The 2018 IMN Middle Market Multifamily Forum for small and mid-sized owners and developers addressed a number of different investment strategies, best practices and trends within the multifamily real estate market.
A panel moderated by Berdon LLP Tax Partner Meyer Mintz, CPA, J.D., LL.M., addressed a number of complex issues related to middle market investing, such as whether or not investors can still count on appreciation to bolster returns and which strategy—cash flow or appreciation—makes sense in the current investment climate of rising interest rates.
Tackling these issues was a distinguished group of executives involved with middle market investing across the country who shared their insights on the latest market trends as well as their analyses of the current real estate landscape.
Joining Mintz on the panel were:
Berdon LLP’s Meyer Mintz kicked off the panel by asking, “when you underwrite a deal, do you look at value, cash flow, or both?”
Cash Flow vs. Appreciation: NYC Metro and Beyond
Institutional Property Advisors’ Peter Von Der Ahe, a broker conducting deals in the middle market, multifamily space in New York City, said that most of what his company underwrites falls into two categories—core and core plus. “The strategies are different because,” said Von Der Ahe, “in one, you're looking for selling at a cash flow stream which is for today, and in the other category, you're selling an upside which is for tomorrow. The whole methodology of the underwriting is really different between both of them.”
Von Der Ahe also noted that, in the New York City Metro Area, most of the profit that investors have made “has all come from appreciation,” adding that, “if you look at the lifecycle of the investment, maybe 80% of it is coming from the appreciation versus cash flow.”
With that said, Von Der Ahe foresees possible market adjustments owning to the Trump Administration and “other influences that may be upon us in terms of inflation and interest rates.” As a result, he added that the mindset of the investment community is shifting, with an increased emphasis placed on cash flow because the market is cycling out of an “appreciation swing.”
Shifting the discussion beyond the New York City Metro Area, Cedar Grove Capital’s Aaron Groin, whose firm invests in multifamily assets located primarily in the Mid-Atlantic and Southeast, cited Nashville as an example of where “it's very hard to find a lot of product that trades at a high cap rate. It's cash flows, so a lot of the value in that kind of a market is being a pull forward for appreciation.”
PIA Group’s Danny Katten said that for his firm, which invests in multifamily units in South Florida, “the key metric” is how much of an investor’s Internal Rate of Return is made by cash flow and how much by speculation. “The biggest thing you can do to avoid risk,” said Katten, “is have cash flow.”
Toro Real Estate Partners’ John Cohen took a somewhat different view, admitting that his firm has “a contrarian view.”
The Test of Time
“We’re okay with not having the cash flow, per se, in year one,” said Cohen, “but we want to get to a point where pretty quickly in the first year or two we can get to a very fair market value.” Cohen explained that his firm achieves a fair market value by adjusting rents and addressing pre-existing problems with the property to increase occupancy.
Von Der Ahe also addressed the issue of timing, explaining that whether his company buys for cash flow or appreciation depends largely upon the current place in the product lifecycle. He added that investors often ask “what inning are we in” to determine which strategy is best.
Barriers to Entry
While the stage of a product lifecycle plays an important part of such a decision, Gomel Capital Partners’ Aaron Weisman also observed that barriers to entry play an equally important role in whether to buy for cash flow or for appreciation.
Some barriers, as in the Austin, TX market, are geological. Weisman pointed out that in Austin, “you can't actually build new product outside of a certain geography because the soil will not sustain the new buildings.” As a result, he added “demand is going to be high, [and] it may be increasing, but your supply is fixed.”
And sometimes, the government serves as a barrier to entry. Weisman cited Toronto as an example where the municipal government has to sign off on all new building permits. He explained how when looking at cash flow versus appreciation in a market with fixed or limited supply, “you think okay, if I own a nice building in some market where they don’t have to let anyone else build into it, it's probably going to appreciate.”
Investment Factors to Consider
The panel closed with a Q&A session where it turned its attention to what aspects of properties the panelists, as investors, find interesting and what prospective investors should look for.
Cohen advised that prospective investors should ask themselves questions regarding whether they want to have to work to keep expenses down and if they are willing to self-manage or hire a property manager. “I think it's very tied,” concluded Cohen, “to how much drama you want to have personally in managing those things.”
Katten urged investors to also consider the concepts that can be controlled against the ones that cannot.
“Taxes and insurance,” said Katten, “you cannot control. A hurricane comes and then your insurance goes 10% higher.” He suggested that investors “concentrate on the controllable and uncontrollable expenses,” adding that real estate investors should “brace for the uncontrollable.”