Multi-family real estate investing has proven to be a great strategy to diversify your portfolio, providing opportunities for great returns while mitigating risk. We want to provide you, our readers, with the information and knowledge you need to make informed investment decisions for your portfolio by sharing some insights from our internal operating history, transaction experience, and market intelligence. Multi-family real estate has the potential to increase your cash flow and provide you with unique tax advantages, but your investment decisions must be contemplated with an awareness of the potential market downturns and the cyclical nature of real estate investing.

As a potential investor, it is imperative that you understand the current economic environment and submarkets, but more importantly, it's essential to familiarize yourself with the Sponsor's past historical performance and the experiences of previous limited partner investors. As we march through 2024 in a world of volatility in interest rates, uncertainty of local markets, and impactful global events, how do we determine if a multi-family opportunity has high enough potential to confidently invest our capital and present valuable ventures to our investors for their consideration?

Read on for a breakdown of the current major stressors on multi-family real estate deals, and some insight on how LREG Investments is seeking opportunities and navigating these challenges.

Interest Rate Volatility

Interest rates have moved up and down 120 basis points in the past four months, rapidly decreasing toward the end of the year and increasing in the present (Source: Freddie Mac). This instability is leaving owners in the midst of an acquisition or assets with floating rates in an increasingly difficult situation. Interest rates along with increased operating expenses have drastically cut into their NOI and proformas, and many owners are now in a tough position planning how to move forward with their assets.

The Interest Rates Used to Finance Multi-family Real Estate Over the Last Three Years have been increasing consistently in lockstep with the Feds Fund Rate and 10-year Treasury Market. (Source: Freddie Mac)

This rate increase has negatively impacted values and changed the calculus for evaluating an asset's potential return for investors. As an expert property buyer, the correct calculation of the interest rate impact of the present and future is critical to determining acquisition costs and financing structure to project a realistic and certain yield to investors in return for their dollars.

Increased Construction Costs and Operating Expenses

New developments have become increasingly challenging, and it is almost impossible to pencil competitive returns for investors. Increased costs of construction materials and labor have yet to abide and according toTradingEconomics.com, the price of 1,000 board feet of lumber has increased from $497 USD to $581 USD [17%] in the last year alone. These increased expenditures along with increased operating costs of wages, insurance, and property taxes have stifled development and forced many sellers to the sidelines. There are two types of remaining sellers: those who own assets purchased in the previous decade and can still turn a profit, or sellers of newly purchased assets (2020-2022) where the owner is being forced to sell due to a lack of refinancing options or the evaporation of future return.

To combat this lack of development opportunities, developers have transitioned to a property acquisition and improvement strategy. More property developers are choosing to renovate existing properties instead of building new ones to keep their organizations and talent engaged.

Those considering investing in acquired properties should look for a Sponsor with the following:

• An experienced Property Management Team
• A successful track record of executing property improvements and retaining occupancy rates while increasing rents.
• Structuring the appropriate financing to execute the business plan.

At LREG we have served our investors well with strong returns when holding an asset over a long duration, allowing Net Operating Income and value to grow and blossom through the economic cycles.

When investing with a Sponsor looking to simply 'fix and flip' a property, understand these are riskier opportunities. These endeavors are highly sensitive to scheduling delays, bad loans, and even labor price increases, which have the potential to halt progress and significantly cut into investor profits.

What We Talk About with Our Investors

When looking into potential multi-family investment opportunities, understand the upside and downside of the deal structure on the equity and debt side. How much capital is the Sponsor investing? What is the Debt-to-Equity ratio and what stress tests have the Sponsor calculated? Additionally, what mitigating strategies and contingency plans are on the table over the projected investment time horizon including the exit strategy? How much of the project is fixed debt vs. floating rate?

As an investor, take your time and do not rush into an investment. Ask questions. Be open-minded and think like an entrepreneur, not a bank credit officer. Your due diligence should first pass the laugh test and next be detailed, providing a story of reality, profitability, and potential risks.

The opportunities we consider at LREG can stand the test of time. We view opportunities on a long-term investment horizon to avoid the impact up-and-down cycles can have on asset value. We utilize quantitative analysis of employment, population, household formation, and supply and demand data in the immediate term and for the near future. Our success is achieved by implementing a proven management strategy with an experienced acquisition and property management team, allowing for a smooth transition in ownership. Finally, conservative underwriting and collaborating with dependable subcontractors are all the things that will separate our investment opportunities and dictate our positive returns.

There will always be a place for the tortoise owner/operators like LREG who march ahead slowly and steadily and focus on incrementally improving operations through rental revenue growth and managing operating expenses. When you invest with us, you are handing the reigns over to multi-family real estate wealth-building experts, resulting in higher earnings while containing risk over a long time horizon.