We Haven’t Bought Anything Lately, Why?
If you are a regular reader of our newsletters or are invested in one of our projects you may have noticed we haven’t bought anything since last May. Why haven’t we bought anything lately? What has been holding us back from being the winning bidder? What are we seeing today? And, where do we head from here?
Our lack of investment purchases haven’t been the result of a lack of effort. We have been over-turning every stone to find the next project that we believe in. In fact, from March 1 2024, through April 11 2024 we bid on 17 properties and reviewed more than 40. Why do we keep losing? It usually comes down to two assumptions, exit cap and renovations funds / operating reserves.
While we predict high interest rates won’t be around forever we don’t forecast rates going back to 3% either. These assumptions directly correlate with our investment model’s future sale price. In effect, if future interest rates are lower, buyers will be able to pay more for the asset down the road. For more reading on this topic, check out this article from JP Morgan Cap Rates Explained. Other investment groups are being more aggressive in this area by projecting lower future interest rates, a lower sale Cap Rate and therefore higher sale price. In a recent deal we bid on, an exit cap adjustment of 0.25% would allowed us to pay $1 million more for the asset today. This assumption would indicate (among other variables) the winning bidder projects the interest rates would go from 6% today to 4.5-4.75% in the future.
The other assumption we tend to be conservative on in today’s market is our renovation and reserves budgets. When we underwrite a value-add project we want to be able to make long term improvements and not just paint over problems. We also like to go into projects with ample reserves to cover the ‘unknown-unknowns’. Especially now, we want to create lasting value that we can effectively operate at a profit should market timing work against us. When we review underwriting with brokers we often hear we are assuming too much for repairs or that delinquency should correct itself quickly. These assumptions would lead to lower equity requirements and the ability to pay more.
What are we seeing today? For a period of time owners who were operating at a profit and didn’t have an impending debt maturity were just not sellers. Instead most of the deals we were seeing were new construction lease up (construction debt maturity) and properties with high delinquency or other severe operational issues (with bridge debt maturities). We are now seeing more activity in the market from sellers who don’t necessarily have to sell but, are willing to, recognizing that rates may not be coming back down quickly. We have been actively pursuing projects in all of these categories having come closest recently in categories two and three.
Looking ahead, there is still a wave of debt maturities and a historic level of new supply coming to market. Investment sales activity remains low, but we are hearing that this may be changing soon. Have we hit the bottom in values in this cycle for Multifamily? Maybe. If not, we should be closing in on that floor.
Although more difficult to make sense of investment properties in today’s market given current rates, the long term demand drivers of multifamily in the markets that we are targeting remain strong. When we find the next “needle in the haystack” we know there is value to be created for our investors though implementation our proven business plans. I guess we just need to find that needle :).
Best wishes,
Josh and Donato
DXE Properties | www.dxeproperties.com