How to Invest in a Recession

March 14, 2023

How do you maintain a steady course in your multifamily real estate investments if you are uncertain what the future holds? Here are my 3.14 tips, it is Pi day after all.

From today's Seeking Alpha article:

Investors await the?latest inflation data, which will be released later in the day, for clues on the Federal Reserve's future monetary policy and progress so far on the disinflation process. February consumer prices are expected to rise 0.4% M/M and 6% Y/Y, which would mark the smallest increase since October 2021.

Bigger picture:?Markets are now pricing in a 73.1% chance of a 25-bp hike at the Fed meeting next week, and 26.9% probability of no hike at all, according to the CME FedWatch?Tool. Just a week earlier, markets were seeing a 69.8% chance of a 50-bp hike and 30.2% probability of a 25-bp hike.?The shift in expectations comes amid a moderating?job growth rate?and contagion fears over recent failures in the banking sector.

SA commentary:?Investors should pay particular attention to the number for CPI services, excluding housing, said SA contributor?James Kostohryz. "Under current conditions of distress in the U.S. banking system, if the CPI numbers come in higher than expected, the Fed would be placed in an extremely difficult predicament," he said.

Outlook:?In his?testimony to Congress, Powell said no decision was made on the pace of rate hikes at next week's meeting as Fed officials await more economic data to see if inflation was nearing its 2% target.?UBS economist Jonathan Pingle said if the latest CPI report restores confidence in inflation's downward trajectory, the Fed will deliver a 25-bp hike.?

My Take:

The news can scare you. Don't let it. I will say that this period in history is similar in some ways to what happened in the last recession and in other ways, it is different.

I was invested in traditional equities until 2007 when a large shareholder of one of my stock positions decided to take profits and sold their shares. The price of my stock dropped 30% overnight. There was no fundamental difference in the performance of the company the day before to the day after this happened. I vowed that no other large company would be ever able to determine the value of one my investments ever again. Thus began my journey in real estate investing. I began in 2008 before the global financial crisis and I am still investing today. Through the recessions of 2008 and 2009, I had to buy several of my properties all cash, including a 42-unit multifamily property in Austin, Texas. We weren't able to secure financing on any property until two years later. Surviving through those two years and the challenges that came after have equipped me to navigate through the next decade of real estate of investing.

The Environment Today vs. The Great Recession

The constriction of the money supply is real, but it isn't as bad as 2008 and 2009. Government agencies are capable and willing to step in. Multifamily housing is a $3 trillion industry and it is 14% of the US GDP. Since multifamily housing is the only commercial real estate asset class that can be backed by a governmental agency, it is their responsibility to ensure its success. Bridge lenders were the primary source of multifamily lending in recent years. An increasing trend that started in 2014, began to pick up steam in 2017 and in 2020 when Fannie and Freddie stopped lending all together for a period of time, it exploded for the last three years. Today it is limited, because the interest rates aren't feasible. Bridge loans are short-term, variable interest loans. A good portion of the current multifamily mortgages are bridge loans and they are coming due. The total volume of multifamily mortgages in the last several years is enormous. In 2019, there were $364 billion in multifamily mortgages issued, in 2020 $359 billion and in 2021 $487 billion. Since, a majority of these loans are bridge loans, they are maturing. With that amount of mortgages maturing soon, there will be plenty of investment opportunities. Especially, if the mortgages were given to inexperienced operators, because they cannot refinance given today's rates or sell because the assets are valued less today than when they purchased it.

The job market is better than it was 15 years ago. Our unemployment rate and job market doesn't make sense, but it is what it is. Our economy wants to continue to grow. We have so much work to do since we were on a shut down from CoVID, that it is just now busting at the seams to push forward. By the way, did you know that yesterday was our 3 year anniversary? March 13, 2020 was when CoVID was announced as a pandemic in the US.

There is a ton more inventory now than there was in '08. For context, in 2015 in the US there were 30.5 million multifamily units and in 2023 there will be 155.5 million units. The decade following 2008 has been dubbed "The Rise of the Renter." 34% of the US population rents. And with current demand, the US needs between 4 million and 5 million new units by 2030. The amount of new multifamily builds accomplished for the last 8 years have been around 400,000 - 450,000 units per year, at this pace, we will still be short 1.4 million units by 2030. We can't catch up unless something miraculous happens in the supply chain, cost structures, or construction technology.

My Advice

Now that you are armed with this information, it should help you understand my 3.14 tips.

1. Find cash quickly. (It is the reason I started a multifamily fund.) There is opportunity coming. It is actually already here, if you are connected to the right people. I am working on three property restructuring deals right now and I am looking at buying properties pre-foreclosure or from the bank. In 2010, we bought our first multifamily property out of foreclosure. The process was not for the faint of heart, but can be done. With bridge loans maturing and inexperienced operators not able to refinance or sell, some will be forced to just walk away. No joke, Blackstone (yeah them, the biggest real estate investor out there) just walked away from an office property, and gave the lender the asset.

2. Get plugged into the multifamily brokers who work with lenders. Network to find them. They usually don't advertise. Ask around. These are the brokers you need to know. And the easiest way to find them is if they have been a broker for more than 15 years. Filter from there.

3. Build your team. And it is different than you think it is.

Lenders: The lenders that you have been using in the past won't want to touch the distressed or opportunistic deals that you will find. In the last five years, inexperienced mortgage brokers have flooded the market due to the low barriers for entry into the industry. They can't help you, and even if they could, they don't know how to best help you.

The past 5 - 8 years has the been the era of the bridge lender. That is no longer the case. It is now the era of the mezz lender. There will be assumptions, but they will be difficult because the appraisal will be lower than when the seller acquired it. You will have to make up the difference. Additionally, if you do purchase an asset that will qualify for a new loan from Fannie or Freddie, they are only loaning up to 55-60% leverage in most cases. A mezz or pref loan on top of that will be extremely helpful to get deals done.

Attorneys: Your real estate attorney is not who I am talking about. You will need to employ corporate attorneys more, if you choose to buy out partnerships or do any recapitalizations. With the shift in deal structures, the typical syndication attorneys you've been using might not be used to the deals you are going to be presenting to them today.

Property Management: The property management teams who have been dealing with assets that haven't had to face this kind of crisis management won't know what hit them. This is a challenging time in multifamily. In addition to dealing with this challenge, there is an ongoing property management crisis in this country. It is the one thing that people are continuing to sweep under the rug. Finding good property management companies is no longer just a problem, it is a full-scale crisis. Lots of property management companies are also trying to consolidate operations into a centralized model. This will also create havoc to the sites while that transition happens. It is a necessary step to survive the current conditions, but the transition will be difficult over the next 5-10 years.

Asset Management: I promise I will only be on my soap box for the next few sentences. ASSET MANAGEMENT IS NOT PROPERTY MANAGEMENT. It is a distinct and necessary role that property management doesn't cover and it is the missing link for the inexperienced operators who are now failing. Ok, I'm off. Your asset management teams will now need to navigate through the exponential rise in property insurance costs, new liquidity requirements by lenders, the property management crisis, investor relations requirements, and host of other challenges as we move forward.

Acquisitions: Your acquisitions teams will think that there is nothing out there - (total BS, but they just haven't had time to figure it out yet). You have to find properties differently. You can't just wait for a broker blast, scroll on Crexi or LoopNet. Good news is that we have had this competitive environment for awhile and it has been honing your acquisition teams to hunt strategically. Now they just need to look in different places. Do not sit on the sidelines with the rest of the investors who are too scared to take a chance on a distressed property. There are a lot of people who are waiting. Why would you wait with them? So when it's safe you can just compete with all of them later? You need to get in now when there are less interested or unable parties, or you can wait and I'll buy all the good assets now.

In summary, the all of the team members you need now, must have at least 15 years of experience or you are putting your investment at greater risk.

.14 The last bonus tip I have for you. If you feel like you do not have time or you are just getting started, instead of trying to figure this out all on your own, you can partner with us. We have several properties that you can invest in where you can benefit from our expertise. Please visit our website, tm1properties.com.