As a provider of joint venture and general partner equity, real estate investment firm RanchHarbor has been seeing an influx lately of multifamily investment opportunities presented by sponsors as value-add. However, upon a closer look at theunderwriting, these deals do not actually fit the typical value-addinvestment profile, says Adam Deermount, co-founder and managing director of the company. Instead, these opportunities end upbeing cap rate compression plays under the guise of value-add andare priced to perfection in today’s market. “Most of the return oninvestment is generated by rent inflation buoyed in the early yearsof the investment by positive debt service arbitrage due to interestonly terms,” Deermount says.
Now here’s the rub: If a value-add opportunity requires market
annual rent growth of 3% over annual expense growth of 2% to 3%
over a five-year hold for the returns to work, it is not a really a value-
add deal. ”True value-add plays have renovation or management or
leasing risks so the increase in value from those activities should be
enough to achieve returns in order to justify the risk on a shorter-
This is particularly important in this current environment where
net operating income growth in major urban markets is likely to
see headwinds due to urban flight, a lack of affordability and a
recessionary economy, Deermount says.
The bottom line, he says, is that market appreciation plays with-
out rent growth is a rather dangerous way to play the market if cap
rates do not contract and rental growth stagnates.
Six months ago in the pre-pandemic world, concerns aboutrental growth stagnation for the multifamily asset class would havebeen laughable. Even perhaps three or four months ago, in thebeginning of the spread of COVID- 19, multifamily properties wereholding their own.
More recently, a slightly different picture has emerged. First,though, make no mistake: apartments as a long-term play are seenas a solid bet. But as the uncertainties and economic vulnerabilitiesintroduced by the pandemic mount, cracks are beginning toemerge in what was once an almost unassailable asset class.
Let’s start at the beginning. Renters are finding it increasingly difficult to pay their monthly obligations. The most recent data fromthe National Multifamily Housing Council, which measures thenumber of apartment households that make a full or partial rentpayment, shows a drop of 2.4%—or 279,457 households—year-over-year, as well as a monthly decline. According to the NMHCTracker, 86.2% of apartment households made a full or partial rentpayment by September 13, compared to 86.9% that paid by August
13 of this year.
“While it remains clear that many apartment residents con
AN UNASSAILABLEASSET CLASSDEVELOPS SOMECRACKS
THE MULTIFAMILY ASSET CLASS ISSTILL A STRONG PERFORMER BUTTHE PANDEMIC IS HAVING AN IMPACT.
BY ERIKA MORPHY