The Pandemic’s Impact on Multifamily Investing

September 10, 2020

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In this installment of Breaking Ground, Darren Griffith, a Director in EisnerAmper’s Real Estate Services Group, interviews Michael Cohan, Managing Partner of Opus North, a multifamily real estate investment company. Acquisitions, valuations and investor relations are the focus of the discussion, as Darren and Michael explore how multifamily investors have seen these factors impacted by COVID -19.


Transcript

Darren Griffith: Hello, and welcome to Breaking Ground, Real Estate Insights from EisnerAmper I'm your host today Darren Griffith, a director at EisnerAmper. With us today is Michael Cohan, managing partner at Opus North Real Estate. Opus North specializes in acquisition and management of multifamily properties in the U.S. During today's episode, we'll be discussing the challenges of today's environment for GPs and LPs, as well as investment strategies and how they have been impacted. Michael, thank you again for joining me today for today's podcast.
Michael Cohan: It's my pleasure, Darren. Thanks for having me.

DG: No problem. So obviously COVID has had a tremendous impact on investors. A lot of the people that I talk to have been playing defense, and obviously there are also some opportunities that are arising. What are you guys doing at Opus North? What steps have you taken to one, protect your portfolio, and two, what opportunities do you see arising in the next few months?
MC: Sure. So we've focused pretty in depth across our portfolio on managing occupancy and cash flow and making sure that we're keeping “heads in beds.” The majority of our portfolio is garden-style multifamily, and as opposed to pushing rents and looking to hold out for every last dime, we've been very focused on keeping people in place, signing renewals, where we're able to. Making sure that our residents are happy and also having full, open, and transparent conversations with our partners, our vendors, and all our other stakeholders to let them know what's going on and not hide from the truth. And make sure that our balance sheets are well-positioned to ride through this cycle and the next cycle to come.

And we've done that by building additional reserves at properties, holding back extra cash on a monthly basis. And then I would say that we've been able to ride out the storm pretty well because we're not over levered anywhere. And that has definitely served us very well through this economic cycle.
DG:Great. And then I guess the second part of that question is have you seen any opportunities or when do you see some opportunities arising that you might be able to take advantage of on the acquisition side of the business?
MC: Sure. We're not yet seeing the steal deals that I think a lot of folks in our business are looking for and then hoping that they're going to find. We've seen discounts anywhere from 2% to 5% for well-located products and high-growth secondary markets, which is where we focus the most of our time.

We've seen some discounts a little bit higher than that, because they tend to be in more tertiary locations. I think there's a couple of competing factors out there that are contributing to that, one being that the debt markets are pricing so cheap right now that it's enabling people to buy deals with tighter cap rates.

So oftentimes we're actually seeing deals, pricing north of where they were pricing pre-COVID on a cap rate basis. And we're not seeing the steal deals yet, but I think that real estate takes longer to process all of the information that's out there. And we do believe there are going to be more opportunities down the road, but we also believe that people are better capitalized now than they were in 2008, and we think that that is contributing to a lot of people having stronger balance sheets and being in a better position to ride through the cycle, which, in turn, is not creating a lot of fire sale opportunities out in the market.
DG: I 100% agree with what you're saying. When we talk about the beginning part of COVID-19, and when we were trying to digest everything back in April, I think a lot of GPs were saying that new investors and deal origination as a part of their business was most effected by the pandemic. But three months later, are you seeing those same issues? I know you talk to cash flow, and I know you talk to a much better overall financial position, whether it's the debt or equity markets, are you seeing those things as severe? And then on the back end of that, is it possible to raise and deploy capital effectively in the era of social distancing? I'm sure your acquisition processes are taking a little bit of a different form at this point.
MC: I think it's harder to get deals to stick today. I think that to get things through, investment committees are requiring a lot more check-the-box than they did previously. And I think if there were seven out of 10 boxes that an investor had to check previously, there's probably nine to nine-and-a-half boxes that they have to check to get comfortable with the deal today. And I think we've also seen that there are some very large institutional equity providers in our business that are not deploying as much capital in garden style, multi as they were prior. And maybe they're rotating into other sectors. So I think we're seeing that as well, but there are good opportunities. Earlier today, right before we got on this podcast, we just signed a contract to buy a town home deal in Raleigh.

And that was, or is, an opportunity that we were able to find off market and put together that we feel really good about. And we think the downside protection is really good, and we think the fundamentals are good. Is our underwriting more stringent today? Definitely. But we do think there are opportunities out there. There's just not as many. I think you have to work harder than ever to find them. And then, even when you do find them today going from finding them to closing them, there's just more moving parts with the geopolitical climate, the economic climate, and coronavirus and all the other competing factors that are making you think about additional things that you didn't necessarily think as hard about 15 weeks ago.
DG:Of course. And obviously the whole acquisition aspect of things and you being under contract with that deal on Raleigh leads to the next question, which we didn't talk about beforehand. How are you changing your underwriting in order to account for COVID? When you're modeling out these deals, are you increasing your vacancy rate? Are you dropping down your growth rate? How are you and your firm, or if you can give me some insight into that, how are you guys going about trying to underwrite what the future might look like?
MC: So we've definitely dialed back our rent gross significantly. We're modeling zero to negative rent growth in the first year. We're maybe modeling zero or 1% in the second year. And then we're starting to grow back to 2% thereafter, and we think the days of 3% rent growth are over for now. We think those are going to be pretty tough to achieve. We're also extremely sensitive to major value add execution right now. The days of pumping in $10,000 a unit and automatically getting $175 rent premium are most likely over. And we do believe there could be diamonds in the rough, but we think those are very difficult to find today. And often we're finding that even if you can find those deals, when we run our downside scenarios, if we don't hit our value add, and the returns are really weak, we don't think they're solid on a risk adjusted basis.

So we're definitely a lot more conservative, but I do think that there are some people out there that if you're just going to take the approach, you're going to be conservative for the next five to seven years out. Well, then you're never going to be able to find a deal that works, and you're never going to be able to make a deal work. So there's definitely still risk taking involved, but we believe that it's calculated risk and we're focusing our acquisitions in locations that we believe are as close to bulletproof as possible and in locations that are well-diversified, and have median household incomes an excess of $70,000 a year. There's no one sector that makes up more than 20% of the economy. There's a heavy presence of education, technology, medicine, industries that we believe are going to be a growing concern on the other side of COVID.
DG:That's great. Now, before on one of the prior questions, you touched on some of the markets that you look to invest in, maybe your secondary or tertiary markets. I think there's been a lot of movement. Can you give me your perspective on it as well? A lot of movement outside of some of your primary or more densely populated areas. Now that there's been some movement toward secondary and tertiary cities, have more GPs and more LPs been targeting those areas a little bit more? Have they driven up competition, and should the big city investors be worried? And are there ways to kind of mitigate that risk?
MC: I think we're definitely seeing a significant amount of capital chase into secondary and tertiary markets because everyone, the end of the day, is looking to generate yield. How much yield is always, I guess, the million dollar question. But we're definitely seeing more competition than ever, I believe, in new secondary markets. The proof is in the pudding that people are leaving gateway cities, and the cost of living is better in these secondary markets.

Although I do think there is a distinction between secondary and tertiary, I think the really strong secondary markets are attracting very large institutional players who are putting hundreds of millions of dollars to work in individual sub-markets. But I do think as you go more tertiary outside what I call the major secondary markets (e.g., the Atlantas, the Charlottes, Raleighs, and Orlandos of the world.

As you go to some of the smaller towns, I think you have to be really cautious about where you're investing today. How many people are unemployed there? Do industries there make a comeback from COVID? Is there a major industry there, something that can sustain more pain from COVID because no one really knows how long this is going to last? And when are we going to have the vaccine and what does that future look like? So we are very cautious about going to two tertiary locations where the job base isn’t strong enough to sustain another year of economic pain. Or, maybe, some people are going to survive, but maybe occupancy at these buildings are going to go to 80%. And considering that multifamily has been trading in a pretty tight cap rate across the country, oftentimes sub-five cap in most good locations today. There's not a ton of room to lose a large portion of your rent roll or not be able to collect rent.
DG:The margins are tight when you're talking about those valuations of course. So I agree with you. I think those are those tertiary markets are going to be … if you don't understand those very well, it's definitely not a place to go in there and start something new.
MC: There can be unique opportunities in tertiary markets. We just feel that you have to really get paid to go there. So, if we're solving for 12 to 13 IRRs and 6% to 7% on our cash and what I refer to as major secondary markets, we believe that you have to get paid another 300 to 400 days at this point to go to these tertiary markets, and we get very scared off when pricing in the tertiary market is the same as buying in core Charlotte or core Raleigh.
DG:Distress funds are a popular strategy that LPs are targeting. Do you think a run on distress assets is inevitable, and how far away are we before the market starts to heat up? Have you seen more on the debt or equity side being made available?
MC: I think there are going to be opportunities, I just don't think we're seeing them yet. I think there are a number of bridge lenders who are looking for these opportunities and very large institutional players who are raising capital to chase after this. The question ultimately will be is how long does it take for these opportunities to surface? And I alluded to before that, I think people are better capitalized today than they were in 2008. And based off what we're seeing to date, I'm not convinced that there is going to be an abundance of these opportunities out there. But I think that there are definitely groups that are going to be very well-positioned to chase them, and people who made big money in this space in ‘08 and understand the nuances of taking on a distressed project will be very well-positioned to do it again here. Although I'm not convinced that the discounts will be as big as they were at that time. However, if COVID continues on and unemployment benefits slow and stimulus slows, that could definitely be a big challenge for distressed investors.
DG: That makes sense. A big play of what I've seen is a lot of what COVID has done, not just in real estate, but in other arenas as well has accelerated a lot of things. And I've seen a lot of people looking more and more into some level of technology, and technology can be used to keep in touch with your investors--and with your tenants. And it also could be on an operational sense. What kind of technology have you seen out there? Have you and your firm, Opus North, been implementing any technologies to help you with some level of efficiency, whether it's communication or operational efficiencies?
MC: We use a variety of technology platforms, either internally or through our management companies. I'm just going to talk broadly about this. I think there's a number of good platforms out there. And I think that speed and efficiency and being able to measure performance are more important than ever. And our management companies have been very good at this in keeping track of data in real time and looking at trends on T3 or T12 in a forward-looking basis. And we rely on that trend data to make decisions. And also we rely on our portfolio data to help us make judgments on what we believe trends are going to look like in new acquisitions. Back to my point before, it's very easy to sit behind your model and say, you're just going to grow rents 3% a year.

But meanwhile, we own a net market and we own 1,000 units or 1,500 units in that market. And we see that we're not growing rent at 3% at any of our buildings. Well, it's not really prudent to underrate that 3% market rent growth anymore. And so I would say that we rely very heavily on the real-time data that our management partners provide to us and that we use to feed internal decision making. And I think that it's more important than ever.

And then when you combine that with the fact that all of these deals create a very tight cap rates, the ability to take data and make decisions off of it and have real-time insight is just incredibly valuable. I think we're living in a world where if you're looking at data that's three months old and then you're not making the use of all the technology that's out there, that can feed you that real-time information, you're just going to be completely unable.
DG:Michael, I'd like to thank you for taking the time to share this valuable information with us. And thanks to our listeners for tuning into Breaking Ground. Join us for our next podcast episode or visit EisnerAmper.com/RE for more Real Estate news.

About Darren Griffith

Darren’s experience includes real estate private equity, financing, acquisitions and dispositions, marketing, leasing, underwriting, asset management, property management, real estate risk management and business consulting.


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