Multifamily pricing insanity - Broker input appreciated
I need some serious help understanding what's happening with multifamily pricing right now. 

I'm looking at multifamily assets, generally class b or c, 80s-2000s product. Things in that 40-60 year vintage would traditionally trade at 6.5-7 caps, but were even high 5/low 6 as recently as 2017. 

Now I'm seeing similar assets with asking prices "pro forma high 4 low 5". For B-C product. How do you make that work? Borrow money at 3% (good luck) and hope interest rates go negative? Or try to time the market and sell before interest rates move again? Why wouldn't I just buy Class A+ property at a 4 cap. 

I know interest rates are low, but they were also low in 2017 and the fundamentals were there. Everyone is betting on long term rent growth but I'm guessing this is too much money chasing too few deals. 

Or am I completely underestimating this whole "US housing crisis" thing and people betting on short-medium term rent gouging. 

https://i.kym-cdn.com/photos/images/original/000/645/713/888.jpg
[{"id": "fi3z20u", "text": "which city are u looking at? different city really varies a lot. Not to mention whether your deal population is already screened and filtered out through the large CRE investors/clubs.", "replies": [{"id": "fi42t79", "text": "everywhere in the southeast, but I dinked a few deals in Tampa and Jacksonville (LOL) thinking they would be cheaper.", "replies": [{"id": "fi47tsj", "text": "try looking into Texas and maybe Oklahoma. That's where we are doing our business and so far no complaints.", "replies": [{"id": "fi4kxij", "text": "We looked in TX last cycle, I'll start getting a feel for where deals are trading. My bosses have given me a hard \"no\" on investing in Houston which makes life complicated.", "replies": [{"id": "fi4opzb", "text": "Houston is tricky cuz it has a lot of exposure to oil&amp;gas, which is not the best spot to be in for the moment. But other than that, Dallas and Austin are pretty hot. Problem is market is very monopolized by local brokerage firms and investor circles, so for a complete outsider to tap into this market and hope to get ~6% cap rate is almost impossible.", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fi3zwvb", "text": "Much of the class A assets are bought with equity, so debt isn\u2019t really considered, at least it isn\u2019t a primary driver - just their cost of capital. Institutional investors look at IRRs over the holding period for their returns. CapRates just influence the potential exit value, which impacts IRR.\n\nYes, so much capital has compressed all asset categories as cash seeks out yields across the CRE food groups and delves into what would have traditionally been avoided assets like tertiary markets and class b assets.\n\nReal estate is all local though, so it entirely depends on area. Coastal markets have been flooded with capital for a long time.\n\nHousing crisis is exasperated by very high construction costs and labor costs, and rents that are increasing at a lessor rate. Restrictive policies in places with California only make the issue worse.\n\nEdited for clarity.", "replies": [{"id": "fi430fd", "text": "I know the IRR thing matters a lot but your sale price is going to depend on your exit cap rate, which depends a lot on prevailing interest rates. I get the all-cash thing but if the market is squeezed out for traditional owners and operators, who do you sell to? At the same token its a LOT of work and risk to chase a 5-6% IRR", "replies": [{"id": "fi47bw3", "text": "Cap rates and IRR are very different. You can have a 5% caprate with an unlevered IRR of 8-9%, and if you do bring in some light long term debt, you can get your IRRs into the low teens, and your Equity Mulitples into the 2x+ Mark.\n\nKeep in mind this for Institutional buyers/sellers. At smaller projects though(&lt;$75M), I would guess your returns would have to be even greater since the risk is more.", "replies": [{"id": "fi485a1", "text": "How are you getting unlevered irr above the cap rate? I'm assuming you're factoring in appreciation on sale which would (in turn) depend on exit cap rates and future expectations?\n\nEdit: this is a 2008 conversation to have. No need to make fundamental or business sense, we can just sell it to the next guy at a profit.", "replies": [{"id": "fi5s3nd", "text": "IRR is almost always higher than the going in cap rate. At a basic level, you\u2019re collecting that NOI over the holding period while rents presumably inflate and you then realize the sale proceeds at the end (at the market cap rate at that time). So you\u2019re seeing incremental return monthly that grows over and above the starting cap rate and you get a kicker at the end. \n\nWhen you add in debt, this is magnified because you\u2019re putting less cash in at acquisition so the cash you get out from operations, even after debt service, along with the proceeds from the sale at the end drive IRR higher.", "replies": [{"id": "fi5tale", "text": "^this is correct", "replies": [], "depth": 6}, {"id": "fi5yifh", "text": "Honestly I don't need an explanation on what irr is and how you juice the numbers by over leveraging a property.  It doesn't explain the insane amount of risk involved with most of these assets. Putting yourself on the razor's edge to justify a 4 cap acquisition because you can get a possible 6-8-10 irr is stupid business sense", "replies": [{"id": "fi5zi8p", "text": "I didn\u2019t mean to lecture, I was just trying to shed light on your question regarding the relationship between cap rates and IRR. It might be helpful for newer members of the sub.\n\nAs for the risk profile, it\u2019s all market driven. In my market for example (Vancouver, Canada), a 4% cap purchase is considered conservative. We regularly see sub-2.5% going in caps where there is sufficient upside in rents on turnover. \n\nThere are few asset classes as safe as multi-family rental in most major urban markets, and if you\u2019re able to generate potentially double digit IRR with the security of an asset backstop with variable exit strategies, that\u2019s a good investment. Most alternative investments like REITs, mutual funds or ETFs won\u2019t post that type of return after fees and you don\u2019t get the upside from events like upzoning that could drive your yield even higher.", "replies": [], "depth": 7}, {"id": "fi6mjcz", "text": "Typical attorney. Relax buddy. IT will be okay. He was just trying to help. We all know you think you're smarter than everyone here but if that was the case you wouldn't be asking the question.\n\nIn the MF sector, you're seeing the industry being flooded with a lot of UHNWI and institutional activity. You're seeing the same activity across the industrial and even the self-storage sectors.\n\nRight now, I'd throw cap rates out the window. Especially \"pro-forma\" cap rates. I'm seeing a lot of inflated caps on B &amp; C properties, with the hope to gather more attention and move the asset at a quicker rate. As you know, the problem on the sale side is finding a replacement property to trade into that cash floes the same, or more. This is why in a \"hot\" market, you're seeing almost zero to slim Trophy Assets out on the market. A cap rate is only as good as the actual numbers, and with ever increasing PPU #'s, they are starting to become skewed across the board. The only thing worth noting about cap rates right now is that the treasury is still at record lows, and these type of investors cannot go out and get the same return on a bond near the same cap rate while the rates are so low. Forecast for 2020 is to see this trend continuing. This is one of the main reasons the STNL or NET LEASE field in general is on FIRE right now.\n\nYou are correct in your assumption that it is insanity, because it is. The even crazier thing that I am seeing and hearing, is that in some Tier 1 cities in the USA, there is starting to become an apparent overbuilt state of multifamily. I am seeing this first hand in major US cities like Charlotte and Austin where the boom in the past three years is starting to exceed the demand. It will be interesting to see what happens.\n\nI've read some of your comments below and you are right. Most guys right now are either in acquisition mode to take advantage of depreciation with low interest rates, or are in hold mode, waiting for the market to cool down. Either way, if you're an investor or a broker, I think there will be some very good opportunities in these sectors in the coming years. You can thank the internet for that, as a lot of people who are acquiring these older dated properties at low cap rates, are doing so just to get in the game, and do not know the path to success in this arena. Buy right, manage right, sell right. If they are not buying right, they will not manage right, and they will not sell right.\n\nAlso, for me personally, I like using both IRR (since it gives time value of money and factors in for appreciation) and cash on cash. I know people get to values using cap rates, but I always discredit them. I spend a majority of my time in the bread and butter of deals. That is rent rolls and income and expenses. I've been doing this long enough that I know if something is looking lean or something is looking inflated. This knowledge was all acquired through so much time in deals and this profession and and considers thousands of factors. Even my institutional guys like to fudge the numbers a bit and when I find it we have a nice productive chat :)\n\nYou're right though, it's insane. Just sit back and enjoy the show. I love real estate so if you have any other questions or comments let me know", "replies": [{"id": "fi6u5dx", "text": "In my limited MF experience, cap rates are used as a benchmark against the current acquisitions market. IRR, DSCR and EMx tend to be what investors and their lenders look at.", "replies": [], "depth": 8}], "depth": 7}], "depth": 6}], "depth": 5}, {"id": "fi6b1qz", "text": "You can still achieve solid returns on an I/O loan around ~50% leverage. This is how our institutional partner likes to structure our JV deals. Debt is cheap right now", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}, {"id": "fi4d32l", "text": "He\u2019s not right, in my opinion. They use debt. Even a REIT will either lever after the fact at the individual asset level or at the entity level via a corporate line. Alternately the PE model uses debt on all their acquisitions. Look at the spread between the cost of funds and the cap rate, as the cost of funds drops, cap rates drop (ie value goes up) and the return IRR stay the same. It\u2019s all driven by cost of funds, which is driven by interest rates. Demand is also very, very strong. So, most capital providers view it as a safe bet and are willing to take a lower return. None of this factors in rent growth expections, which can also dig you out of a low, going in cap rate very quickly", "replies": [{"id": "fi4e6bq", "text": "Pretty much all of this. Yes.", "replies": [], "depth": 4}, {"id": "fi4en1e", "text": "At the entity, or fund level, sure. Occasionally at the asset level of it makes sense. But yes, after the fact. It is variable of course, I didn\u2019t mean to imply every single transaction is cash over the hold term. Leverage helps boost returns, of course.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fi417lg", "text": "Are rents at market?  Are market rents trending up?  Buying a 4.75 cap on in place might be a screaming deal if you can move rents and have some market movement.  Lots of folks chasing income yield across all asset classes and with boomer retirees over the next couple decades I think we will see a lot of demand compressing cap rates for multifamily even when demand and rents continue to flatten.", "replies": [{"id": "fi42q9h", "text": "pro forma 4.75 cap. in place 4", "replies": [{"id": "fi49f13", "text": "Aggressive but I can\u2019t say I\u2019m surprised given all the economic conditions.  If you\u2019re an institutional investor looking at yield opportunities, a ~5 cap is still 200bps above some corporate bond indices which may make a lot of sense given the alternatives.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fi41cej", "text": "&gt; I'm guessing this is too much money chasing too few deals.\n\nBingo- everyone likes the idea of hedging capital with low-middle class income housing as any downturn in the economy might actually improve the asset as more people would be renting rather than buying homes.  Add that with a lot of big firms looking to diversify off retail and you get where there's more buyers than sellers compressing cap rates. \n\nThey make it work by buying at a 5 CAP - they don't leverage and hope to push return up in the 7.5-8 range with some value add by adding interior updates or amenities updates.\n\nIt's all market dependent though, as I'm sure you know.", "replies": [], "depth": 1}, {"id": "fi42b4k", "text": "Probably short run it's about the funds and investors warming up to multifamily real estate so more cash $ chasing deals.\n\nProbably also highly valued public equity and bond markets making cash flow real estate seem relatively cheap.\n\nAnother wild theory is that there could be a structural decrease in risk premiums for multifamily real estate.", "replies": [{"id": "fi4egh2", "text": "I've pondered this last bit. In general I'm skeptical of structural changes. The \"this time it's different\" mentality because usually this time is \\*not\\* different.  \n\n\nHowever, there are certain long-term macro trends that absolutely favor multi-family. So it may very well be that the compression of risk premiums across classes is here to stay.", "replies": [{"id": "fi4f6vj", "text": "I mean, junk bonds were untouchable until michael milken and co. came along. similarly, you can argue that in the realm of berkshire's value investing - those companies had massive implied risk premiums when buffet started versus now. \n\nI think these can all may be seen as long term structural decreases in risk premiums. Of course though throughout the century america has probably seen its risk free rate decrease dramatically as well. i haven't looked empirically at it, just a thought.", "replies": [{"id": "fi4g068", "text": "I like it.\n\nPlus, Milken got pardoned ;)", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fi43ded", "text": "This pricing is probably why so many 200+ unit buildings of 80's to 2000's vintage have gone on the market over the last 3 months.\n\nYou can't count on people being logical...", "replies": [], "depth": 1}, {"id": "fi45cgl", "text": "I work in the space and you are correct. There is just too much capital chasing too few deals. Groups I talk to are settling for lower returns. Multifamily fundamentals are still strong, it\u2019s still a great risk adjusted return compared to other asset classes. \n\nJust lost an 80s Orlando deal that traded for a sub 4 cap. It\u2019s tough out there.", "replies": [{"id": "fi4kssd", "text": "yup. sounds like its time to cash out and wait for November.", "replies": [{"id": "fi4ozfd", "text": "President Bernie's national rent control will cause absolute mayhem.", "replies": [{"id": "fi4tnrm", "text": "[Trump has been extremely vocal that he's pumping the fed rates until november election, so I'm expecting the party to end then.](https://markets.businessinsider.com/news/stocks/trump-it-would-be-great-fed-slashed-rates-dollar-tweet-2019-12-1028769616) \n\nRent control is a god awful idea, but otherwise I'm not as pessimistic about a democratic presidency.", "replies": [{"id": "fi4tvjn", "text": "Rates have been far too low for far too long which has inflated the market.", "replies": [], "depth": 5}], "depth": 4}, {"id": "fi5r9hg", "text": "There's a big difference between what a president might want to do and what Congress will actually pass.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fi4aqtx", "text": "You can look at RCA for bigger trends. What I am seeing is cap rates compressing, average unit price increasing, volume increasing. Overall, it looks a lot like 2001-2006 but on a much larger scale. \n\nWhen looking at who is investing this, we get a huge upsurge in private buyers, and a slight uptick in institutional sellers. \n\nSo, asset inflation but most of these deals are not super high mortgaged, meaning there is not likely to be a crash since most of these are not financed by debt. \n\nSo, if everyone is spending stupid money, does that make you stupid if you don't spend?", "replies": [{"id": "fi5ohaf", "text": "I'd agree. I'm on the debt side but the banks have stayed fairly disciplined on equity requirements. The bank I work for is holding firm on keeping cash equity in refis regardless of valuation. 60% LTV cash out still need to keep at least some hard equity in", "replies": [], "depth": 2}], "depth": 1}, {"id": "fi57sku", "text": "When you get close to the cost of money in terms of cap rates of 3-4%. Often investors are banking on appreciation versus a high monetary return. Than again, when you start to get into core markets such as downtown areas people are also just parking money based on the level of safety they believe real estate will provide while still beating a CD.", "replies": [{"id": "fi6lue1", "text": "&gt; investors are banking on appreciation \n\nboth value over the longer term and income to rise in the nearer; rent rates are anticipated to march steadily higher", "replies": [], "depth": 2}], "depth": 1}, {"id": "fi5dhqg", "text": "Most deals of this type are bought with a value add scenario.", "replies": [{"id": "fi5shnp", "text": "In a normal market, value add deals should trade at higher cap rates than core plus deals, because there is more risk in value add. But we are not in a normal market.", "replies": [{"id": "fi5y1wn", "text": "You can\u2019t cap a value add deal. Not to be a dick, but you should know that. Look at Y1/Y2 cap.", "replies": [{"id": "fi6kkfd", "text": "A value add deal is a stabilized asset, as is core plus and core. You can most definitely cap a value add deal.", "replies": [], "depth": 4}, {"id": "fi6s40e", "text": "he's talking about going-in cap rate, not \"post-reno\"/\"mark-to-market\" cap rate", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "fi5o8qq", "text": "Welcome to the dumb money phase of a cycle. If you don't have a value add component you're better off in equities. It's really hard to buy properties at valuations that make sense. The existing inventory cap compression has also fueled the significant construction cost growth.", "replies": [], "depth": 1}, {"id": "fi8d95q", "text": "Compare prices online, check out zumbly or trulia", "replies": [], "depth": 1}]