by Dwight Unti, CPM
(used with permission; edited for brevity)
After nearly 30 years of apartment development, investment and management I'm wondering why I still fall into the old trap of letting current economic circumstances affect my judgment about the long term, intrinsic value of apartment investments. Am I slipping in discipline and focus or are my defenses just not sufficient to thwart the volume and speed of negative information currently spewing forth about capital markets, real estate values, cash flow, vacancies and other apparent measurements of doom?
Unfortunately, I'm having a hard time fighting the feeling that I should just dump all my apartment investments. I mean apparently they've dropped in value along with everything else and according to some prognosticators they may just fall a lot further.
Oh, I know they still produce excellent cash flow and tax shelter, but who cares about minor stuff like that anymore? Haven't you heard, all real estate has plummeted and no longer offers much in the way of real value?
You see what's happening to me don't you? I'm letting current economic circumstances cause me to stop thinking like an investor and start thinking more like a banker or appraiser. It's a condition where you start to judge everything up ahead by what you see immediately behind. A little like walking down the sidewalk with your head partially turned backwards - as if someone is sneaking up on you. No wonder bankers and appraisers are a bit frightened these days - I would be too.
Okay, I'm being somewhat facetious, but my observation does seem to have some merit based on real world experience. Let's start with lenders. The buildings they once coveted as quality security for loans are now viewed as some sort of liability rather than asset. Traditional lender guidelines about vacancy rates, expenses per unit, debt coverage ratios and loan-to-values, all completely acceptable just a short time ago, are now entirely unacceptable. Where are they looking to reach this conclusion? They're looking back down the sidewalk. What they see immediately behind are increases in vacancy, rent concessions and soft economic conditions. Using this data and the look behind approach, they readily conclude apartment values are trending down for the foreseeable future. Oops, delete the word "foreseeable" - that's not allowed when living by the "look immediately behind" theory. Values are down and that's all you need to know.
Plenty of appraisers are also apparently on board with the "look immediately behind" theory. I suppose I can partially excuse appraisers for this practice because when you look at what they're charged to do and how they are told to do it -- it's pretty hard for them to look anywhere else. One thing is for certain, appraisers are under pressure from lenders to confirm they aren't overvaluing assets. The result is many have taken to carefully documenting downward trends. It's not hard to do when looking immediately behind. Just take the very few and mostly distressed sales over the past year and measure how far they've fallen from the over-inflated and mostly unrealistic values two years ago.
Boy, you get a good looking downward trend line when you go through that exercise. Now just apply the downward trend to all known apartment investments. Sometimes the process even produces humorous results. For example, by applying this approach, the same appraisers who two years ago concluded their clients were sitting on a gold mine of apartment investments now conclude their clients are sitting on empty mine shafts which are about to collapse!
Honestly, the speed at which apartment values have been revalued over the past several years is a fascination. It's been more like watching the stock market than a traditional real estate market. You know what I mean - up 20% this year, down 30% the next year. And much of this occurs without logical explanation and despite the fact the underlying investment chugs along producing a consistent net operating income. It seems the only difference lately between my stock broker and some appraisers is my stock broker always tries to make me feel better about a loss. True, my stock broker often resorts to a convoluted and nonsensical explanation for the loss, but I appreciate the effort and it can be quite entertaining. Appraisers, on the other hand, have become much drier and don't even attempt to explain away the pain. I've concluded it's more fun talking with my stock broker.
When I fight back against the slippage into banker/appraiser thought patterns and start thinking like an investor again, it brings up the strangest observations.
For example, did you know that demographic data indicates a surge of people will be entering their 20's in the next few years? As I recall, aren't those the same people who often rent? And what about the growing population of elderly who are choosing, with ever greater frequency, to exit ownership and seek low maintenance rental housing? Or how about the fact that few people are buying homes and it may take a generation for home buying confidence to return? And let's not forget the growing immigrant population and the positive impact it has on rental demand. Lastly, has anyone noticed that nothing new is being built and the supply of apartments will soon fall far short of demand? Doesn't this sound like the basis for an upward trend in apartment values, not down?
- Why is it so few apartment sales are occurring?
- Is it really caused by the lack of financing, distress in the capital markets and/or softness in the economy?
- Is there an absence of buyers or is it more about an absence of sellers?
- Could it be that apartment owners are simply refusing to part with their assets because they actually think they're worth something?
- Are apartments really in a long downward value spiral as current and "look behind" theory would suggest?
- Is there another answer that I just can't see because of the influence of too much coffee?
What are Joe Weston or Paul Labby doing? They're very smart, experienced and more often right than wrong abou the direction of the apartment market. So what are these fellows up to these days? From what I can tell they seem to be calmly holding to their apartment assets and looking to acquire more. I'll be darned they're thinking like investors, looking ahead and liking what they see. Hmm, maybe these apartment investments have some value after all.
Note to my dear friends in the finance and appraisal business. You guys are the best and I mean that, but things are getting a little out of hand. Rest assured, apartments remain an excellent investment and are only going to get stronger over the years ahead. It's now time to get moving again, not with free money or inflated appraisals, but with sound and reasoned underwriting and quality appraisals based on realistic market trends.
Dwight Unti, CPM is President of Tokola Properties, a real estate development, construction and property management company focused on multifamily and mixed-use development in Oregon and Washington. Mr. Unti is a Past President of the Columbia River chapter of the Institute of Real Estate Management and past board member of the Metro Multifamily Housing council.
