A few days ago I was reviewing my underwriting for the acquisition of a 164 Class B+ apartment community with my firms Director of Acquisitions and our CEO. Due to lack of sale comps (Ohio doesn't require disclosure as you can buy the entity controlling the property), I referenced how a neighboring property recently appraised for approximately 21% more than our purchase price, despite having similar finishes. A good sign to me (we're buying at a 21% discount!), both looked over and opined how "the debt market feels like 2006 all over again."
While that comment has merit and though the economic backdrop has changed materially since that time, I appreciated that my colleagues had experienced several real estate cycles and survived/flourished through each. Nevertheless, I began to wonder about those younger real estate entrepreneurs that have never lived through a string of interest rate hikes (like myself). After all, the Fed has only raised interest rates just a handful of times in the last decade, the most recent prior to the current cycle being in June 2006.
Many operators are too young to have experienced investing in CRE during a period of rising interest rates, low (or negative) rent growth and a lackluster jobs market. That does not mean they shouldn't try to understand its impact.
Interest rates will rise, rent growth will revert to its long term mean (2.2% - it's already there, according to Axiometrics) and occupancy rates will fall (December's rate was its lowest in 35 months). And all of this is okay, as long as you understand the risks.
Whether a first your analyst or starting to do your own deals, you have a responsibility to do meticulous due diligence on behalf of your investors. A few questions you should always be prepared to answer:
How does your property perform on an unlevered basis?
How do your rent and occupancy forecasts relate to historical trends in that particular market?
What are the economic drivers that impact jobs growth in your market and how are those industries projected to perform over the next several years?
Sidebar: We just looked at a deal in Fayetteville, a market whose employment is driven majorly by Ft. Bragg and military spending. With President Trump looking to spend an incremental $60+ billion dollars on the military over the next several years, this is a market that could indeed see significant jobs growth over the next several years (and thus strong apartment market fundamentals).
It's really easy to underwite a deal, but it takes skill and experience to evaluate the impact of a confluence of factors on that investment.
In a later post, I'll illustrate the impact something as simple as a 100bps swing in annual rent growth can have on an investments IRR and a simple way to (hint: data tables) to measures its impact on your investment returns.