“How dare that guy say this!”
I know that’s what many of you are thinking.
Yeah, I feel sheepish about it, too. But as the author of a book on multifamily investing, and a commercial real estate fund manager, I want to raise a flag…yet again…about the danger of overpaying for stabilized assets in an overheated market. Or passively investing in deals like this.
What am I talking about…and who does this apply to?
This post reviews how potential cap rate decompression could lead to a significant drop in the value of your assets…and how to avoid or overcome this potential danger.
This could apply to you if you are a passive investor in multifamily or any other commercial asset type that is valued by this formula:
Value = Net Operating Income ÷ Cap Rate
This applies to apartments, self-storage, mobile home parks, RV parks, senior living, industrial, hotels, malls, retail, cell towers, and more.
So why am I picking on multifamily?
Partially because I had the “humility” to entitle my 2016 apartment investing book, The Perfect Investment, I feel responsible for ensuring investors know what they are getting into. The “perfect investment” isn’t perfect if you overpay to get it.
Now that said, many apartment investors aren’t overpaying. Some are crushing it and making millions for their investors. I’m visited one in Dallas last week who is doing just that.
But I’m concerned when I see so many telltale signs of a potential bubble. And so many assumptions about rent growth, continued cap rate compression, and high LTV debt with aggressive assumptions about interest rates. But that’s not all.
I’m really concerned about syndicators/investors making risky bets on assets that great operators already run and have optimized/stabilized. Many of these will need to hope and pray for inflation with continued low-interest rates to survive.
While I’m all for hope and prayer, this is not the best business strategy….