Originally Posted March 2024
Edited May 2024
Over the past three years, RM Adviser has focused primarily on joint venture equity investments in multifamily properties for both REITs. Income REIT typically targets stabilized assets, meaning those with historically high occupancy and consistent projected cash flow while Growth REIT focuses on both value-add apartment communities that can benefit from a full-scale interior and exterior renovation as well as stabilized apartment communities that have high projected occupancy.
We feel that the multifamily asset class reasonably targets an optimal risk adjusted return for a number of reasons. First, the United States currently has a housing supply shortage, and coupled with the basic need for housing, we believe the asset class has strong downside protection. We also believe this asset class has built-in inflation protection as rents can be reset on an annual basis.
Barriers to home purchase:
There had been a steady trendline in the median sale price of homes from the global financial crisis of 2007 to 2008, or the GFC, on through 2020, but once the pandemic hit, single family home prices rose dramatically from a $320,000 median sales price up to almost $480,000 at its peak, approximately a 50% increase. We believe prices rose due to the low interest rate environment coupled with a desire to exit large cities which led to a flight to single family homes which were already supply constrained. Although the median sale price of homes fell throughout most of 2023, the figure is still up significantly since the pandemic.
As noted above, one of the reasons we believe median sales price decreased in 2023 compared to 2022 due to the rapid rise in interest rates. The Federal Reserve, or the Fed, raised interest rates 11 times between March 2022 and July 2023. As seen below, the average 30-year fixed mortgage went from approximately 3% in 2022 to peaking at almost 8% in 2023.
Finally, the rise in home prices along with the sharp increase in interest rates has had a distinct effect on the affordability of homes. The Atlanta Fed publishes its HOAM index, which measures the ability of a median-income household to absorb estimated annual costs associated with owning a median-priced home. The HOAM index sits at 68.4 as of November 2023, near its lowest level since before the GFC. A HOAM index value lower than 100 indicates that the median household income is insufficient to cover the annual costs of owning a median-priced home, meaning housing costs are greater than 30 percent of one’s income. Everyone needs shelter, and if home affordability is low, we believe that will drive people to seek out rental units for their housing needs.
Nationwide housing shortage:
Another issue exacerbating the cost of shelter is the nationwide housing shortage due to underbuilding in the wake of the GFC. It has been analyzed that as of 2022, the U.S. is short approximately 3.2 million homes.
Housing supply may also be pressured by mortgage holders with below market mortgages. 60% of homeowners in the U.S. have a mortgage, and 60% of those borrowers have a rate below 4%. In this current interest rate environment with mortgage rates above 6.5%, existing homeowners may have little incentive to move for two reasons. One, the carrying cost of a new home will be significantly higher than that of their current home. And two, those with sub-4% rates have a mortgage rate that is considerably lower than the average rate of return of almost any investment class.
Inflation protection:
Lastly, we like multifamily investments in an inflationary environment as the typical one-year lease term allows an owner to mark rents to market on an annual basis. Shelter is the largest component of CPI, which accounts for nearly 33% of the index. We feel that shelter costs are positively correlated with CPI, which leads to built-in inflation protection for multifamily assets.
As we look ahead to multifamily acquisition targets, we believe there is still price discovery to be done in this “new normal” interest rate environment. We always want to ensure we are entering a real estate investment at the right value. One of the main barometers for our multifamily underwriting is to compare the affordability of our underwritten rents to median incomes in the area. We believe affordability to be around 25-30% of area median income, and we typically target underwritten rents that support that range. Secondly, we want to be smart about using leverage for our acquisitions. There are still instances in which operators are acquiring properties with negative leverage given how high interest rates still are relative to cap rates. In most cases, we want to avoid negative leverage. Lastly, we want to prudently manage our cash positions and reserves throughout 2024. While the macro climate is looking better, went want to proceed cautiously. We want to protect the REITs by keeping some cash invested in money market or treasuries. As of year-end 2023, cash and liquid securities comprises greater than 15% of each REIT’s assets. As we enter 2024, we want to strike a balance between being prudent with our cash position while also taking advantage of the buying opportunities that we believe will arise in the market.
This article is for informational purposes only, and is not a recommendation or offer to buy or sell securities. Information herein may include forward looking statements and is for informational purposes only. Forward-looking statements, hypothetical information, or calculations, financial estimates and targeted returns are inherently uncertain. Past performance is never indicative of future performance. None of the opinions expressed are the opinions of RealtyMogul. Advice from a securities professional is strongly advised, and we recommend that you consult with a financial advisor, attorney, accountant, and any other professional that can help you to understand and assess the risks and tax consequences associated with any real estate investment. All real estate investments are speculative and involve substantial risk and there can be no assurance that any investor will not suffer significant losses. A loss of part or all of the principal value of a real estate investment may occur. All prospective investors should not invest unless such prospective investor can readily bear the consequences of such loss.
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