You have likely noticed the skyrocketing prices and “values” of real estate. Whether it is your personal single-family, your portfolio of rentals, or the multifamily asset class, especially in hot markets, things are through the roof.

There are two schools of thoughts on how to navigate this situation. Some advise to sit out and not invest because things are too hot. Others keep investing and buying apartments to take advantage of this activity and demand for this asset class. I believe that the proper way to proceed is directly in the middle: continuing to buy multifamily real estate but doing so with fundamentals so that you are protected against any market cycle.

Greater Fool

There is a term that describes the madness from buying high and hoping to sell higher. It is referred to as “Greater Fool Theory.” The idea is that there is always a greater fool who will pay a higher price – that is, until things change. This happens in every recession and in each bubble. So how does one participate in multifamily with confidence that they will not be the greater fool? Buy with fundamentals.

Housing Demand

First of all, regardless of what happens in the economy, people will always need a place to live and there is a shortage of housing to the national need. According to the national census, the US is short more than 5 million homes. The inherent demand and scarcity of real estate makes it an asset class worth paying attention to. Now, investors just need to buy right!

How To Buy Right

In an earlier post, I talked about conservative underwriting, and I will add a few new thoughts here. Commercial real estate is valued based on net operating income, which means when a firm buys with the opportunity to improve the performance of these assets, they grow value. Unfortunately today, many firms are buying with little opportunity to truly improve income; they are betting that they can simply ‘push rents’ based on where the market could be next year.

The best protected investments are those that are significantly undervalued at the time of acquisition. These include the following:

Current rents well below current market levels
High-vacancy with opportunities to improve occupancy
Abnormally high expense ratio
Sub-par property management
Poor property image
Asset located in path-to progress

Because of the competitiveness in today’s market, it is more difficult to find these opportunities, but they exist and astute active and passive investors should wait for these deals. There will come a time when things slow and those firms and investors who thought they could simply push rents may have a tough time meeting their return targets.

Passive Investors

If you are risk averse like me, you want a built-in margin in your investment, one that secures your investment capital and creates realistic targets for your returns based on a realistic business plan.

If you have not already, download our free Passive Investor Startup Guide and schedule your call with us to find out more about our investment strategy and criteria and if passive investing in multifamily is right for you.

Safe Investing!

RRII