Many investors are invested in multifamily real estate with the preconceived idea that multifamily as an asset class is completely impervious to the effects of a recession and will continue to perform through any economic conditions.
Given the amount of content dedicated to multifamily investing circulating in the ether, it is easy to understand why investors have this preconceived notion. However, this is little more than an ideology, and is far from the truth.
Not all multifamily is created equal. Some Class C assets with a low socio-economic demographic may struggle to collect rent during a recession, some luxury Class A assets may face declining occupancy as prosepctive tenants search for more value in uncertain times, and some B class assets may actual benefit both from stable collections from a reliable tenant base, and increased demand from new tenants who no longer may be as willing to splurge on more expensive housing.
It is important to look at the finer details, rather than make generalizations about the asset class as a whole.
Another fact investors often hear cited is that during the 2008 crash, multifamily had the lowest mortgage defaults of any asset class. While this was true, it was mostly due to the fact that during that time, multifamily mortgages were predominantly financed by long term fixed rate agency debt.
This time around there are many assets that have been finance with floating rate, short term bridge debt and that is going to add a completely different dynamic.
Solid asset management is the best risk mitigant
As we have said many times before – when investors buy commercial real estate, they are really investing in a business, and how that business performs is largely determined by the business plan and the team behind it, managing the business to success or failure.
This is why asset management is such an essential part of successful multifamily investing. The success of the investment is dependent on the management team generating a realistic and achievable business plan, based on sound research, factual data, and reasonable assumptions. It is also highly dependent on that team managing the business through unpredictable market conditions.
The business plan must always be used as a guide, but market conditions are continually changing, and a good management team must be nimble and alert in how they pivot and change strategy as a result of these market changes.
We are seeing many operators pausing distributions – in some cases, it may mean that the deal is in trouble. In other cases, it may represent prudent management by the operator.
Current volatility within the debt and insurance markets, combined with the increasing reality that we may be facing a severe economic recession, is the greatest challenge facing investors and asset managers today.
While market conditions are creating cap rate expansion and an environment that is more favorable to investors looking to buy multifamily real estate, it is not a favorable environment for investors to sell or refinance owned assets.
The goal of asset managers who are currently responsible for owned assets, is to batten the hatches, and prepare the asset to weather the storm, and make sure that the business survives the turbulent waters long enough to see the clear skies ahead.
This leaves managers with some very tough decisions to make. In this environment, it may be best practice to pause distributions and hold cash in the business. This will provide the business with the additional reserves it may need to cover increasing uncontrollable expenses or make up for declining revenue due to higher bad debt, or declining rents and occupancy.
Although declining revenues is not guaranteed to be seen on all multifamily assets, it is very tough to predict the impact of an economic recession on an individual asset. Managers must hope for sunshine but prepare for rain.
Although many investors may be frustrated and disappointed when distributions are paused, it is important to understand that the alternative may be a capital call.
Investors should closely monitor the financials to determine the health of the business. Even though distributions may be on pause, the business could still be accruing cashflow, the managers are just waiting to distribute the cashflow until they are more certain about the impact of changing market conditions and the future capital needs of the business.
Communicate, communicate, communicate!
The most important thing managers need to do during times of economic uncertainty or market volatility is to communicate with investors so that investors know what is going on.
At the end of the day, asset managers are not only responsible for generating ROI, but also managing downside risk and protecting investor capital.
If the manager is shifting strategy or has identified a change in the market that they expect to have a material impact on the business plan, managers need to communicate the challenges they have identified, and the change in strategy they plan to implement, along with any change in the expected results.
Investors should not hesitate to reach out to their sponsors and asset managers and ask questions about market conditions or investment performance. Be aware of the headwinds. Be aware of any required changes in strategy and most importantly remember that you are investing in a business, and the success of that business is determined by how well it is being managed on your behalf.