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The West Coast is different. It’s entrepreneurial; it’s leading edge, and it’s full of big ideas. So I headed west to LA to pick the brains of the big guys – some of the smartest in the real estate investment industry. I visited three large real estate funds and two very large family offices. Here’s my take-away.
At Fund #1, the managing director was lamenting that over the past two years, they have acquired only one multifamily investment. In retrospect, he said he wished they had bought more, because it has been their best performer of all real estate asset classes.
When I asked why they had bought only one, he admitted he couldn’t get his head around the prediction that rent growth would be in the 3% to 5% range. Consequently he had presumptively marked his proforma down to a lower number, and the returns were not as good. Surprise!! In hindsight, even those aggressive assumptions have turned out to be conservative. In fact, in many cases, those rent growth numbers have been exceeded.
My take-away:
Obviously, last year he was premature in his concern about rent growth, but he may be right on target for the next several years. In my opinion, multifamily rent growth will be hard to maintain, especially in A and B product. That is, of course, unless – or until – inflation raises its ugly head.
There may be a little room left in C product, but that will hinge more on the ability to pay than on demand. Demand will be insatiable, but already, almost 50 % of all renter households are rent “burdened” (spending more than 30% of income on housing costs).
Major Fund #2 voiced concern that we’re at the top of the market. To confirm his position, he pointed out his office window to a 100,000 square foot spec home under construction. With a $500 million price tag, this home is the highest priced residence in the world. And it’s a spec building! It does make one pause.
Nevertheless, after recently raising substantial funds from one of the big California pension plans, he agreed that multifamily still makes sense. But he added a caveat: It is critical to underwrite the investment very carefully in order to weather any future downturn.
My take-away:
I couldn’t agree more. We need to go into our investments with the mindset to ride out any storm. The multifamily demographics are so overwhelming that I am certain any storm will be a short one, but like all storms, if you are not prepared, it can mean death.
#3 Fund is a multi-billion dollar fund that invests in all asset classes and all around the world. This fund is still very bullish on U.S. multifamily, but it has substantially reduced its return metrics to what is achievable in this market.
My takeaway:
How on earth do these guys expect to deploy all that capital? They, like so many other funds, are collecting billions of dollars for real estate investment. Everybody wants real estate. But where do they find enough assets – and good deals – for all that capital? This is not a distressed situation. Assets are for sale, but at what price? It’s hard to find a really good multifamily real estate investment – primarily because people are paying too much, or at least more than rents can justify.
Another thing we have to consider: A lot of major pension funds are now at the exit stage of previous investments made five to seven years ago. And they have been reaping huge profits. That capital will have to be re-deployed into real estate investments.
Family Office
Finally, we visited a billion dollar family office.
Real estate – specifically multifamily real estate – will be this group’s major investment focus going forward. In the past its investments were spread over all asset classes. This group confided that it now realizes that multifamily provides, without question, the best return metrics in terms of both cash flow and IRR.
In summary, it was a great week with the big boys. It’s always fun to learn how those West Coast brains work. I was happy to see that we are in agreement on most issues.
My final take-away is that my meetings confirmed what I have been preaching for some time:
• Look for C and B product in good neighborhoods. This is still the best possible real estate investment.
• Do not over-leverage.
• Remember that operations/property management is key.
• Be realistic about rent growth.
• Underwrite to weather any upcoming storm.
• Avoid the buying frenzy; be patient; and keep underwriting everything to find the right deal.
Then you will have a safe investment with excellent returns.
Christopher Finlay is Chairman/CEO of Lloyd Jones Capital, a private-equity real-estate firm that specializes in the multifamily sector. With 35 years of experience in the real estate industry, the firm acquires, manages and improves multifamily real estate on behalf of its institutional partners, private investors and its own principals. Headquartered in Miami, the firm has operations throughout Texas, Florida and the Southeast. For more information visit: lloydjones.wpengine.com.