Recently, we have had an enormous number of discussions surrounding the US economy and its current inflation.  One thing we do know is that “inflation is here,” and it appears that there are no near-term signs of stopping.

The Consumer Price Index (“CPI”), the most common index to measure inflation, reached 283.716 points in February 2022, nearly 8% higher than in February 2021 – the largest year-over-year increase in 40 years. 

But what does that really mean for multifamily real estate investors in the US?

Historically, many financial experts and academics have recommended real estate as a hedge (or a source of financial protection) against inflation.  If you’ve invested in the real estate market lately, you have most likely felt some of the forces of inflation.  If not, I am sure many of you have heard a story or two from your family, friends, or network.

Since no one can say they’re quite certain about the future, it’s important for our audience to understand: 1) inflation; 2) how it works; 3) how it affects your current and/or future real estate investments; and 4) the best ways to protect your financial health and portfolio of investment assets.

What Is Inflation?

Inflation is essentially the rise in prices of goods and services within an economy over a set period of time (one-year or year-over-year is most commonly used).

To paint this picture simply, here’s an example

·       Over the long-term we are usually experiencing an average annual rate of inflation of 1.8%.  Let’s say you bought a microwave for $400 last year at this time, you would need to pay an additional $7.20 for the same cooker today.

·       With today’s inflation we are looking at 7.9%., so instead of $7.20 additional from the average 1.8% you would now pay $31.60 more (a $24.40 difference).

It might not seem like a lot of money to be worried about in this case.  However, after adding up all your bills for the year, like internet, gas, groceries, phone bills, and other expenses, you actually end up spending a lot more.

In terms of purchasing power this means a dollar buys less over time.

For example, since 1913, the US dollar’s purchasing power has declined by roughly 96.5%.  If you had $1 a century ago, it would only be worth about 3.5 cents today

Some people confuse inflation with appreciation.  The two are different.  

1)      Appreciation in real estate refers to the rate at which a property’s value goes up over time.

2)      The increase in value in appreciation isn’t due to inflation. The value appreciates due to the rise in demand and underlying fundamentals of the asset.

It’s common to see the value of property increasing at a higher rate than inflation, but can also increase at a slower rate, or perhaps even depreciate, as the economy experiences inflation.

What Causes Inflation?

We made a short list of some of the important (and currently relevant) causes of inflation for you all:

·       Lax monetary policy - This is also known as money printing. It increases the amount of money in circulation, which, in turn, results in the decline of the currency value. The US government provided a $5 trillion stimulus during the pandemic, which was the largest amount of money ever distributed in US inflation history.  To put this in perspective, this amount is 3x the amount after the financial crisis in 2008.

·       Expecting prices to rise - Based on knowledge of the experts, expectations of rising prices eventually become self-fulfilling.  When businesses expect prices to increase, they also adjust their prices.  This is when you find rent prices increasing or see real estate investment firms directing their property managers to negotiate wages of the property staff.

·       Supply Shocks - Supply shocks happen when there’s a rise in prices due to an increase in demand but a low supply.  It happens when there are natural disasters or business lockdowns.

·       Demand Shocks - Demand shocks include when you find real estate investors engaging in bidding wars to purchase investment properties with the potential to yield rental income.

(View our past discussion on navigating the market cycle)

How Does Inflation Impact Real Estate Investors?

While inflation can look like a negative thing, it’s not entirely so – believe it or not, there are some positives.  Let’s break down this section into what inflation means for current and prospective real estate investors.

Inflation for (Current) Investors

One case is if an investor or investment firm has financing to invest in property as a leveraged asset while interest rates were low (and in the meantime still are, relatively speaking).  Depending on the type of financing, the investor could be paying back the same rate while the investment property appreciates in value.

(View our past discussion on interest rates)

In the current inflationary environment, financing (i.e. interest) rates aren’t rising at the same rate as the inflation.  Given a sale, this means that an investor’s return on investment could soar.

Inflation for Prospective Investors

Based on historical data, prospective investors could potentially experience the most negative effects in an inflationary market.  

·       Inflationary times lead to high costs of borrowing. Since banks and lenders don’t want to lose their money, they offer fewer loans at high interest rates to reduce their risk.

·       Inflationary times lead to a high cost of building.  Due to the high cost of borrowing and building materials, new constructions or larger renovations during inflationary periods could make for a difficult investment.

With that said, this would not be the case for every prospective investor.  In fact, there are always ways to find hidden value and participate in the market as a contrarian.

(View our past posts on: identifying hidden value & contrarianism)

How Does Inflation Impact the Real Estate Prices?

Some are expecting real estate prices to continue rising into the double digits over the next year. 

So how about we answer the question, “what are the causes of the real estate price increases during inflation periods?”

1)      Demand in Income Generating Assets

One of the major reasons why real estate prices increase during inflation times is because real estate investors search for assets that will generate rental income that keeps up with or outpaces the current inflation rate.

Rental income is the money collected from the tenants and used to settle property operating expenses, taxes, and mortgages.  Any money that remains after settling the expenses is the net cash flow. In this case, we express the rate of return as the cash-on-cash return. . Cash-on-cash return measures the amount of cash flow relative to the amount of cash originally invested in a property. As inflation increases over time the inflated income dollars collected measured against the original investment amount should help to boost this cash-on-cash return.

2)      Limited Real Estate Inventory

Real estate prices during inflationary periods also go up because of the limited amount of real estate compared to fiat currency.  You’ll find governments printing more money during such periods to increase the money supply.

This can cause real estate prices to rise.

3)      Increase in Construction and Renovation Costs

Inflation tends to cause all prices to increase, including land, wages, building materials, and supplies.  

As a result, home builders and multifamily property developers pass the cost of construction to home buyers and investors, which we are currently seeing in the market today.

·       Over the past 12 months, building material prices have risen by over 19%, including lumber, ready-mix concrete, and boards used for finishing ceilings and walls.

(View our past discussion on capital expenditures)

So, what’s the remedy for real estate investors during inflation?

What Should Real Estate Investors Do During Inflation Periods?

Ask yourself: how long would you like to (or intend to) own the prospective investment property?

If you want to keep it in the long term, you can expect to enjoy the same benefits as existing owners, such as property value appreciation.  If you’re looking to invest in a much shorter period, we advise you to proceed with a lot of caution.

One major danger of investing in the short-term during inflation is that the potential risk of a real estate bubble.  If you are a new direct investor, if you don’t have enough equity to settle such costs, then you may lose a lot of money should the bubble burst.

 

Book a meeting with the CF Capital team today to learn more about how we can help you navigate inflation with multifamily real estate investing utilizing our tools expertise.

 

Recently, property prices have risen to historic levels.  While the trend may not cause concern, it emphasizes the importance of understanding your investment time horizon and planning accordingly.  For CF Capital, we are spending more time than you can even imagine to make sure we are being as thoughtful as possible with our Business Plan.  (View our past discussion on our Business Plan)

How Can Investors Use Investment Property as an Inflation Hedge?

Investing in real estate during inflationary periods always depends on the location and the state of the market. However, investors may use the following ways to gain a hedge (i.e. protect their investment portfolio) against inflation:

·       Invest in Multifamily properties: Since many people can’t afford to build their own homes during inflation, multifamily rental properties tend to have a higher demand.  As a real estate investor, you can then hedge against inflation by controlling the revenue levers available in the marketplace as a result.  For those looking to gain exposure without the hassle of managing a property, please feel free to reach out to us – we can discuss our current or potential upcoming investment offerings OR just guide you to the right path that you are looking for.  Either way, we would be more than happy to have a conversation.  (CLICK HERE to fill out our inquiry form)

·       Leverage historically low financing: Interest rates for real estate financing reached historical lows, and still remain quite low in relative terms. A real estate investor can take advantage of the low-interest-rate environment to steer clear of paying higher rates in the future.

·       Capitalize on rising asset values: History has demonstrated that real estate investors benefit from owning properties in the long term.  For example, since 1990, median home prices have risen by 345%.  Similarly, property prices have increased by nearly 20% since 2020.  It is another reason to justify using real estate as a hedge against inflation.

It’s essential for you to have funds available so that you can seize any available opportunities.  As we always advise, make sure you carry out your due diligence since investing during inflation periods can go either way.  If you do not have the capacity or do not feel comfortable in your due diligence, we would be more than happy to discuss what we do!

(View past discussion on due diligence checklists)

What’s Next for Real Estate Investors?

The bursting of the 2008 real estate bubble and consecutive economic recession still haunts investors, buyers, and sellers to date.  

Please note that while prices continue to go up, it’s difficult to predict a market decline.  On top of our lack of interest in speculation, there’s still insufficient data to suggest that a recession is imminent.

The current market inflation is quite different from what we experienced just before the Global Financial Crisis.  Though there’s a short supply of labor, the economy is growing at a steady rate, and the rate of unemployment is on a decline.  

We remain optimistic that the post-pandemic economy will fully reopen and grow to provide more opportunities.

Remember to always do your due diligence.  Smart planning and time management will help you manage your economic risk.  

Finally, we recommend that you speak to your financial advisor or a real estate investment firm, like CF Capital, so you can find the best way to invest in a multifamily property.

Main Takeaways

·       Real estate prices tend to increase during periods of inflation due to the excess money in circulation in the economy.

·       Many investors have used real estate as a hedge against inflationary periods.

·       You can use multifamily real estate investment to generate income above the inflation rate while also capitalizing on the potential property value appreciation in the long term.

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Even the most concrete plans will show some cracks every now and then.

In the world of real estate, if you are depending on your first option you will quickly realize that things don’t always go as planned. The most successful investors will make contingency plans for such a scenario, as there is a slight chance it will be needed.

It is usually in times of panic or crisis that bad decisions are made. Inappropriate knee-jerk reactions will only compound the initial lack of preparation.

With every property that you get involved in you need to protect yourself and have a backup plan ready. It may be the only thing that protects  your investment. 

Deals Processes are Rarely Perfect

It is very rare that a deal will go exactly how you envision it from the time you make an offer until the time you take ownership. Even after you close on the property, you will have another set of obstacles and challenges that you will be forced to deal with. 

It is always great to have a plan, but you also need to have a couple of backup plans in place as well. This is a critical part of the CF Capital investment process that investors rest assured we’re prepared to execute contingency plans on their behalf while they passively invest alongside our team.

Everything from budgeting to scheduling could throw a monkey wrench in your plans if you are not prepared. Even if you are prepared and have everything in place, it doesn’t mean that the people around you share the same vision.

Things to Cover in the Deal Process

If you intend to flip, how realistic are you with your end price? What would you do if there is not as much interest as you thought there would be? If you opt to rent, what are the fair market rents and do you want to be a landlord? If you decide to sell, what is the minimum you would take?

All of these questions, and many more, have to be thought about before you even make an offer. Once you acquire the property, it is too late to run these scenarios when there is real money at stake. If you are forced to make a tough decision in times of desperation you are more likely to  compound the error.

Making a Good Plan

Take the time and lay out every step of the process and what can go wrong in each area. Play out what you would do in the worst case scenario and how it would impact your bottom line.

There are those who say that thinking like this is negative and is a precursor of how the deal will go. The reality is that this is much more the exception than the norm. If you don’t prepare for negative circumstances along the way you will end up disappointed in the results and will be less positioned to take the necessary actions to iterate. If you have to say that you hope it doesn’t come to that or you don’t know what you would do if that happened, you may be taking too much of a risk with the property. As the saying goes, hope is not a strategy.

Of course, some worst-case scenarios are not very realistic, but if others are only a couple of steps away from happening you have to put that on your radar and at least consider the possibility. It’s also helpful to consider probabilities and work to project various potential future outcomes ahead of time, and ask yourself if the worst-case is something you can mitigate and what you might do should it occur.

Closing Thoughts

A truly smooth deal from beginning to end is not the most likely scenario with any real estate deal. The more prepared you are for this, the better your investing business will be. What you will quickly find is that your backup plan may be your only plan.

When making investment decisions, choosing to invest alongside a team like CF Capital helps investors find comfort in contingency planning from the professionals to protect and grow your capital through a fluid and constantly changing market and day to day business. Knowing that you’re investing with a sponsor who considers alternative scenarios from the beginning drives confidence and eases concerns. 

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When dipping your toes into the water of real estate investing and eventually jumping all the way in, it’s important to have a good grasp of what outcomes are attainable and measurable. This will help you set realistic goals.

Real estate investors have different goals based on many different factors. These factors may include their level of experience in investing, level of risk aversion (how tolerant they are of taking risk in exchange for the possibility of financial return), financial stability, and what their financial needs are in both the short and long term. For investors who are getting into real estate investing for the first time, goals should be related to learning as much as possible and building a profitable portfolio of investments.

Today we will dive into a few  specific, realistic goals for new real estate investors and how to measure and track them.

Acquire Your First Assets

One of the most daunting things about getting into real estate is the thought of tackling the real estate acquisition process for the first time. This process is the largest deterrent for those who want to get into real estate investing — potential investors often quit before purchasing their first property. What most investors quickly realize after overcoming this obstacle, however, is that the subsequent properties quickly follow suit, and the acquisition of properties snowballs.

To keep from being too overwhelmed in the beginning, set realistic goals that you know you can achieve before you even get started. A great example of a realistic goal is obtaining one real estate property within a 12-month time frame. Break this goal down into smaller and more manageable bite-sized tasks that you can accomplish over time.

With a realistic goal in mind, the next step is determining the best way to measure and track progress toward your goal. One method for doing so is working backwards.

Work backwards from closing day to the day that you decided to invest in real estate and decide what action items must be accomplished at each point along the way. This may take some time at first, but doing it correctly will save you from wasted time and headaches in the long run. See the list below for an example of steps to take when acquiring your first investment property.

• Find the right real estate agent (ideally one who specializes in investments)

• Find an investor-friendly lender to work with and get a pre-qualification letter

• Analyze 10 deals per day

• Tour deals that meet investment criteria

• Submit offer on best potential investment property

• Negotiate final contract terms on the property

• Send contract documents to the lender

• Hire and schedule a property inspector to perform an inspection

• Negotiate repairs or concessions

• Inspect agreed-upon repairs upon completion

• Await appraisal results

• Receive final loan approval

• Schedule closing day

• On closing day, sign documents and wire funds to escrow account

• Await notification that the seller has received funds — deal complete!

By breaking down the real estate investing process into an itemized checklist of smaller, more manageable tasks, you can transform what you once thought to be a formidable obstacle into a standard procedure. Once this process is refined, it can be executed smoothly as part of your well-formulated real estate investing process.

Build Muscle Memory for Analyzing Deals

Another realistic goal to have when getting into real estate investing is to build strong muscle memory when it comes to analyzing deals. At first, it may seem like you are double-checking all of your numbers and reference equations multiple times. You’re not crazy — this is completely normal.

The goal is to get to the point where you know whether or not a certain investment is worth looking into further without having to spend more than 30 seconds on it. To develop this skill, you must become an expert on your target market. You need to develop an understanding of any factors that will immediately eliminate properties from your investment search that might not get filtered out by your realtor or property search engine. These are often different for every market and based on your investing criteria. You’ll also need to practice the art of observing what rough numbers it takes to make a deal fit your investment parameters.

Often overlooked, this skill is an important one to add to your toolbelt as a new investor. It will not only save you dozens of hours in time but also provide you with the confidence to be decisive when good deals present themselves. Once refined, this muscle memory allows you to know whether the deal you are looking at is worth pursuing or just a dead-end lead.

How do you track deal analysis so that you can become better at it? The best way to accomplish this goal is to keep track of how many deals you are analyzing on a daily, weekly, and monthly basis, as well as how long you spend running numbers. Tracking these numbers over the course of your first month alone, you will see significant improvement in the number of properties you can analyze in the same amount of time as when you started.

A good mini goal to set initially is to analyze 3 deals per day. Once you have done this for several months, your ability to recognize a good deal in your market will be significantly improved. To level up your deal analysis skills, start analyzing deals outside of your market in addition to ones within — you will build up your skills and ability to underwrite properties regardless of where they are located.

Optimize Your Investment Portfolio

Another crucial and realistic goal for new investors is to run your investment portfolio profitably. Doing so is essential for continued real estate investing success, so mastering this skill as early as possible should be a top priority. Do not expect 90% cash-on-cash returns or unrealistic monthly cash flow — aim for profitability and realistic cash-on-cash returns.

By establishing good practices at the outset and leading with revenue-generating activities rather than those that produce expenses, the growth of your real estate portfolio will come naturally. Not only that, but the growth will more likely than not continue being profitable.

Following are some actions you can take to ensure you are optimizing your portfolio and maintaining profitability.

Establish a Schedule for Routine and Preventative Maintenance

By establishing a schedule for routine and preventative maintenance for your property, you will reduce the number of large failures and breakdowns that take place at your property. Repairs to the furnace, HVAC condenser and compressor units, water heater, and smoke and fire alarms can become a nuisance. However, routine is the key to ensuring profitability while also remaining in compliance with local fire and rental property codes.

A well-cared-for property will continue to take care of you and produce your desired amount of cash flow. Without maintaining it and making necessary repairs when they present themselves, the property is likely to fall toward disrepair until it reaches the point of condemnation.

Preemptively Get Quotes from Multiple Service Providers

When getting into real estate investing, it is recommended to put together a spreadsheet or notebook with three to five contacts for service providers in a variety of fields (e.g., electricians, plumbers, handymen, roofers, and so on). When something inevitably goes wrong and the first few people you call do not answer or return your calls, you will already have several backups at the ready who are capable of making a service call to your property. This ensures repairs are done quickly for a reasonable price.

Properly Screen Your Tenants

Another great way to stay profitable and prevent catastrophic expenses is to properly screen your tenants. Nightmare tenants who trash the property to the point of needing expensive repairs and require you to take them to court (or try to chase them down) are far too common. If you are unable to track them down, you still have to pay to repair your property. Take the time and spend a few extra dollars to properly screen your tenants upfront.

Set Up Your Tenants’ Rent Payment to Be Delivered via Recurring ACH

Setting up your tenants to automatically pay rent on a recurring basis via electronic transfer is an easy way to ensure that monthly rent is being paid on the same day each month. It also lets you know if there are insufficient funds for the payment. If this happens, you can take the necessary next steps, including reaching out to your tenant to resolve the situation without there being days of worry or awkward phone calls.

Remind Yourself to Send Out Lease Renewals

Finally, setting reminders for yourself to send out lease renewals with increased rent rates each year (minimum of 45 days prior to lease expiration) is a simple way to increase the odds of your tenants signing on for another year. Rather than waiting for them to notify you that they’re moving to a cheaper place, be the one to make the first move and send them a renewal that is already signed by you. Put the ball in their court and make it as easy as possible for them to renew with you.

Realistic Goals Make the Difference Between Failure and Success

It is a wise choice to set realistic goals when first getting into real estate investing. While it may be tempting to set your sights high, these realistic goals will encourage your confidence and keep you from crashing and burning early in your investing career.

In summary, you may choose to be an active real estate investor and set these types of activity goals for your own investing future. You may alternatively (or in addition) choose to invest alongside other deals passively with teams that execute on these types of activities on a daily basis. If that is the case, we’d invite you to explore those passive investing opportunities with CF Capital. You might be surprised at how much upside you can actually gain while obtaining none of the day to day headaches. 

Until next time, thanks for reading!

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More than $12 trillion in assets are considered “sustainable” investment strategies in the United States, according to the U.S. Forum for Sustainable and Responsible Investments. Globally, the amount of sustainable investments exceeds $40 trillion, tripling since 2012.

This rapid growth creates an enormous opportunity for real estate companies to create added value and drive new investment, but many are uncertain of how and where to get started. 

Because “impact investing” is still relatively new, it can be challenging for firms to figure out how to fully incorporate environmental priorities into their multifamily properties. We’ve found that the key is to develop a framework that is both rigorous and flexible enough to meet existing environmental standards while satisfying an evolving set of outcome measurements and reporting requirements. 

As multifamily owners and operators dip their toe into this area and attempt to make sense of this rapidly changing landscape, here are three simple questions to get the process started.

1. Are you doing relevant things that matter?

Simply put, are the actions that you are taking making an impact on globally recognized environmental priorities?  This may seem obvious, but as the environmental impact investing sector grows up, it is important to ensure that your environmental impact goals are aligned with widely recognized global priorities, such as those outlined in the United Nations Sustainable Development Goals (UN SDGs).  

Let’s say, for instance, you’re investing in property upgrades and management practices. Investments in energy and water efficiency not only reduce operating expenses but they also can be directly linked to tangible SDG targets, whereas a marketing campaign that urges renters to recycle may be less impactful.  

It is also important to note that stakeholders across the globe are increasingly holding property owners to ever higher standards.  

If you are already incorporating energy and water savings at your properties, it will be more important to demonstrate how your property is reducing greenhouse gas emissions that occur up front in the development process.  Going forward, that means you should be considering the environmental impact of your building materials and construction techniques and how you can incorporate more clean energy sources at the property level to reduce your overall carbon footprint. 

2. Do your actions reduce the risk to your portfolio or enhance your return on investment?

Just as multifamily owners and operators must consider the on-the-ground impacts of their investments in the communities and households they serve, they should also keep the big picture in mind – i.e. the business outcomes and returns of their investment strategy.

For example, do your energy and water savings reduce operating expenses and support stable returns on investment?  Do the pay back periods for your green investments make financial sense?   Do they create marketable advantages for you with competing properties?  In short, a property has to find the right balance between environmental and economic sustainability.

3. Can you demonstrate that what you’re doing is working?  

No impact framework is sustainable if it can’t be measured and proven out.  Establish clear metrics of success at the onset – ones that can be backed by data or concrete evidence and that align with common standards like the UN SDGs (United Nations Sustainable Development Goals).

In the environmental impact space, there are already established metrics for measuring the impact of energy and water savings and reduced carbon emissions.  But as more and more countries focus specifically on goals to eliminate dependence on fossil fuels, it will be increasingly important for investors and operators to find ways to quantify the environmental impact of their building materials and sources of energy as well. 

Main Takeaways

As environmental impact gains acceptance in the multifamily sector, having a clear framework for your business will be critical to attracting the attention of impact investors. Although it can be a confusing space to dive into, the opportunity is ripe for firms that are ready to take a thoughtful (and measurable) approach to environmental impact.

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Lately, I’m sure many of you know about the activity in the real estate market, whether you are seeing it in the news or witnessing it first-hand.  It isn’t any secret that most of the activity is a result of increased demand.  There’s no question there are a litany of supply issues to speak of, which certainly impacts pricing dynamics, but today we’d like to focus on the demand side of the spectrum. 

You can either consider this market to be driven primarily by artificial demand (via monetary policy) or not.  Regardless of nuance, it is still a demand dynamic.  The underlying drivers of demand say so.

Which brings us to our discussion today – how to evaluate market demand.  Alternatively, how to look at market factors that impact demand.

Preliminary Thoughts

Below we talk about some of the higher-level factors responsible for some of the movement we see in the real estate market – the economy, demographics, interest rates, and government policy.

We would like you to keep in mind that the “puzzle” is more complicated than it seems.  Also, a number of the high-level factors do have a clear and distinct relationship with the market, but when it comes to the real world, what takes place may be quite different.   

With that said, we would like to reiterate the importance of understanding the primary drivers of the real estate market in order to effectively evaluate a real estate investment opportunity.

The Economy

This factor is often seen broken up by measurements (or indicators) that provide insight on individual components of economic health, a driver of market demand.  Among some of the indicators are GDP, employment levels, manufacturing activity, and the prices of goods.

If these indicators reveal “bad” numbers, you can generally assume that the economy’s health is not in its “best shape.”

But this generalization forgets to account for other forces, such as the cycle of the market and how it impacts a specific type of real estate. 

To illustrate this further, let’s compare shopping malls to a commercial office building.  In most cases, a mall would experience more negative impacts from a sudden plummet in the economy than a commercial office building. 

Why?

As it relates to malls, when average incomes drop dramatically, research shows consumers' first move typically involves a reduction in their discretionary spending habits.  In other words, there is a drop in consumer demand for malls and the goods it offers.  A mall is driven by discretionary spending, and if most consumers aren’t buying anything in stores, a chain reaction within the mall may occur.  In the mall, when some businesses cannot pay their bills, they are forced to shut down, often breaking their more-flexible lease.  Depending on the characteristics of the mall tenants and existing demand to become a mall tenant, a sharp increase in vacancies may take place with virtually zero replacement tenants in sight (i.e. a very low demand from businesses).

In the case of a commercial office building, property owners often lock up the most stable tenants (i.e. businesses) in long-term leases, so there is no ability to change an office rental even when the economy’s conditions are poor.  Therefore, an office building is generally more durable than a mall in the case of an economic downturn. Of course, there are other dynamics to consider when it comes to office asset stability (and retail, for that matter), but that’s beyond the scope of this blog. Further, neither are an asset class our firm focuses on.

Demographics

Just like the economy, demographics also have indicators, in the form of statistics, that provide insight on the potential demand of a real estate market.   Population-based examples include age, race, gender, income, migration patterns, and population growth.

Amateur investors forget the importance of these statistics when evaluating a property, resulting in mispricing mistakes and misinterpretations of which properties are in high demand.  We must not forget that large demographic shifts can have significant long-term impacts on real estate.

One example is the baby boomer generation (i.e. grouped by age) and the significant influence that their retirement may continue to have on the real estate market.  Starting their retirement back in 2010, baby boomers have shifted the demand landscape in many ways already:

• The demand for second homes in popular vacation spots has increased as more and more baby boomers retire

• The demand for larger homes has decreased because all baby boomer children have moved out for the most part and their incomes are now lower.

• There’s a segment of baby boomers that have become renters by choice and renters by necessity, driving substantial movement in the multifamily real estate market as a result. 

Interest Rates

Interest rates and any changes to interest rates can have a large influence on a person’s decision to purchase real estate or not.  Put simply, as interest rates decrease, the cost to obtain financing (mortgage or a loan) also decreases.  Lower financing costs creates an increase in demand, and eventually real estate prices go up as a result.  

The opposite scenario is also important to review.  As interest rates increase, the cost to obtain financing also increases, which decreases demand, and generally results in real estate prices going down. 

Government Policy

Government policy may implement policies related to taxation (deduction, credits, and subsidies) that provide the real estate market with temporary increased demand – a scenario that can last as long as they are in place.  Some think of this as the artificial creation of demand. 

Awareness of current government policies, such as tax incentives, can help one determine the potential changes demand while identifying the possible false trends.

For instance, let’s examine a scenario where the government implemented a first-time homebuyer's tax credit for the purposes of boosting housing market sales in the middle of a time when economic growth was sluggish.  According to the reported statistics, over two million Americans took advantage of the temporary tax credit, which was a significant increase in home ownership.  Without knowledge of the tax incentive and the result it had on the housing market, one might have instead concluded that demand was produced from other factors. 

There are many other examples of policies that impact various asset classes in real estate. 

Reviewing the Main Points

• There are a number of factors that impact real estate demand, prices, availability, and investment potential.

• The cycle of the economy influences the prices and demand for real estate.  An investor can reduce the potential negative impacts through strategic investments in parts of the real estate market that are less impacted by economic downturns.

• Demographics provide characteristics, such as age, income, and migration patterns of the population.  These characteristics are used to identify actual or potential buyers, retirees, and how likely they are to make a purchase of a home or even a second home.

• Interest rates impact the price and demand of real estate.  Low interest rates increase the demand from homebuyers, reflecting the decrease in cost of obtaining a mortgage.  This results in an increase of home prices. 

• Government policy, such as the implementation of various tax incentives can either temporarily increase or decrease demand in the real estate market.

To make effective investment decisions for the long term success of your real estate portfolio, you must have an accurate high level understanding of the demand drivers from a macro and micro level. As policies or patterns change, we can course correct our strategy as necessary, and anticipate the next beneficial wave for opportunistic positioning. By remaining educated and nimble, we can avoid pitfalls and capture opportunities appropriately, and pass along those benefits to our investment partners.

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I attended a virtual conference the other day and witnessed something interesting. 

One individual on the call asked a leader of a large real estate investment firm about the strategy at his firm.  The conversation kept going in circles and it seemed as though each of them was genuinely trying to work out an answer.  Frustration continued to build as the person who asked the question wasn’t getting what he wanted, and the real estate leader wasn’t pleased by giving an answer in so many ways, even though he was providing very detailed responses each time.

Then it hit me.  There was a clear disconnect in what each had in mind when it came to the definition of strategy.

Some see strategy as a various list of descriptors (both qualitative and quantitative) that typically go along with an investment firm.  Others see strategy as choices an investment firm makes to win in the competitive marketplace.  Note that these are not the same, but if you provide enough details in explaining a strategy according to one of these definitions, often you answer both (just in a less organized and structured way).

Our discussion today focuses on the latter definition, using a framework developed by a famous businessman and former Dean of the business school at University of Toronto, named Roger Martin.

To establish further credibility, in 2017 Roger Martin was chosen to be at the top of the Thinkers50 list, which includes a select group of the world’s most influential management thinkers. It is believed that working under the famous Michael Porter (the one who developed Porter’s Five Forces) was one of the greatest influences on his career and life.  He has also written a number of books.  One of which we will touch on today, the bestseller, Playing to Win: How Strategy Really Works.  

But let’s get back to the disconnect that the two individuals had during the virtual conference.

I do believe the source of the problem comes from people in the industry using words interchangeably.  But perhaps the individual was testing the real estate leader for his willingness to be transparent and thoughtful in his explanation. 

With that in mind, we wanted to write to you today to provide transparent details related to our strategy in a clear structure developed by Mr. Martin. 

CF Capital’s Strategy

1. What is our winning aspiration?

• We aspire to be the best at providing property investment and asset management solutions that help investors maximize their returns by investing in high-value multifamily communities.

•  We also strive to serve our investors and place a strong emphasis on transparency, trust, commitment, leadership, stability and value, allowing us to foster long-term relationships and deliver superior rates of return.

2.  Where do we play?

• We target stabilized properties with physical and/or operational reposition opportunities that also provide stable cash flow, capital appreciation, and a margin of safety. 

• Typically, these include 100+ unit garden-style communities that are well-located, underperforming and/or value-add assets in growing areas throughout the Southeast and Midwest regions of the United States.

• These opportunities also carry characteristics of underperformance, mismanagement, and are undervalued relative to the market, yet remain under-the-radar to many other investors (due to size, unique markets, more exclusive deal sourcing networks, etc.)

  3. How will we win where we have chosen to play?

•  Our team’s experience, dedicated leadership, and best-in-class team who all pride themselves on maximizing the value of every asset we purchase with a hands-on approach.

•  Alternatively stated, our expertise in acquisitions and management will serve as a basis of providing investors with superior risk-adjusted returns while placing a premium on preserving capital.

    4. What capabilities must be in place to win?

• Superior information, analysis, and behaviors relative to our competition.

• Discipline, structure, organization, and craft, coupled with relentless and ambitious attitude that is balanced by humility/intellectual honesty and integrity.

5. What management systems are required to ensure the capabilities are in place

• Dedicating significant attention to resources, processes, and the right people.

• Resources often involve the most cost-effective and efficient systems available.

• Our process is circular and involves five components: evaluation & economic analysis; fostering best-in-class relationships; acquisition, reposition, refinance/disposition.

• The right people are partially included in the bullet point above related to process, but these are relationships, both internal and external, that are viewed as long-term partnerships.  This means any party connected to CF Capital that regularly contributes (by various frequencies) to our daily operation, and more importantly, our mission.

Summary

“A company must seek to win. If it doesn’t seek to win, it is wasting the time of its people.”

We strive to be the best at serving our investors through outperformance in our select investments in our target markets. 

These target markets offer an advantage to us because our strengths are played against our competitors’ weaknesses, and our access to properties that “fit the mold” are often overlooked and undiscovered. 

Our strengths involve combining a hands-on approach with our differentiated/regional experience, unique expertise, leadership mindset, team strength, and powerful network of partners. 

We believe our competitors do not have this same strength. 

By focusing on resources, processes, and the right people we are able to not only achieve superior information, analysis, and behaviors, but greater attitudes and disciplines.

We believe the language is quite powerful, but we want to remind you that these are statements meant to fulfill a set framework.  Regardless, we hope that this exercise of transparency provides you all with more clarity on CF Capital and our strategy, so you can decide how it aligns with your own investment objectives.   

“It is natural to want to keep your options open as long as possible, rather than closing off possibilities by making explicit choices. But it is only through making and acting on choices that you can win. Yes, clear, tough choices force your hand and confine you to a path. But they also free you to focus on what matters.”

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Over the weekend during my relaxation time (yes, believe it or not I do have relaxation time), I was flipping through my options on Netflix and came across this show, called Motel Makeover.  As you might guess, the name says it all – the show is about some unique design work done to spruce up a motel.

Out of curiosity, I turned it on.  And I almost regret doing that because it got “my wheels spinning,” with my mind going off on all sorts of tangents.  One thing led to another, and I started piecing together an idea for a blog post in my head that talks about some of the things that we do to “makeover” a multifamily property.

When I say “makeover,” I mean the type that CF Capital is involved with in apartment units – including both the “design stuff” and the “less juicy” parts of a renovation (see our post on asset repositioning and capital expenditures for more on this).

In all seriousness, the renovation process is an essential component in executing a value-add investment strategy, like ours. 

But why is it so important?

How about we start our discussion by setting the stage of the decision that precludes a renovation – the decision to buy a multifamily property that needs a renovation

Buying an Apartment Complex with Renovation in Mind

There are tradeoffs to buying an apartment that needs renovation.  Typically, these buildings are older and initially require higher costs to operate, even though the acquisition price may be “right.”  In terms of rental competition, this building may be competing in the rental market with newer, more modern properties.  This could mean you are further down on their list of priorities, and a lower demand (with increased supply) forces you to offer lower monthly rents.

However, there is great opportunity with an older apartment, and most of that relates to renovation and repositioning the asset within the submarket. 

Which brings me back to my point earlier in this post – the “makeover” process is an essential component to executing a value-add strategy.  Renovation aims to reduce the negative tradeoffs of the property investment by targeting things like appeal (increasing it) and operating costs (decreasing it).

We could even use “green” features to tackle those two tradeoffs, while highlighting it as an attractive feature in marketing. And it is no secret that this is becoming more and more important to our society today.

With that said, let’s walk through some of the more important areas that a real estate investor could focus on in a renovation process that would really drive the value creation process. 

1.     Improve the aesthetic and design

This is what people see when they walk by it and tour the property.  Impressions taken by potential renters can either make or break their desire to join your apartment community.  Here you want to update anything with a dated look that will still match the brand of the property.  Remember, you never get back your first impression, so here are some easy guidelines:

• Modern, sleek lines

• Intimate, welcoming leasing offices with modern furniture

• Updated, on-brand signage

2.     Replace on the lighting and hardware

New lighting and lighting controls should reduce energy consumption and reduce costs to operate the property.  Also, tenants enjoy the benefits of lower energy bills. With regard to hardware, appealing kitchens and bathrooms have the potential to make or break the first impression.  Try to do both because a mismatch in update-drive appeal may have a worse result.

• LED Light Bulbs, dimmers/timers, sensors for lighting 

•  Lighter colors with these items, even stone and concrete

• Touch-free and new/appealing fixtures

• Refurbished cabinets with modern cabinet hardware

• Reglazed/replaced tubs

3.     Utilize technology, including automated systems

Smart technology and building automation systems (BAS) are amazing options for both tenants and property owners.  For both parties, utilizing this should almost always reduce costs – operating costs for the property owner and energy bill costs for the tenant.  Also, energy efficient options are great to reduce maintenance costs for the property owner. 

• Smart locks

• Smart thermostats

• Energy-efficient boilers, plumbing, and windows

4.     Incorporate “green” features 

There is a reason green building strategies are so popular. They are good for the planet and the people living in your buildings. But sustainable practices reduce operating costs, too. They also appeal to renters, who feel good about their living space and are more likely to renew (and be referrers, too!). In addition to all of this, there may be additional incentives or even tax credits available for investors incorporating green features. 

• LEED certified options

• Ultra-low-flow toilets and showerheads

• Non-toxic, energy-efficient materials

 5.     Include attractive amenities

Bottom line is residents are attracted to amenities.  By adding amenities that your target resident is attracted to, you can improve and sustain occupancy levels.  Find out what other apartments in the area aren’t doing and see if it makes sense to add.  You can also discover the amenities that others enjoy at other properties.

• Natural spaces for a park-like feel

• Community spaces

• Recycling programs

• Fitness centers 

• Docking stations, WiFi, and package delivery systems

Closing Thoughts

Even doing just one or two of these during the renovation process could go a long way.  If you’re an investor, keep in mind a few things to help push you over the hump if you’re still questioning whether or not to invest in renovations.

• With the renovations, you will attract new, higher-quality tenants and retain ones that enjoy the upgrades.

• With the renovations (more so the lighting, technology, and green features), you will reduce operating expenses, and more cash will flow through to your bottom line.

•  With the renovations process, you can frontload the capital expenditures and depreciate the new assets, which will reduce your tax base and increase your cash flow.

• With the renovation process, you could be contributing to a cleaner and greener world, while also (potentially) reaping the monetary benefits by incorporating items that are energy efficient.

• When renovating an apartment community, pay special attention to how you’re financing the improvements, and how that impacts your projected returns. 

When considering an active or a passive investment, it’s always wise to thoughtfully consider the value-add strategy. One of the most important questions we ask ourselves at CF Capital is, “how might we add additional value to our residents?” This question usually leads to constructive thinking and creative business plan creation and execution. When we take care of our residents in this way, that value is returned to our investors as well. 

If you’d like to benefit from being a part of this process by investing alongside our team, reach out anytime. We welcome you to set up a call to discuss your investment goals further

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Recently, I had a conversation with another real estate investor about a purchase he made in the middle of the pandemic.  He was extremely optimistic because of its high return potential but started to notice that the property’s vacancy started to go up as soon as conditions in the pandemic started to improve. 

Why?

Tenants in that Class C apartments generally chose to live there because their relative incomes forced them to a lower rent apartment complex, and as employment prospects improved, their new income allowed for a large flight outwards.  This was accelerated by vacancies in other available, higher-class apartments. 

As he was walking through his case, explaining the numbers, and trying to figure out what went wrong, a light bulb went off in my head.  So I said to him, “It sounds like you had a lot of numbers that made the case compelling, but what qualities made it a great opportunity at the time?”

He paused and thought about it.  Then it hit him – he really did think too much about the qualities of the property.  He spent too much time focusing on the numbers. (see our post about following the numbers)

Blinded by the Numbers

Usually it comes down to being overly distracted by the compelling return numbers, so much so that the desire to get a “piece of it” overtakes the warning signs from other parts of the picture.

Either one chooses to completely ignore all other characteristics, or you choose to shrug off the potential red flags.

Being hyper-focused on the numbers and forgetting about the core drivers (or driving qualities) often leads to real estate investment failure. Getting to know the asset and the drivers of the community always impact the viability of the investment. At CF Capital, we look at multifamily communities as living, breathing entities. What’s it’s health and longevity? Is it plagued by something inherently that might cause adverse conditions relative to our projections?

The Downfalls of the Numbers Saga Continued…

The numbers are great at providing insight on the direction of the beginning of the investment story, by giving a sense of where the property has historically “been,” but will not always be accurate when it comes to anticipating about the “speed bumps” (big and small). This is where nuance insight comes into play as investors.

In other words, historical performance serves as an aid to short-term investment decisions, but those decisions may be detrimental for the long-term if investors are not careful to understand how the nuances of micro and macro economics are at play.

In fact, focusing on the numbers alone, often breeds short-term thinking and puts metaphorical blinders on many investors. It’s certainly paradoxical, because we often say “do the math and let the numbers tell you what to do,” and while that’s certainly true in many ways, as investors we must understand the probability of certain events playing out in the future of a particular real estate investment.

For example, let’s say an investor’s model and financial plan doesn’t account for enough  short-term repairs and maintenance.  When a pipe bursts and a replacement is required, the high expenses associated with the repair could deter the investor from making the right decision to buy a replacement, and instead put a proverbial bandaid on a problem that really needs surgery.  So instead the investor chooses the short-term solution and tries to cheaply fix the pipe.  This causes more and more maintenance requests over time, ending up costing the investor significantly more capital  than it would have to replace the pipe the first time.  These compounded decisions can have cascading effects on any property and ultimately severely negatively impact investment returns.

Specifically, this behavior puts a damper on cash-on-cash returns.  To say it another way, this is likely the same short-term-minded approach with many other expenses, and because of that, we already know what to expect when it comes to property performance.

Avoiding the Downfalls

This advice is really simple, and it is something that we have discussed before.

(see our posts on due diligence, underwriting, and asset management)

First, dive into the qualities of the submarket. 

Is this where you and enough other people would want to live long-term?  Is this a good location for a family?  Are there enough quality schools nearby?   Is this submarket in the path of progress of future development and growth?  

And finally, some questions that would have saved our friend, the real estate investor from earlier… what are the reasons and conditions that cause people to choose to live in the neighborhood?  How might future conditions, in various directions, impact that type of resident behavior?

Second, dive into the qualities of the property, including the physical characteristics and the renters. 

What are the current attractive property characteristics?  What tenants are attracted to the property now, and what tenants could be attracted in the future?  Will our target tenants be attracted to this property?  What potential property cost-effective characteristics could be added to attract and retain tenants? 

The list goes on and on. At CF Capital, we ask these questions and more on a daily basis when considering various prospective investments. We invite you to incorporate these considerations in your own investing, whether passively with our group or actively with your own team. 

Until next time, happy investing!

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Day after day we come across other investment firms, real estate or not, providing the public and potential investors with information that seems a bit off.  

What do we mean when we say it “seems a bit off?”

For starters, I was inspired today to write this post because I felt I had seen enough of the stretched numbers, empty opinions, and sometimes misleading information related to investment offerings.  I was scrolling through instagram for a few minutes, and came across a public advertisement by a multifamily real estate firm with a value-add 506C offering to accredited investors.  The advertisement stated a return expectation that initially felt “too good to be true.”

After clicking on the link, I was presented with additional deal information, disclosing the following: 

• an entry and exit cap rate of 3.2% over a period of 5 years;

• a current vacancy rate of 0.5%;

• a rent growth projection of 6%;

• deal financing was from a permanent fixed loan with a 65% loan-to-value (“LTV”);

• and had an expected net IRR of 21% of a Class B property based in California.  

With that information alone and with my experience in real estate, it made me wonder how does that even make sense?

Our discussion today will review this investment and its metrics, using facts and reasoning.  Let us offer you some guidance and break it down:

Cap Rate 

The 3.2% cap rate at entry and exit is below average for this type of investment, and it indicates that there is no projected change in the market from the beginning of the investment to the end. (See our post on cap rates)

THE FACTS: 

→ One of most recent National Multifamily Cap Rate reports* revealed a national average cap rate of 5.04% for multifamily across all types of investments (core, value-add, and opportunistic).  The report also revealed that the Pacific West region (where the property is located) has the lowest cap rates in the country (4.29%) with a downward trend lasting over two years.  In other words, evidence is showing us that the investment conviction is more than likely not coming from the cap rate.

→ The formula for cap rate is Net Operating Income (“NOI”) divided by the property value.  If the cap rate does not change it means that, based on the formula alone, your: 

1) NOI (i.e. cash flow) and property will not change; or 

2) the NOI and property value increase or decrease just enough to offset each other; or 

3) the property value will decrease enough so that any increase in NOI is offset; or 

4) the NOI will decrease enough so that any increase in property value is offset. 

All of these scenarios are entirely possible, and does not necessarily need to be a cause for concern; it could even just reflect conservative underwriting. However, when you take into account the other factors and the stated expected return, it might be something you need to look deeper into.

Vacancy Rate

A current vacancy rate of 0.5% is lower than average.  So that’s good right?  It could be, especially for projected cash flow stability.  But when you are looking for factors to justify a higher-than-average expected return for a value-add property, you might want to see that some “value” is going to be added by improving key investment drivers, like vacancy.  (see our post on vacancy underwriting)

THE FACTS:

→  One of the most recent reports on US Multifamily Figures** and statistics showed the national average for vacancy rates was 4.0% across all multifamily property types.  Class B properties had a vacancy rate of 3.5% and the relevant submarket in California had a vacancy rate of 2.3%.  There was a very large drop in vacancy last quarter for the first time, which could indicate the beginning of a trending improvement, but with fluctuating rates and no real evidence of a continued trend, we will not assume that this is a return driver.  Besides, a path from 0.5% vacancy to an absolute best-case scenario of 0.0% would probably not be enough to drive the projected investment returns.

We could continue to talk about rent growth, financing and LTV, as well as the IRR number, but I think you get where we are going with this.

CF Capital Philosophy & Closing Thoughts

As investors, we do not speculate.  While there are always elements of the unknown in any investment, we focus on what we know, and what facts we can gather to build (or not build) a case.

We would also like to think that we know ourselves.  We are a firm driven by integrity, purpose, excellence, and leadership.  We know that we wouldn’t have started CF Capital with four core values if we knew we couldn’t look people in the eye everyday and tell them we are sticking to those values through thick and thin.  We burn the midnight oil regularly and even lose sleep at night because we want to make sure we do our absolute best to serve our current (and future) partners.

The CF Capital team will always aim to provide you with solid reasoning, backed by as many facts as possible, and will do everything in our power to make sure you are as fully informed as possible.  Among other reasons, that is why we write blog posts like this one - it feeds our purpose.

It might seem odd, but we would be quite happy (and feed our purpose) if just one of our readers approached us and started to interrogate us on our past and future deals, using discussion points reviewed in today’s post.

Before we bring the discussion to a close, we would like to reiterate that we are always here for you.  

We want to be your resource, even if you want to talk about an investment opportunity that is not offered by us.  We would gladly help you find clarity through the facts and the evidence out there in this world.  Let’s elevate communities together!

As always, feel free to reach out to us anytime.

Relevant ELEVATE podcasts:

• Episode 159 Barbara Oakley - Learning How to Learn Effectively

• Episode 148 - Elevate Exclusive with Tyler - The Resourcefulness Mindset

• Episode 123 - Leveraging the Drivers of Success with Renowned Wall Street Housing Analyst Ivy Zelman

• Episode 51 - Shifting Your Focus From Getting to Giving with Bestselling Co-Author Bob Burg

Recommended Books Related to this Post:

• How to Make Sense of Any Mess: Information Architecture for Everybody by Abby Covert

• Devil Take the Hindmost: a History of Financial Speculation by Edward Chancellor

• Streetlights and Shadows: Searching for the Keys to Adaptive Decision Making by Gary Klein

*https://www.cbre.com/united%20states/real-estate-services/directory/valuation-and-advisory-services/valuation-cap-rate-reports/articles/us-multifamily-cap-rate-report

**https://www.cbre.us/research-and-reports/US-Multifamily-Figures-Q2-2021

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