 2024 will look very smart in 2-3 years. I am confident we will be rewarded for continuing to buy high-quality assets in strong locations and submarkets that we believe in with foundational long-term demand drivers.
Right now, we are primarily focused on both the Core+ new construction assets in addition to the 2000s and newer, light value-add assets, which make up the bulk of our portfolio today and we still believe are the better part of the market for now. If and when more owners of older vintage assets are forced to sell and meet today’s more realistic market valuations, we will likely dip our toes back into that space (specifically the 1980s vintage assets). It feels that this inflection point is getting near as we are seeing the leading edges of distress in the workforce housing segment hit the market. It appears gravity is starting to set in and, once a few more deals trade at lower values, the velocity of transactions in the workforce housing space should increase and spell the beginning of the end for the "Pretend and Extend" game the workforce housing market has been playing for a while now.
A good indicator for SPI that the time is right to go downstream is when we can qualify for an Agency loan on a 1980s deal at 75% or higher leverage (with their conservative underwriting standards). I’m not necessarily saying that we would take that much leverage, but it is a good rule of thumb that suggests pricing is better in line with the realities of capital markets and current interest rates. I keep thinking that time is right around the corner, but we haven’t seen it just yet. My current thinking is that Q4 2024 into 2025 is when we might see these conditions materialize market-wide. We will likely see one-off deals qualify for 75%+ LTV agency loans sooner.
Cheers,
Read Michael Becker's Previous Articles:
