June 22, 2016

Einstein’s lesson on Real Estate!

Posted in Keith Knutsson, Real Estate at 5:51 am by Keith Knutsson

The debate of its veracity aside, Albert Einstein reportedly said, in some variation or another, that “the most powerful force in the universe is compound interest.” It is unimportant whether he actually said it. What is important is that we believe that the most important figure in physics and mathematics who ever lived actually believed it. It is also important because it is an obvious truth, and like gravity, we take it for granted.

Real estate developers and investors, the financiers who leverage them, or your pension fund that invests in real estate, all live by this fundamental rule. It is far better to earn a consistent 3 percent per year with no reversals against the principal than to have a volatile real estate investment return pattern gaining 10 percent in years one to three, and then losing 5 percent per year for the next three years. A single dollar invested in 2016 that returns 3 percent for six years results in a return of and on your money of $1.19. The same dollar growing 10 percent for three years and losing 4 percent for three years returns $1.17. These spreads on volatility get much wider in 20- and 30-year periods.

So when we look at the increasing purchase prices of rental apartment buildings, we see that they’re expensive — particularly because there are many that are being built. This could lead to declines in rent and higher vacancies, both affecting the net amount an investor receives in net operating income. And yet the major multifamily complexes around South Florida continue to be acquired at ever-higher prices.

The market is thinking about Einstein:

The investment market in commercial real estate assets, whether they are multifamily rental complexes, hotels, office buildings or shopping centers, are investing to generate net income after expenses. Their overall investment returns (yields) are derived from the net income they receive annually (from tenant rents) plus the price for which they ultimately sell the building.

But when the economic outlook is weakening, hotel revenues from leisure and business travel, and retail rental income, all driven by discretionary spending, become more suspect. When the investment market senses economic weakness or desires a flight to safety, investors flock to multifamily assets.

In many ways, this investment strategy is rooted in the cultural and social changes of the past 50 years. Our habits and changes in the workplace affect office utilization; our changing spending patterns and acceptance of online marketplaces are changing retail habits; and our worldwide logistics systems are changing industrial utilization patterns. What has not changed fundamentally is where and how we live — as my grandpa’s old friend Myron Cohen used to say, “Everybody has to be somewhere” — except that in the decades ahead, more people will live in urbanized areas.

In looking forward into 2017, there remains a fair degree of concern regarding the level of multifamily rental supply under construction in South Florida. The supply pipeline is a reaction to the growth in rents, coupled with a period of pent-up demand when almost no construction was present (2009-11). The federal government spurred multifamily investment and housing construction with U.S. Department of Housing and Urban Development financing programs offering longer loan terms and fixed interest rate financing. To compete, the banks have been more aggressive in multifamily lending, particularly on new construction. All of these factors are focusing cheap capital toward new multifamily construction.

But this upcoming pipeline of multifamily rental complexes is part of the key to the stability of multifamily generally. In Miami-Dade, Class A multifamily (the newest, most luxurious rental complexes) has experienced rent growth over 4 percent for three years running. Vacancies in the Class B product are below 4 percent, so Class B prices (second-tier rental products that are 10-20 years old) will continue to rise, lifting demand for new Class A product. While new supply may force Class A vacancy higher (which in fact it did in 2015 and 2016), slowing rent growth to 2 percent to 3 percent has been the success and stability of the multifamily investment class for decades. The new product tends to match better the tastes and lifestyles of the new generation of renters, and over a 10- to 20-year investment cycle, the sector outperforms with steady 2 percent to 3 percent average annual investment growth.

I’ve been through four major investment cycles in my career, including the one that saw the U.S.-owned Resolution Trust Corp. liquidate real estate assets in the early 1990s, and the only people I ever knew who ever lost money in multifamily investments were those who over-leveraged themselves with too much bank debt or who unsuccessfully tried to convert their 1970s apartment complex into condominiums only to get 30 percent sold out and lose the property to their debtors.

On the whole, multifamily investment that is not over-leveraged compounds geometrically. This applies to four- and eight-unit apartment complexes as easily as 300-unit complexes. The only difference is the amount of the initial investment that compounds.

So let’s not lament the multifamily pipeline as an evil harbinger of doom and destruction. This is not to say that every developer should take their condominium plan and convert to rentals next week. But under current economic conditions, watch the multifamily landscape in the coming 12 months. It speaks volumes about where the market sees the economy heading.

Whether he said it or not, my money is on Einstein and low-debt multifamily investments heading into 2017.

ANTHONY M. GRAZIANO IS SENIOR MANAGING DIRECTOR FOR INTEGRA REALTY RESOURCES — MIAMI/PALM BEACH, BASED IN CORAL GABLES. HE HAS BEEN INVOLVED IN THE REAL ESTATE FIELD SINCE 1986. HE CAN BE REACHED AT AMGRAZIANO@IRR.COM AND WWW.IRR.COM.

S. FLORIDA MULTIFAMILY RENT GROWTH, BY PROPERTY CLASS.

The percentages represent year-over-year average rent growth in Class A (the newest, most luxurious rental complexes) and Class B (second-tier rental products that are 10-20 years old) in Miami-Dade and Broward counties.

 Einstein’s lesson on Real Estate!

Source: http://www.miamiherald.com/news/business/real-estate-news/article84505057.html

Know more about the real estate advisor – Keith Knutsson:

http://www.integraleadvisors.com/

https://keithknutsson.wordpress.com/

https://www.xing.com/profile/Keith_Knutsson

keithknutsson.tumblr.com/

www.slideshare.net/keithknutsson/keith-knutssons-affiliation

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