Is Multifamily Recession Proof? Not Quite…

Is Multifamily Recession Proof? Not Quite…

Maggie-C-Headshot
Maggie Collister
Are multifamily investment properties ‘”recession-proof?” Not quite.

A common refrain heard from apartment investors (especially those suffering from the acquisition mania of 2019 – 2022) is that apartments are recession proof. “People always need a place to live,” they’ll say. Or “You can always drop the rent and get it filled.”  

But, is that true in practice? Sometimes – but not always.  

Why Not?

The recent boom in apartment acquisition with bridge loans and floating-rate debt emphasizes one glaring fact: assumptions matter when investing in real estate in Montana and elsewhere.  

Underwriting for 10%+ annual rent growth and assuming occupancy rates of 97%+ in perpetuity is turning out to be a bad deal for many apartment investors who acquired new properties in recent years. Overly optimistic underwriting assumptions diminish investment performance. Nowhere is that more true than in apartments, where tenants sign gross leases. 

In contrast, a primary advantage of most commercial property investing (industrial, retail, office) is that operating expenses pass through to the tenants in a standard truple net (NNN) lease stucture. As the cost of taxes, insurance, and Operations Expenses or “OpEx” (maintenance, utilities, etc) rise, a NNN lease assures that those expenses are passed through, pro rata, to tenants. That means Net Operating Income (NOI) stays the same or grows, assuming stable vacancy.

For apartments, however, that typically does not occur. As taxes, insurance, maintenance, turnover, utilities, and personnel costs increase with inflation, they do not automatically pass through to tenants. Instead, owners of apartments eat that cost in diminished NOI. 

For investors with floating-rate debt or bridge loans coming due, the cost of debt is becoming more expensive. 

It’s safe to assume few investors expected the federal funds rate to go from near zero at the end of 2021 to nearly 5% in spring 2023. That wild swing can detonate an apartment investment model, especially for those who bought in 2021-22 with floating rate debt. Even more so for value-add investors who banked on large trade-outs to happen quickly. Also impacted are developers moving from construction loans to permanent loans. 

Good News

The good news is, recent economic disruption is not impacting the majority of apartment deals locked into long-term debt at lower rates. For those owners, achieving operational efficiency through strategic property and asset management can help them weather the storm. These owners have no reason right now to panic and/or sell at discounted prices. In part, that’s why apartment sales have dropped to a 14-year low in early 2023. 

To maximize value in the current market, smart multifamily investors hire professional property managers who can effectively control expenses. Compass Communities offers a team of skilled professionals, dedicated facilities management personnel, and a wide network of vendor relationships that can be utilized as needed. 

Contact the Compass Communities team for more info on streamlining management. 

Matt Mellott
Matt Mellott, CCIM/SIOR

Is Multifamily Recession Proof? Not Quite…

Maggie-C-Headshot
Maggie Collister
Are multifamily investment properties ‘”recession-proof?” Not quite.

A common refrain heard from apartment investors (especially those suffering from the acquisition mania of 2019 – 2022) is that apartments are recession proof. “People always need a place to live,” they’ll say. Or “You can always drop the rent and get it filled.”  

But, is that true in practice? Sometimes – but not always.  

Why Not?

The recent boom in apartment acquisition with bridge loans and floating-rate debt emphasizes one glaring fact: assumptions matter when investing in real estate in Montana and elsewhere.  

Underwriting for 10%+ annual rent growth and assuming occupancy rates of 97%+ in perpetuity is turning out to be a bad deal for many apartment investors who acquired new properties in recent years. Overly optimistic underwriting assumptions diminish investment performance. Nowhere is that more true than in apartments, where tenants sign gross leases. 

In contrast, a primary advantage of most commercial property investing (industrial, retail, office) is that operating expenses pass through to the tenants in a standard truple net (NNN) lease stucture. As the cost of taxes, insurance, and Operations Expenses or “OpEx” (maintenance, utilities, etc) rise, a NNN lease assures that those expenses are passed through, pro rata, to tenants. That means Net Operating Income (NOI) stays the same or grows, assuming stable vacancy.

For apartments, however, that typically does not occur. As taxes, insurance, maintenance, turnover, utilities, and personnel costs increase with inflation, they do not automatically pass through to tenants. Instead, owners of apartments eat that cost in diminished NOI. 

For investors with floating-rate debt or bridge loans coming due, the cost of debt is becoming more expensive. 

It’s safe to assume few investors expected the federal funds rate to go from near zero at the end of 2021 to nearly 5% in spring 2023. That wild swing can detonate an apartment investment model, especially for those who bought in 2021-22 with floating rate debt. Even more so for value-add investors who banked on large trade-outs to happen quickly. Also impacted are developers moving from construction loans to permanent loans. 

Good News

The good news is, recent economic disruption is not impacting the majority of apartment deals locked into long-term debt at lower rates. For those owners, achieving operational efficiency through strategic property and asset management can help them weather the storm. These owners have no reason right now to panic and/or sell at discounted prices. In part, that’s why apartment sales have dropped to a 14-year low in early 2023. 

To maximize value in the current market, smart multifamily investors hire professional property managers who can effectively control expenses. Compass Communities offers a team of skilled professionals, dedicated facilities management personnel, and a wide network of vendor relationships that can be utilized as needed. 

Contact the Compass Communities team for more info on streamlining management.