Apartment Investing Took a Huge Hit, Is a Comeback On the Way?

Dave:
It seems like every single media asset that I look at has some sort of headline saying that you should stay away from commercial investing or that multifamily is in trouble. So when did all of this negative sentiment start, and why are we seeing this softness today? We’re covering everything on the multifamily asset class.

Dave:
Hey investors. I am Dave Meyer, and in this episode we are bringing back a fan favorite and a BiggerPockets OG member Brian Burke. You’ve probably seen him on this podcast or some of our sister podcasts. He was recently on, on the market, and we bring him on a lot because Brian is a seasoned investor in the multifamily space. And today we’re going to pepper him with questions about multifamily. And he’s gonna start by giving us a little bit of a history lesson to help us understand what some of the macroeconomic, some of the housing demographic trends that led us to where we are in multifamily. And before we jump into this, I just want to clarify that when we say multifamily, we are specifically talking about commercial real estate assets, which are defined as five or more units. And that may seem like a arbitrary number, but it’s actually not.

Dave:
It comes from lending. And the reason we’re sticking with just one side of this and just talking about those large multifamily assets is that the residential housing market and the commercial real estate market work pretty differently. And you can see dynamics exist in one, and it can be the totally opposite in the other. And last thing before we bring on Brian, our bigger news episode today is brought to you by Rent app, the free and easy way to collect rent. Learn more at rent.app/landlord. All right, let’s bring on Brian. All right, Brian, to start the show from pre Covid Times, can you just give us a little bit of a history lesson, help us understand how we got to where we are now with multifamily in the somewhat concerning state it’s in today?

Brian:
Well, um, how about irrational exuberance? , may, maybe that’s how we got here. So I, and I think that that really applies on a number of fronts. So let’s break that down. Residents, prospective residents, uh, got some irrational exuberance of wanting to move into new apartments or move to new areas. And, uh, we’re competing for a limited amount of apartment stock, uh, which drove up rents tremendously. Uh, kind of starting pre covid actually about 20 18, 20 19 rents started to climb. And then by 2020 after Covid, they just really went into hyperdrive. At the same time, investors got irrational exuberance because they all wanted a piece of the action. Everybody wanted to buy multifamily, you know, buy apartment complexes. That was the thing. And, uh, and then, and then while all this was going on, uh, developers were in the background going like, look at this interesting multifamily opportunity.

Brian:
Demand for, uh, apartments is really high demand from buyers is really high. Call your architects, call your land brokers, and let’s get going. And unfortunately, as the development business is, it takes 2, 3, 4 years before those projects go from concept to reality. And now kind of here we are post COD and you know, post inflation and all these other things. And, you know, rents are a lot higher than they were pre covid. Uh, pricing for apartments went really, really high. And then when the developers projects all started coming online and inflation became a headline, uh, interest rates went up and all of this stuff collided at exactly the same time to find us where we are now.

Dave:
All right. That’s a great summary, but I do wanna dig in here because the whole point of this conversation is to really understand some of the context and history that’s led us to today so you can understand the dynamics that are going on and what might happen in the near future. So you started by saying that there is irrational exuberance among renters, which is not where I thought you would start. So can you tell us a little bit more about that? Uh, you said even back to 2018, renters were starting to move and move particularly into multifamily.

Brian:
Yeah. And renovated apartments. You know, there was a lot of demand for renovated apartments. There was a lot of demand for apartments in general. And that was just because we have a housing shortage in general, there’s a housing shortage in a lot of markets. And when people are moving around, especially if you’re moving to a new city, um, you know, you’re moving outta California because cost of living is so high or New York, ’cause cost of living is so high and you’re moving to a new area, you most people don’t just move to the new area and just straight out buy a home. Usually they’ll go rent an apartment. And when you have limited amount of supply, uh, you know, these, these units will get bid up by tenants. Not like the tenants are standing at an auction going, you know, another a hundred, another a hundred. It doesn’t work like that. But those rents will go up as the occupancy start to get squeezed, you know, and when occupancies are 98, 90 9%, uh, landlords are emboldened and they can increase rents. And that all started long before Covid came along. Covid just put it in amplified hyperdrive.

Dave:
Okay, got it. So people were moving across the country and they wasn’t an availability or desire to rent a single family home. And I also think one of the interesting things about multifamily, especially when people are moving, is that often they have multiple units on the market. It’s easier to see them sight unseen, they’re more, you know, preset layout. So people who are moving are often a bit more comfortable with multifamily than, you know, getting sort of a unique one-off small multifamily or something like that. At that point in 20 18, 20 19, that sort of thing, what was the supply level? It sounds like it was relatively low or stable in multifamily if vacancies were going down and, you know, occupancy was so high. Is that right?

Brian:
Yeah, it was relatively stable. There weren’t a lot of housing units under construction. I think if you look at, uh, construction trends over the last decade, there’s always been, well, actually you can go back two decades, maybe even three. There’s been dialogue about how construction isn’t keeping up with household formation, increases in population and that sort of stuff. And, you know, population in the US was increasing pre covid. I I actually post covid. It came to a grinding halt. Uh, but pre covid we had population growth. And you know, you, I know you’re surprised that I started with irrational exuberance from tenants, but all of this has to start somewhere. Investors aren’t interested in buying apartments no one wants, but when people want apartments and that’s driving up incomes, investors then want a piece of that. And so that’s what drives buyers. And then the buyers and the, uh, tenant prospects is what drives the developers. So it all has to start somewhere. If the tenants didn’t have irrational exuberance early on, none of those other things would ever have happened.

Dave:
And let’s take a quick break here from the history lesson. I wanna know what you were doing in thinking at this time, the 20 18 20 19 time, because you once on a previous episode of the show said something, I always remember you said, there’s a time to buy, there’s a time to sell, there’s a time to sit on the beach. So which of the three were you doing in 2018 and 2019?

Brian:
That was the time to buy. And, uh, we were buying, we were buying in 20, well, all the way from, uh, 2011, uh, all the way through 2020, we were buying, uh, 20 18, 19. We were buying a lot of units, hundreds of units per year, uh, maybe even thousands in some of those years. And we were renovating and, you know, improving revenue and doing all the things. And what was funny is every time we did that, I would always get a comment by someone where they would say something like, how is it even possible to make money in this market? You know, prices already went up. Uh, you know, they’re just gonna go down and it’s impossible to make any money. And it’s like, all right, all right, watch this . And then we would, we would get another one. And then six months later, you know, we’d get another one. I’d get the same comment, well, how is it possible? Uh, and so, you know, that’s when I think it’s a good time to buy is when some people are still questioning whether or not it’s a good time to buy, is a lot of times a good time to buy.

Dave:
Well, that makes sense and good for you. I think that that was probably very wise in, in retrospect. So right after this maybe 18 and 19, that when the investor irrational exuberance kicked in, it

Brian:
Really started kicking in, in 2021. Uh, it was when it really went overboard. So there was, there was a lot of investor interest in 2019 in multifamily, because I think a lot of people were saying like, all right, for the last five years I’ve been saying that we missed it. It’s too late and I keep not buying anything, and the prices keep going up. So they finally started to give in and say like, we’re gonna buy. And so we started to get just a thread of this, uh, irrational exuberance in 2019. And that all got erased in, uh, early 2020. As soon as Covid came out, everybody was like, pencils down. Uh, we don’t know what’s gonna happen. The world’s gonna come to an end. Nobody can leave their house ever again. And all this stuff. Uh, and transaction volume plummeted very, very quickly in a matter of days. Tra transaction volume went, uh, down about 75, 80% from where it was just months prior. So it didn’t take long though to realize that the worst of the fears weren’t going to materialize. And actually, um, rent started climbing dramatically. Mm-Hmm. . And once that happened, that’s when the investor irrational exuberance really kicked into hyper speed.

Dave:
And I just wanna to help people understand why increasing rents might create that exuberance. Because if you’re not familiar, one of the common ways that people think about valuing commercial real estate is based on net operating income. A lot of how as an investor you look at is like, how much revenue can it produce? And so when a asset, like a large multifamily property starts to see rent increase, a lot of investors think I should buy now because the value of that asset’s gonna be tied to, in some ways, to that rent increase. And is that why people were buying despite some of the warnings, Brian?

Brian:
Yeah, I mean, when you think, when you really break this down into the simplest, you know, of terms, forget about the real estate, you’re buying an income stream and, and a growing income stream is always worth more than a stagnant income stream or a shrinking income stream. So if rents are increasing and this income stream is getting larger and you pay x for y of income, uh, it stands to reason that y plus one will be worth, you know, X times two. So that’s the, the whole theory behind it. The real estate is just the hard asset that gets you there, but really it’s the income stream is really what you’re buying.

Dave:
Very, very well said. Alright, so we’re starting now to get a sense of how multifamily arrived at this point. But how has this perfect storm impacted investors and how can investors deal with the issues facing this sector today? Brian’s gonna break down his take on occupancy funding and more after the break. Welcome back to bigger news. I’m here with Brian Burke talking about the state of multifamily. Let’s jump back in. I wanna revisit what you said earlier about developers. And as you said, it could take three, four years to get a multifamily development. When did we start to see an increase in development activity, pulling permits starting construction? It

Brian:
Really started, um, kicking in about 2022. Uh, in fact, I’m, I’m looking right now at, um, a uh, chart put out by RealPage that shows multifamily quarterly apartment supply. And the supply started really kicking in middle of 22. There was a little bit of bump in mid 20, but it really started to kick in in 22. Now that means that they would’ve started all of that process in 2017 to 2018, maybe 2019. So about the time when I said that buyer irrational exuberance was just kind of beginning, developers saw that right away. And like I said before, they call up your architect, call up your land broker, they get these projects underway, and then by the time they start releasing out units, it’s now three to four years later, which coincides exactly what the increases in deliveries, uh, that we saw in middle of 22.

Dave:
Yeah, and I, I just pulled, just to help us out here, I just pulled up the number of multifamily building permits. So basically when they start construction and you know, through the early two thousands it was 400, 450,000. It totally plummeted during the financial recession. And leading up to Covid, we were back to that level, 450, 400 70,000. When we got to 2021, it went up nearly 50% to 600,000. And in 2022 it went up to nearly 700,000. So it seems like even past the point where you were feeling irrational exuberance, people were still starting projects, which I think we’ll get to in a couple minutes, but may lead us to why we’re still seeing sort of this increasing amount of supply. But before we go there, I wanna get back to this 20 21, 20 22 era and return to what, I guess we’ll call the Brian Burke index, where you buying, selling, or sitting on the beach during that time

Brian:
In 21 and 22, I was selling, uh, I could clearly see the irrational exuberance on behalf of buyers. And when someone wants something really, really badly and you have that something that they want, you should not deny them the opportunity to have

Dave:
It. How generous of you.

Brian:
Yes, of course. So, uh, I was, I was aggressively selling in 21 and 22 sold about three quarters of our portfolio during that, uh, 18 month period of time.

Dave:
Well, good for you. It sounds like you, you timed the market very well. So with that history lesson in mind, uh, can you maybe just bring us up the last year or 2, 20 23, 20 24, where it seems like things spilled over from exact irrational exuberance to sobering reality, or I don’t know what you would call it?

Brian:
Yeah, that’s a really good term. I like that a lot. . I I say either it’s that or it’s a, you know, a traffic accident that spread glass all over the intersection. , oh God. ’cause ’cause every, everyone showed up at the same time and nobody stopped at the red light. Oh, wow. Uh, and they all hit each other right in the middle of the intersection. And so, so who, who got in the crash? Interest rates got in the crash, uh, insurance prices got in the crash. General costs of doing business such as payroll, office supplies, building materials, everything else got in the crash. Uh, rents got in the crash because the developers are in the car too. And, uh, they started releasing all these units and now there’s so many apartments to choose from, uh, that vacancy started to increase. So there was this kind of perfect storm where apartment owners were getting hit from all directions. This is a four-way intersection, and there was a car coming from every single direction, and they all collided in the middle because you’re getting hit from your debt service expenses and income all at the same time.

Dave:
That is a very good and gra somewhat graphic description of what’s going on, but I think it does paint a very good picture of how challenging things are right now. And so how, how does this play out? If you were someone, let’s just say who bought in 2021 or 2022, how would this, you know, confluence of negative events, impact valuations, rent, everything? Well,

Brian:
It, a lot of it depends on how your, uh, capital is, uh, structured. If you have a loan maturity coming, uh, within the next year or two, or you already have faced a loan maturity and you’re on some sort of a kick, the can down the road extension, uh, this situation could play out much differently than if you have a long term time horizon. Uh, because if you, if you have the ability to wait, as always has been the case with real estate, time heals all wounds and eventually, uh, these things will normalize. Things will come back, rent growth will come back. Uh, I, I kind of see the, the path of progress to look something like this. Uh, the, uh, high number of apartment deliveries, meaning new construction is going to decline. Uh, because these developers can’t continue to get financing for these projects at today’s interest rates.

Brian:
Material costs are higher. Uh, you know, a lot of the reason some of these projects still went off the ground was because they were past the point of no return. They kind of had to finish them. Uh, that’s, that’s gonna come to an end and, and once that supply starts to come down, that’s gonna help. Uh, the other thing that I think will happen is, uh, with less to choose from, residents are going to fill the apartments that remain and that’s going to solve to a degree the occupancy problem. Uh, perhaps insurance rates will normalize some, perhaps this is the new normal. It’s hard to say. Uh, that depends a little bit on natural disasters and uh, and, you know, insurance companies and that sort of stuff. Uh, and I think at some point, uh, inflation will finally moderate not because the Fed was brilliant and used the best tool in their toolbox to, to tamp it down, but just because eventually that’s going to happen and that will force interest rates to, uh, normalize.

Brian:
Now what normalize means is anybody’s guess, does it mean zero interest rate policy? Again, probably not. Is today’s higher rates the new normal? Maybe, maybe not quite as high. It’s, you know, a little tough to say. But I would assume that the way this kind of plays out is over the next three to five years, you’re gonna see demand, improve supply, reduce interest rates, normalize costs normalize, and then the apartment market will begin to accept the current reality, uh, get back on its feet, uh, go to the body shop and get the car fixed and get back on the road.

Dave:
Okay. Super helpful context there. Thank you. I’m curious, because you said so much depends on the debt structure and the capital stack. Do you have any sense of what percentage of multifamily assets are in some sort of distress?

Brian:
Well, I thi this is a little bit all over the board. If you look at, um, agency statistics like Freddie Mac, they have a delinquency rate right now, double what the delinquency rate was pre covid. I however, double is four tenths of 1%, uh, versus where it used to be at two tenths of 1%. So it’s very, very low. So, but agency financing is kind of like the only, the best borrowers and the best properties had agency financing. Uh, they’re lower loan to value ratios. So it stands to reason that those loans wouldn’t be in an extreme amount of distress. Uh, couple that up with data from, uh, debt funds. IE bridge lenders who made short term loans, uh, for the purpose of repositioning properties. Uh, those are the ones that come due in three to five years, which that’s now because if people were buying in 2021, here we are, it’s three years later.

Brian:
Notes due, someone’s knock at the door. Uh, those, uh, delinquency rates are, I don’t have data on it ’cause it’s a whole bunch of different lenders so they don’t publish like, oh, guess what, here’s our delinquency rate. But you can tell just by looking at things like, you know, Arbor, uh, is a big bridge lender and their stock is in the toilet and there’s all kinds of stuff going on and there’s major short interest in the stock. And um, you know, you look at some of the other CLOs and debt, uh, debt fund stuff out there and there’s a lot of talk about distress. There’s a lot of talk about, um, loan extensions and, you know, maturity extensions, even maturity extensions that the bars wouldn’t really otherwise qualify for. ’cause the lenders are kind of hoping they can kick the can down the road a little bit and maybe the recovery will happen before somebody knocks on their door and tells ’em they’ve gotta get this loan repaid.

Brian:
Uh, so I think the percentage is higher than what the data is showing. Now, having said that, that’s really limited mostly to the subset of properties that were purchased in, call it, you know, 2021 to 2022. Uh, you know, that two year period I think is the worst, uh, you know, call it vintage and vintage, not being year of construction, but year of acquisition stuff that was bought before then is probably largely okay. Stuff bought very recently, like in the last six months to a year, jury is still out. Uh, but I would suspect it will be better off than the 2021 and 22 stuff.

Dave:
So it’s the people who bought the properties you were unloading?

Brian:
It was, and in fact, a lot of the properties that we sold have been offered back to us, some of ’em for less than the loan amount for the new borrower. So yes.

Dave:
Wow. And so, I mean, no one knows, as you said, it’s impossible to know exactly when rates may come down, if they come down at all when inflation gets nipped. But it sounds like you’re not seeing a recovery or, or any sort of fundamental change in market fundamentals in the imminent future. Let’s just say the, the second half of 2024

Brian:
For me, this is the sit on the beach period. . So ,

Dave:
Yes. Okay.

Brian:
This, this is the sit on the beach period. No, I don’t, I I really,

Dave:
No wonder you’re so easy to book for this podcast right

Brian:
Now. Oh yeah, I’m available. You need me tomorrow, ? Yeah, sure. , what do you do? What are you doing this afternoon? Well, nothing, yeah,

Dave:
Excellent works for us.

Brian:
It’s easy to get to get on the podcast, that’s for sure. ’cause there’s not a lot going on. This isn’t a really good time to buy. It’s not a good time to sell. And for me it’s not even really a good time to get ready to buy. You know, we’re not even really gearing up, uh, to buy anything right now. It’s wait and watch. And I, I think we’re gonna be doing that for a while. I don’t, I don’t expect we’ll buy anything in 20, 24, 25 is still a little bit further out than my crystal ball is giving me clarity on. But I think early 25 is probably not gonna be all that active. Uh, maybe we get into later 25 there. I think we might have some, you know, some possibilities. But I’m, I’m kind of like, I don’t need to be the first guy to buy. I, I don’t need to say like, I’m gonna start the next market cycle. I wanna see some evidence that the market cycle has shifted direction, uh, before I am ready to jump on board.

Dave:
That makes a lot of sense. It’s, it, it makes sense to be pretty patient right now. Okay. We have to take one more quick break. When we come back, we’ll hear from Brian about what he sees on the horizon. And while we’re away, if you feel like you’ve learned something so far, and I hope you have take a minute and hit the follow button wherever you’re listening, it helps other people find the show so they can learn too. Plus it makes us feel good. We’ll be right back. Welcome back to the show. We’re gonna jump right back in. You know, I’m curious about the long-term implications of this. We don’t know when dynamics will shift, as you just said, but one of the interesting things I’m curious about is we hear these reports from all sorts of government agencies and think tanks that were X number of housing units short in the United States.

Dave:
And that number is anywhere from, I think I saw Freddy the other day said 1.5 million NAR says it’s something like 7 million. So there’s a pretty wide range, but we’re going from this era where we’re still delivering a lot of multifamily supply. But from that chart I was just talking about earlier where we look at permits and new starts for multifamily, it’s almost completely stopped. So the pendulum has swung almost the entire other way for developers. And I’m wondering if that bodes well, maybe for long-term multifamily, like once the dust settles, is there going to all of a sudden be a lack of supply again?

Brian:
I think there will be, it may take a while for that to happen because there was so much supply to absorb. So I don’t think you’re gonna see like that v-shaped recovery. It’s gonna be a little more of a u-shaped recovery or an l-shaped recovery because it’s gonna take some time to absorb that amount of units that I think also the growth of the US population has been declining. Uh, I think it was 2021 was the lowest amount of population growth since like, the Great Depression. I mean, it was first time in a hundred years, it was below a million people. And so, you know, that that also shifts, right? But, you know, there are things to think about, like, you know, birth rates are declining and, you know, there’s a, there’s a lot of factors at play and I think, um, uh, it, you know, it’s gonna take time for, for this to, to shake out.

Brian:
It’s not gonna be evident immediately, but long term, I’m very bullish on housing. I think, uh, you know, if you look at this, you know, the more you zoom out, the better it looks, right? If you look at it like, what’s gonna happen this week? Nothing good. Uh, what’s gonna this year, probably not much. What’s gonna happen this decade? Yeah, there’s probably some real opportunities. What’s gonna happen over the next 50 years? If you own property right now, you’ll be the, the king of the world in 50 years , you know, there’s, there’s a lot of growth potential over that period of time. And I don’t, I don’t think it will disappoint anyone. Uh, but you have to be able to have that kind of staying power.

Dave:
That’s a great insight and I totally agree. I think it’s, it’s, this is a game where you just have to be patient and, and look long term and not try and jump in at an, at an, an ideal time. That’s not to say there’s not some deals possible right, right now, but it is a challenging market. That brings me to my last question. Uh, you know, you’re a syndicator or you have in the past done syndications, and I hear a lot of things these days about syndicators of capital calls. You’ve come on on the market to talk about capital calls, which we greatly appreciate. But can you offer perhaps some words of advice on how investors listening to this who are interested in passive investing may vet or think about participating in syndications in this current environment?

Brian:
Yeah, and you know, you could have a whole show on capital calls. And by the way, didn’t we just, we think we did

Dave:
One. I think we did one. Yeah,

Brian:
We, we a whole,

Dave:
We’ll link to that one in the show. It was on our sister podcast on the market. So if you guys wanna learn more about capital calls, Brian came on the show with Kathy. We did a great episode about that. So check that out in the description below as well.

Brian:
Yeah, we did do a whole show on capital calls and, and you’re right there, there are syndications that are running into trouble, but, you know, the same thing happens every cycle. And it, it’s not unique to syndications, uh, even owning real estate directly syndications is just a method in which you own real estate. So when people say, oh, there’s all these failing syndications, it’s really failing real estate investments and in most cases it’s failing real estate investments in large part due to, in inappropriate capital structure such as, you know, loan maturities at a inopportune moment is really what’s causing the majority of the pain that you’re seeing out there. So I think you have to approach syndication investing, uh, in the future the same way you always approach it in the past, but with the awareness that I’ve been trying to spread for years, I started with four years ago writing the hands-off investor to try to spread the awareness of what to look for.

Brian:
And, and that is, you need to look at how the capital is structured. You need to really dig into what the investment plan is and make sure that you’re buying at a good basis with enough staying power to be able to ride through a market. And staying power means longer loan maturities, plenty of cash reserves, a really strong sponsor who knows what they’re doing, preferably one that’s survived a market cycle in the past. And if you have all those things, you can set yourself up really well. And it’s the same as if you were to go buy an apartment complex on your own and you’re the only investor in it, you’re gonna buy it yourself. You would look for the same thing. You would get a good loan with long-term, uh, maturity. You would get, uh, you would have cash on hand in case the unexpected things happen. All of those things, uh, you would look for the same thing in a syndication investment.

Dave:
That is absolutely true. The syndication is just the way of collecting money and what’s failing is the real estate. I do think though the focus has been somewhat on syndications, because it does seem that a lot of less experienced syndicators may have been involved in this most recent cycle.

Brian:
IE the irrational exuberance I was, I was talking about

Dave:
Earlier. That’s fair.

Brian:
And I think that’s true. I think that they drove a lot of the irrational exuberance and they were fed by investors that had irrational exuberance and gave them the money to do so. Uh, you know, that’s one of the things about, you know, syndications and multifamily investing is that through syndication, small investors can buy large properties. Uh, without syndication only big investors can buy at large properties and generally big investors are gonna have a little bit more discipline and there’s a lot of money at stake. Uh, but as with anything, if you remember the.com stock bubble of 2000 when all the little, so-called little investors got into the stock market is when, uh, stock values inflated and then came crashing down. So the same thing happens in real estate. You know, when you make real estate accessible to people that don’t really know what they’re looking at or looking for, uh, these kinds of dislocations can happen where they feed groups that are taking their money, uh, to make bad investments and they end up predictably, uh, in the situation. We find some of these in, uh, now. So hopefully the takeaway from all this will be for the smaller passive investors to use discipline when making these investments and not just fund any business plan that they see, uh, crosses their email inbox.

Dave:
Well, that’s great advice, Brian. Thank you so much for sharing this history lesson. We’ve now coined the Brian Burke Index and we’re gonna have to monitor this over time. Maybe we’ll publish it on the BiggerPockets, uh, blog. Uh, but we really appreciate you, you sharing your insights and experience here. Thanks a lot.

Brian:
Good to see you again, Dave.