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How to Make Inflation Your Friend

Central banks like the Federal Reserve battle inflation – the general rise in prices—by boosting interest rates. In a benign environment, the rate of inflation is low, but as the economy heats up, inflation increases and robs the local currency of some of its buying power. By lifting interest rates in small increments, the Fed moderates the economy by increasing the cost of capital, that is, how much interest you have to pay to finance a project with borrowed money. Some potential projects will not go forward because they can’t generate the required rate of return necessary for investment due to the higher cost of capital. After all, the more of the project’s revenues that must be spent on interest and higher costs leaves less to compensate investors for committing their money to the investment.

As inflation and interest rates rise, what happens to multifamily real estate investment? In general, real estate values rise along with, and act as a hedge against, inflation. But the devil is in the details, and it takes the right combination of management, financing and location for a particular real-estate investment to benefit from inflation.

Make Inflation Your Friend 

Inflation and its accompanying interest rate increases affect a multifamily real estate investment in several ways. Let’s break it down.

This is how stock markets sometimes operate, with seemingly endless trends suddenly interrupted and/or reversed. A long bull market tends to attract ‘’weak” investors who are not accustomed to, and can’t stomach, a sudden sell-off. Weak investors are the first to sell their stocks when prices begin declining, which can have a snowball effect that causes volatility to skyrocket.

Net Operating Income (NOI) 

A property’s NOI is its revenues from rents and fees minus the costs of operating the property. For a property to benefit from inflation, its income must grow faster than its expenses. In the context of a multifamily property, this means that the rent increases must at least keep pace with the inflation rate, while costs require tight control to keep their rise below the inflation rate.

A good investment property in an inflationary environment will support sufficient rent increases with each lease renewal, which in turn depends upon the value perception of tenants, lease terms, and the availability of competing rentals. Improved property management can increase occupancy rates and rents by addressing structural and operational problems. Operating expenses can be controlled in numerous ways by better, hands-on property management, including switching to lower cost vendors and suppliers, more cost-efficient and effective marketing, and repairing costly problems. All of these are features of a value-add strategy, the hallmark of Lloyd Jones investment properties. The ideal property must pass our proprietary screening protocols that evaluate a property’s suitability for value-add. In other words, we need to make sure the value we add through rehabbing and better management will increase NOI. At Lloyd Jones, very few properties make it through our tough screening.

Net Profits

NOI does not include the cost to finance a property with debt – that is, the interest rate on the underlying mortgage. Net profits, on the other hand, do indeed depend on ensuring that financing is structured to provide maximum protection from the rising interest rates that accompany inflation. Here are several of the strategies we use:

1. Sensitivity analysis: Our screening protocol projects how a property’s value will fare if interest rates rise when we refinance the property (to unlock and extract equity) at the end of the value-add period, typically two to three years after purchase. We model the sensitivity of the investment’s return to a wide spectrum of interest rates so that we can quantify the risk involved in refinancing during an unfavorable borrowing environment.

2. Control leverage: Debt is indispensable to most real estate projects, but too much debt, or leverage, can swamp an investment with unsustainable interest expenses. We typically structure multifamily investments with a 70 percent cap on loan-to-value. In other words, our financing requires 30 percent equity contribution from investors to limit exposure to rising interest rates. We also observe conservative borrowing standards – we take only non-recourse loans (the property alone serves as collateral, and the lender cannot attach other investor assets), and never cross-collateralize our properties (meaning the default of one property doesn’t affect the financing of any other property).

3. Build a cash cushion: By specializing in value-add properties, we have the ability to build a cash cushion that wouldn’t be available from a stabilized property. This cushion can help protect the investment even if high interest rates negatively affect property values and cash flows.

4. Flexible debt: We often use a mix of fixed and floating-rate debt with staggered maturities. This helps keep interest costs low during the value-add period and helps us avoid overly-large refinancing tranches. We also like to structure our loans for terms of at least five years, which gives us a two-to-three-year cushion following the value-add period to refinance. This can come in handy if interest rates spike two to three years after property acquisition.

5. Reap what ye sow: We constantly evaluate whether it would benefit investors more to sell the property rather than hold it. This reduces our investment exposure during periods of rising interest rates. At the same time, we carefully manage our own cash position and debt facilities to weather rough market conditions without having to succumb to panic selling due to a cash crunch.

Property Value

The total return from a real estate investment is composed of the net cash flows and capital appreciation. The value of a properly selected and managed multifamily property should appreciate with inflation. Two factors are at play:

1. Higher rents: The value of a rental property is fundamentally tied to the rents it generates. Periods of high inflation produce rising wages and profits, conditioning tenants to pay higher rents for a given space and thereby boosting property values. Consumers with a greater sense of wealth will be motivated to move to nicer apartments, creating higher demand and higher rents.

2. Restricted construction: As inflation increases, construction costs rise (due to higher material and labor costs) as does the amount of interest charged for construction loans. These factors tend to restrict new construction, helping to limit the supply of competing housing.

Increased demand and decreased supply equates to higher property values and the prospect of greater capital appreciation during times of high inflation.

In summary, multifamily real estate investments can perform well during inflationary times if the properties have the right characteristics and are managed with a strong, knowledgeable hand. We invite you to speak with us about our past performance during all types of economic environments, and the opportunities we see right now in the multifamily and senior community market segment.

About Christopher Finlay
Christopher Finlay is chairman/CEO of Lloyd Jones Capital, a private-equity real estate firm that specializes in the multifamily sector. For the past thirty-seven years, and through every economic cycle, he has owned and operated successful multifamily businesses. Predecessor companies include commercial brokerage, appraisal, property and asset management, construction, and development.

Headquartered in Miami, Lloyd Jones Capital acquires, improves, and operates multifamily real estate in growth markets throughout Texas, Florida, and the Southeast on behalf of institutional partners, private investors, and its own principals.

How Does Stock Market Volatility Affect Multifamily Real Estate Investment?

The short answer is that stock market volatility increases demand for multifamily real estate investment, because real estate is much less volatile than stocks. For those who don’t want to invest all their money in the roller coaster stock market, real estate is, over the long run, a relatively tranquil alternative. Let’s dig deeper into the concept of volatility to explore the differences between the stock and real estate asset classes.

Something’s Happening Here

Volatility is, according to Investopedia, “the amount of uncertainty or risk about the size of changes in a security’s value.” The higher the volatility, the greater the chance that a stock’s or index’s value will suddenly and dramatically change.

A volatility spike in February 2018 awakened many stock investors to the fact the fact that stocks also go down. It’s been a long bull market, and we haven’t had a meaningful correction in more than two years. Suddenly, the Dow Jones Industrial Average dropped more than 1,000 points twice in February, a clear sign of heightened volatility, if not outright panic.

Now, take a look at the following chart. It’s a one-year chart of the Chicago Board of Exchange’s VIX Index, which measures the volatility of stock futures and options. The spike in February is all the more startling when seen against the flat backdrop over the last year.

This is how stock markets sometimes operate, with seemingly endless trends suddenly interrupted and/or reversed. A long bull market tends to attract ‘’weak” investors who are not accustomed to, and can’t stomach, a sudden sell-off. Weak investors are the first to sell their stocks when prices begin declining, which can have a snowball effect that causes volatility to skyrocket.

The Volatility Opportunity

Sudden bouts of volatility create an opportunity for you to think about your own tolerance for risk. Perhaps you invest in the stock market to reap current dividend income, only to realize in horror that a sudden decline in stock value can wipe out years of dividend payments. By the way, the so-called safer bond market is also vulnerable to abrupt bouts of volatility, creating losses that overwhelm interest income. Which brings us to our point: Thoughtful investors look to lower their risks as they seek to achieve their investment goals, and multifamily real estate investing is one of the surest means of accomplishing this strategy, because it offers steady long-term income with very little volatility. Let’s see why:

  1. Diversification: Real estate market returns are not closely correlated to those from stocks, creating an excellent vehicle for diversification. As stocks bounce higher and lower, real estate follows its own course that can help steady the value of your total portfolio. Many financial advisors recommend prudent investors allocate at least 25 percent of their portfolios to alternate investments such as real estate.
  2. Rents vs dividends: During bear markets, companies that find themselves in financial distress often cut their dividends to conserve cash, which takes only a vote by the board of directors to accomplish. Tenants, especially ones living in carefully screened multifamily apartment complexes and senior communities, are highly motivated to keep paying their rent, making it a much more reliable source of income to investors. The multifamily advantage over single-family rentals is due to economies of scale: More separate rental cash flows per square foot. That translates into lower overall management costs and a smaller impact when the occasional collection issue arises.
  3. Alignment of interests: It’s upsetting enough when your stock suddenly loses a good share of its value in a volatile market. Adding insult is the fact that the stock broker or analyst who recommended the stock need not own a single share. Brokers make their living from commissions, which gives them a financial incentive to favor volatility and the churn it creates. By the way, fund managers don’t have to invest in their own funds either. We do things differently at Lloyd Jones, in that we take an equity stake in every one of our properties. In other words, we align our interests with those of our investors.

The Value of Specialization

Many stock investors seek to lower their risks through the purchase of mutual funds and exchange-traded funds. True, this will lower non-systemic risk, but at a cost – you have no control over the choices made by the portfolio manager. If you seek out the best fund managers, you should keep in mind that they will probably charge higher fees and in the long run will likely underperform the market – just ask Warren Buffet.

Purchasing an index fund doesn’t solve the control problem. They are cheap, but by definition give you average returns and average risk, meaning you don’t benefit from expert specialized knowledge since these funds run on auto-pilot.

Lloyd Jones believes you can do better than average when you apply specialized expertise to given segments of a market. We do this through first through geographical specialization, by investing in business-friendly, low-tax states in the Southeast, especially Florida and Texas. Senior and multifamily housing investments are favored in this region due to warm weather, low costs and low taxes.

Geography is a good start, but it takes a lot more to identify real-estate investments with solid cash flow prospects and low risk. We select properties with good cash flows that would benefit from more capitalization or better management. Only one percent of properties make it through our screening process. These are the ones we acquire and operate, and in doing so add value for all investors, including ourselves.

Specialization pays off in this context without sacrificing the benefits of diversification. For one thing, each property stands alone, without cross-collateralization, to isolate any problems from affecting other properties. Our funds provide diversification by spreading risk across eight to ten properties in at least four different markets, and specialization by choosing our markets, property types and properties carefully – a small subset of the total market.

There is no better time than right now to redeploy some of your stock and bond market assets to multifamily real estate investments. Recent volatility spikes are a warning of rough seas ahead, but carefully selected real-estate investments have the ability to steady your portfolio in the most turbulent times.

Post Script:  Based on the front page of the Wall Street Journal of 2/26/18, margin bets will continue to fuel market volatility.

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About Christopher Finlay
Christopher Finlay is chairman/CEO of Lloyd Jones Capital, a private-equity real estate firm that specializes in the multifamily sector. For the past thirty-seven years, and through every economic cycle, he has owned and operated successful multifamily businesses. Predecessor companies include commercial brokerage, appraisal, property and asset management, construction, and development.

Headquartered in Miami, Lloyd Jones Capital acquires, improves, and operates multifamily real estate in growth markets throughout Texas, Florida, and the Southeast on behalf of institutional partners, private investors, and its own principals.

So, What’s An Investor To Do?

“The golden era [of stocks and bonds] has now ended,” says a McKinsey & Company report issued last year. The report suggests that returns on equities and fixed-income investments could see significant decreases – up to 400 or 500 basis points over the next twenty years.   According to the report, this will affect everybody, from pension funds that will face larger funding gaps; asset managers who will see lower fees; and insurers whose earnings depend on investment income.  And on a personal level, the new generation of retirees will retire later and with less income.

And more recently, Bloomberg reported that “U.S. markets are at their highest risk levels since before the 2008 financial crisis… according to Bill Gross, manager of the $2 billion Janus Henderson Global Unconstrained Bond Fund.” The article continues, “Gross said that ‘…returns are going to be lower.’”  These thoughts are echoing throughout the industry.

To prepare for the new era, investors are seeking alternative investments.  Many are choosing real estate. And with good reason. In fact, as far back as 2012, a JP Morgan paper suggested that real estate is no longer an alternative, but rather a “way out.”  “An alternative no more.”  Just look at the endowment portfolios of major academic institutions, led by Yale whose successes are legendary. Yale has allocated 12.5% of its investment to real estate.

Maybe it’s time for you to consider investment alternatives and diversifying your investment portfolio by adding real estate. Why?

Reduced Volatility
Real estate is stable, unlike the stock market that reacts to every nuanced whisper in politics or the economy.  It is not correlated to the stock and bond markets. Real estate offers a steady, reliable return.   Studies show that, by adding real estate to a mixed portfolio, you will see an increase in returns and, perhaps even more important, a reduction of risk based on return/unit of risk.

I’m not talking about a REIT.  A REIT is like a stock; it goes up and down with the equity markets.  I’m talking about a direct investment in private equity joint venture or a fund.

Cash Flow
Cash flow is the key.  You should receive, at the very least, six-plus percent annual return on your investment. Our goal in today’s market is yield – a reliable, on-going cash flow return.

And this is not about short term. The days of “fix and flip” passed us a couple of years ago. Now, we hold our properties for several years while enjoying the steady cash flow and substantial appreciation.

Hedge Against Inflation: Anticipated and Unanticipated
We factor anticipated inflation into our underwriting projections.  We expect an increase in expenses, and we project an increase in rents to cover them.  Remember, real estate is a hard asset.  As new construction costs increase, the cost of replacing the existing structure also rises (along with its value) creating yet another potential hedge against unanticipated inflation.

Capital Gains

When you get your money back, it is treated as capital gain, a favorable tax rate.

The Private-Equity Real Estate Fund          

We like funds. You will, too.  But it is important to focus – and to focus on an asset class your investment partner knows and understands.

Focus
At Lloyd Jones Capital, our focus is middle-income housing. It’s what we have been doing for years. According to virtually every demographic study, the supply will never catch up to the demand.

And we focus on Texas and the Southeast, home to ten of the 15 fastest growing cities plus seven of the ten “best cities for job growth.”  We like to be where the people like to be. Plus, we have existing operations throughout these markets.

Diversification
We like funds because you can spread the risk as an investment alternative among various properties and geographic markets. A disappointing performance of one asset will not affect the others. In fact, the others will most likely compensate for it.

We like eight to ten properties in four or more different markets for maximum diversification. We have operations in every market we serve, and our local presence gives us a tremendous advantage in finding, acquiring, and operating properties within these territories.

Stand-Alone Entities
Our fund structure allows us to hold our investments property by property. Each one operates as a separate business. There is no cross-collateralization.  A market slow-down in one area will not affect the other properties. We prepare a business plan for each specific property, and we can choose individual hold terms and disposition times.

Alignment of Interest
We believe in our investments; we are thoroughly committed to them, so we participate financially in every one, alongside our investors.

So, what’s an investor to do?
I suggest that we all heed the words of today’s best-known economists and be prepared for the unknown future of the equity and fixed-income markets.  It would be wise to look at this asset class as an investment alternative diversify your portfolio with multifamily real estate. Private-equity real estate offers protection from stock market swings and a hedge against inflation.  It provides a steady cash flow, appreciation, and great tax advantages.  What other asset class says that?
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About Christopher Finlay
Christopher Finlay is chairman/CEO of Lloyd Jones Capital, a private-equity real estate firm that specializes in the multifamily sector. For the past thirty-seven years, and through every economic cycle, he has owned and operated successful multifamily businesses. Predecessor companies include commercial brokerage, appraisal, property and asset management, construction, and development.

Headquartered in Miami, Lloyd Jones Capital acquires, improves, and operates multifamily real estate in growth markets throughout Texas, Florida, and the Southeast on behalf of institutional partners, private investors, and its own principals.

Affordable Housing – It’s time to shake it up.

Once upon a time, not so long ago, the American dream was to own a modest home in which to raise a family. This was more than a dream; it was an assumption, an expectation. Even the lowest-income workers aimed for and usually achieved, this dream. Not anymore. There is a tremendous last of affordable housing. Millions of our working families cannot even afford a rental apartment.

But that can change. I submit that we can double affordable housing assistance without increasing funding. We currently spend

$50 billion for affordable housing programs

plus

$130 billion to assist non-low income households via tax deductions

Billions. That’s a lot of money. Where does it go?

1. Affordable housing.

Federal and state governments have literally hundreds of programs designed to provide housing assistance – $50 billion worth. This massive bureaucracy comes at a tremendous cost to efficiency, and it meets the needs of only a fraction of the very-low-income population. Plus, it drives up the costs.

2. Assistance for home-owners

We spend $130 billion to assist non-low- income households through mortgage interest and real estate tax deductions. $130 billion to home-owners when we have homeless families?

I’ve just finished reading a 2015 report by the Congressional Budget Office (Federal Housing Assistance for Low-Income Households). It looks at several potential policy changes to address the problem of affordable housing: revising the composition of the assisted population, adjusting tenant contributions to the rent payment on HUD’s voucher program, and repealing and/or replacing various programs. (Just repealing the LIHTC [Low Income Housing Tax Credit] program would increase revenues $42 billion over the next 10 years per the Joint Committee on Taxation.)

This CBO report is an analysis of various options; it offers no solutions. I propose an additional option, but first, we have to address the real issue.

The real issue:

In my opinion, these options do not address the underlying problem: the massive bureaucracy inherent in any government program. Layer upon layer of bureaucracy: administration, multi-tiered approvals, pages and pages of legislative rules and regulations, legal fees, accounting fees, compliance fees – and record maintenance into perpetuity. In one of my LIHTC compliance newsletters, the writer took over 350 words to explain “simply” which income limits to use to qualify a household. If it takes 350 words to tell me which year’s income limits I must use, it’s not simple. It takes attorneys, accountants, and compliance experts to understand the intricacies of each program. How many thousands of people are involved in every project? It’s very expensive to produce affordable housing. I recently read that the cost to construct a low-income housing tax credit unit is $250,000 – for one unit!! I suspect that same unit, market rate, would come in around $150,000.

My Proposal: Let’s dismantle the entire bureaucracy!

Let’s use the funds – from all sources – and provide assistance directly to the end user whose income is too low to afford a median-income rental apartment.

How many would qualify?

According to the CBO report, in 2014 the federal government provided about $50 billion in housing assistance to 4.8 million low-income households. But we have 20 million eligible households (those earning less than 50% of Area Median Income), so we still have 15 million very-low- income households that receive no assistance.

And what about those between 50% and 100% of median? Families earning $30,000 to $60,000 dollars? According to a 2015 report from Harvard’s Joint Center for Housing Studies, 20 percent of households earning $45,000–$74,999 (median area income range) were cost burdened in 2014.

The term “cost burdened” typically refers to those paying more than 30 percent of income on housing expenses, including utilities. In my opinion, that definition should be raised to 35 percent or 40 percent.

New System:

Now let’s design a system to provide funds directly to the end user– the household or person needing the assistance. Note that I said “directly.” Let’s cut out the middlemen. Let’s keep it simple. Basically, the recipient needs to prove his/her income, perhaps with an income tax return.

Households whose incomes are below national median income (adjusted for family size) will receive a stipend to supplement their incomes to the point that they can afford a median income rent (i.e. 30 percent of national median income.) This stipend will allow renters to go to any apartment in the country and rent whatever they want and wherever they want.

Assume national median income is $55,000. (In 2015, it was $55,775, per US Census.) Affordable rent for a median-income household of four is $1375 per month. ($55,000 /12 x .30)

So, let’s make sure every household can pay $1375 (adjusted for household size).

For instance, if the household earns only $40,000, it can afford $1167 without being overburdened. That household would receive a monthly stipend of $208. ($1375-$1167)

What if the household lives in a high-income area? Let’s take Dallas as an example.

Median income is $71,700, so median income rent is close to $1,800. This same household would have a choice: Stay in Dallas and pay an extra $450 out of pocket (The difference between national median rent and Dallas median rent) or move to a more affordable community. Again, it’s a choice.

The point is: instead of spending billions of dollars on bureaucracy and expensive production, give the money to the end users. Let them decide their own priorities. Proximity to work? Superior school system? Or maybe someone just likes a blue building. Whatever. The recipients may decide to spend more (or less) than 35% of their income on housing (like our Dallas household). That’s OK.

They can’t do that now with a HUD housing voucher. HUD restricts the amount they can pay, so they have no choice of lifestyle or location, or even the number of bedrooms, for that matter.

Employment- a very important issue

I’m talking here about low-income wage earners. There’s no employment requirement to receive HUD housing vouchers. In fact, the CBO report refers to studies that indicate receipt of a voucher reduces both household employment and earnings. About one-half of HUD’s housing voucher and public housing recipients are of work age and able-bodied, but only half of those count work as a majority of their income. Their other income comes from supplemental non-housing assistance.

In my plan, to receive the proposed stipend, households must show a willingness to work, preferably in a full-time capacity. But, per the report, the cost to wean recipients off housing assistance will cost about $10 billion. (more bureaucracy/administration?)

What has happened to common sense? Our voluminous legislative regulations, encouraged by special interest groups have us so tied up in “programs” that we are failing the working American family. There’s a lot of talk about adjusting programs, but I am talking about eliminating them.

Of course, my broad-brush vision is just that – a general concept. But it is based on my thirty-five years in the multifamily industry, as LIHTC developer, manager and now, investor. I think the number crunchers will show it can work. To get from here to there, however, will not be an easy task.

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.

Skip the Flip in Multifamily Investment

It’s time to go long.

Historically, multifamily investment has been about long-term, cash-flow returns. However, in recent years, as the industry caught the eye of private equity, the emphasis turned to a property’s IRR or Internal Rate of Return.

The “fix and flip”, the “value-add” became the standard: short hold, quick fix, big return. And the multifamily real estate buying frenzy began. The strategy has proved to be very profitable over the past five or six years, but in my opinion, those days are (almost) gone – for several reasons.

TODAY, THERE’S NOT ENOUGH MEAT left on the bones of C and B properties to ensure investors of increased rents and resultant returns. The fix and flip strategy had been to buy an apartment community and execute a “value-add” to approximately 20% of the units, thus leaving “meat on the bone” for the next investor. At the same time, the investor would raise the rents to cover the cost of the improvements. So rents increased, NOIs rose, prices went up, and the buying frenzy continued.

The next investor then thought he could upgrade another 40% of the units. But in fact, as cap rates fell and he had to pay more for the asset, he had to rehab 70% or 80% to reach his hurdles, leaving almost nothing left for the following investor. Consequently, today, after a couple of “flips”, most “value-add” deals don’t make financial sense.

RENTAL RATE INCREASES  Because of demand, rents have risen sharply in nearly every market, but according to economists, that increase should moderate to about 3.5 to 4% due to new construction coming online. Consequently, investors cannot assume drastic rent increases in their acquisition proformas. If it doesn’t work now, it won’t work in the future.

THE ECONOMY:  We’re long into our economic expansion cycle having exceeded the historic five-year average, but today in the US, growth is virtually stagnant. Are we reaching the peak? The good news is that multifamily real estate will continue to be among the strongest asset classes (if not #1) for reliable, steady returns regardless of the stage of the economic cycle. Why?

DEMAND: There is still an unfulfilled demand that is expected to be with us for a long time. That is the multifamily investment’s ace in the hole. Seventy-five million millennials plus another 75 million baby boomers. The multifamily rental business is poised to perform better than any other asset class. We have all read about millennials and their student loan debt and inability to afford a home. I personally think it has little to do with money. It’s about lifestyle, flexibility, and priorities. Young people want flexibility to move to that next job; they want amenities and social interaction. A house is not a priority to them. Retiring baby boomers, on the other hand, have “been there; done that.”  They are ready to free themselves from the burdens and expenses of home ownership. Whatever the reason, more people are renting today than at any time in the past 51 years.

INTEREST RATES: This brings us to interest rates – a very key and important ingredient in real estate investment. Who knows what might happen next? Answer: Nobody. One thing we do know: there’s little likelihood of a reduction in interest rates, although it’s not impossible. In Europe, where the real rate is in negative territory, some banks are considering storing money in their vaults because of the negative yields. It costs them money to make loans! And the US is getting close to that level. (See my blog post from June 14, 2016, titled “Is it time to keep your money under the mattress?“) But luckily for the multifamily investment industry, this big question mark can be taken off the table. We can counter the risk by locking in fixed rates today. We know what our debt will be for the duration of our investment.

So what does all this have to do with “going long”?

Multifamily investment is probably the most stable, reliable investment one can choose. But the strategy has changed. It’s time to “go long.” Forget about the unrealistically high-return value-adds so prevalent at the beginning of this cycle. They no longer exist. Lloyd Jones Capital recommends buying quality properties that produce consistent cash flow. Focus more on yield than IRR. Consider a long-term hold and do not over-leverage. Then, assuming good management, you should enjoy a reliable, long-term return on your investment.

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.

Thank You, Harvard. New Study Confirms Multifamily Rental Growth

Thank you, Harvard.

Once again, Harvard’s Joint Center for Housing Studies has published a brilliant paper on the status of rental housing. This study supports what we have been saying for the past couple of years– but says it much better than I can. I thought I would share some of the findings relevant to the multifamily investment community and add my two cents. (You can ignore my two cents, but do read the study. It is very interesting.)

 

Among the findings:

Renter Households Number Almost 43 Million (Out of 116 Million Households)

  • Renters now represent 37% of all households, the highest number since the mid-1960s.

That’s a lot of renters, and they need decent housing.

 

Rental Demand is Broad-Based

  • Income: Renters in the top income bracket grew by 61%. In fact, households with incomes of $100,000 or more accounted for 18% of the rental growth from 2005 to 2015.
  • Household size: Single-person households or married couples without children represented half of the growth.
  • Age: The number of renters aged 50 and over grew 50% in the past ten years. In fact, Baby Boomers (50+) represented the largest share of rental growth.

In fact, households of all generations and all income levels have created an increasing demand for rental housing. We now have 43 million renter households in America. And Millennials – the typical, young, first time renters – are still living at home – 25 million of them! Add that to the current 43 million. On top of that, Baby Boomers are predicted to occupy another 12 million rental units in the coming years. That’s a huge pent-up demand! These are astonishing rental housing demographics. And the study suggests that growth in the adult population alone will increase these numbers.  

 

Investors Are Seeing Strong Returns

  • Annual returns grew to 12% in the 3rd quarter of 2015. Historically they have averaged 9.5%.
  • Cap rates are down to about 5 percent, the lowest since the housing bubble.

And this is why Lloyd Jones Capital advises caution when investing in multifamily real estate assets. There is too much capital chasing too little supply. You have to be very careful not to be caught up in the real estate buying frenzy. And be sure you have a seasoned operator who can manage the investment asset.  From personal experience, we know the importance of dedicated property management to the success of any project, which is why we have worked very hard to create the finest management arm in the industry.

 

Housing Affordability is a New Challenge

  • Housing costs are up 7% in real terms since 2001; median renter household income is down 9% in real terms.
  • “Burdened renters” (those spending more than 30 percent of income on housing costs) now number 21.3 million, half of whom are severely burdened (spending 50% of income on housing costs).
  • There are 11.1 million extremely low-income renters (30% of median income) and only 7.2 million units affordable to them.

There’s a lot of new multifamily rental construction, but it is only for high-income renters. The very-low-income renters have at least some assistance. It’s the middle-income American workforce that lacks a supply of quality housing.

 

Federal Assistance Falls Short

  • Since its inception in 1986, the Low Income Housing Tax Credit (LIHTC) Program has added or preserved more than 2.2 million units. (However, many affordability periods will end between 2015 and 2025 which could jeopardize affordable housing options.) This program provides affordable housing to households earning less than 50% or 60% of median income.

This sounds good, and the LIHTC units are typically well constructed and well maintained. As a developer of approximately 40 LIHTC communities throughout the US, I know the program well. However, what began with great intentions during the Reagan era, has subsequently been diluted by all the layers of bureaucracy and special interests. Now, in fact, the cost to construct a LIHTC property can be double that of a market rate, Class A property.

  • The United States Department of Housing & Urban Development (HUD) has programs, including the voucher assistance, which cover very-low-income households (those earning less than 50% of median income). But real funding for those programs remains below 2008 levels. And the average wait time for a voucher is 23 months.

I have some suggestions here, but will leave the details up to those who understand the HUD housing programs better than I. There are a lot of programs for the very poor. But what about the American workforce that also struggles to find affordable housing? These households don’t have all the assistance that is available to the very low income households. If you took all the money poured into various programs, including LIHTC, and applied it directly to vouchers, I suspect households would be moving out of bad neighborhoods and into safer communities. First, I would expand the voucher program. I would include households above the “very low-income” levels (50% of median income). I would give the low-to-middle income earner some financial assistance, and then let the household choose a neighborhood. Right now, the household is limited by the maximum rent HUD decides is appropriate, and often that is not high enough to meet the asking rent in a nice property. Let the voucher holder contribute to the rent. Let the voucher holder decide priorities. It might be worth being “burdened” in order to live closer to work or in a highly rated school district.

Again, at Lloyd Jones Capital, we are a real estate investment firm that is addressing this issue with our American Workforce Housing Fund. Through this fund, we are acquiring C and C+ properties in good neighborhoods. With modernization and upgrades, we can give these communities amenities similar to those found in Class A properties. And the rental rates remain affordable.

In summary, this is fascinating information regarding the multifamily real estate sector. The Joint Center for Housing Studies of Harvard University does an exceptional job compiling and presenting the data. The study is full of interesting charts and facts. At Lloyd Jones Capital, we have been saying these things for the past couple of years as we follow trends in cap rates, occupancy rates, etc. We are grateful to Harvard for supplying the quantifying support. You can find the complete study with abundant charts and data here.

 

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.