Want to Buy a Building? Three Reasons to Think Long Term.
With the Republican and Democratic primaries in full swing, presidential hopefuls have been touring the country to offer their stances on key issues. One topic that has garnered attention is what politicians call “quarterly capitalism.” The term describes the pressure investors put on corporations to take short-term actions to achieve quick returns, and some argue that the push toward immediate results distracts companies from pursuing their long-term strategies.
Politics aside, the concept of investing with a focus on the short term is an important topic when considering today’s real estate environment. When speaking with buyers about multifamily acquisitions in New York City, the recent trend of investors is to purchase one or more assets, boost net operating income and then sell or refinance the properties in less than three years.
Many of these buyers have little direct experience in the New York real estate market and are often focused on secondary markets in the outer boroughs, including the South Bronx and East New York. Many have raised equity from foreign investors, and their business plans are predicated on successfully increasing a property’s rent roll through the destabilization of regulated units. Many of the individuals interested in this approach are younger investors (often 25 to 35 years old), who found early success by purchasing distressed assets during the last downturn and then watched values rise as the market regained strength.
While it’s true that a rising tide lifts boats, it is also true that when the tide goes out, you can see which boats are in the best shape. Of course, these investors may prove successful in the short term, but come the next recession, we may find many walking away from properties unenthusiastically. With that said, it’s my belief that investing in New York City real estate involves a long-term commitment for three reasons
First: Unlocking value through the conversion of rent-regulated units to market rate is a complex process that takes both time and expertise. New York State’s website has more than 40 different fact sheets addressing the various intricacies of rent control and rent stabilization in the city. Furthermore, housing policies continue to evolve in favor of tenants, as Mayor Bill de Blasio has made affordability and increased tenant protection a priority for his administration. Historically, the most successful investors in rent-regulated buildings have underwritten in-place cash flow on purchases and deregulated units over time through a combination of tenant buyouts, tenant move outs and gradual rent increases.
Second: Patient equity wins in New York. Today, there is an abundance of private money in real estate, which both increases competition and decreases returns. Speculative investors who are looking for a quick flip may be apt to purchase assets in competitive environments, but they are left with no room for error once they take possession of the building. The investors that build wealth over time understand that purchase price is everything. They also tend to be most active with purchases when the market is going through a correction and, once they buy, they hold the properties for several generations.
Third: Investors are selectively making purchases this year—but at a noticeably slower rate than last year. According to CoStar, multifamily sales transactions are down 10 percent from the third quarter of 2014. The sentiment I hear most often is, “I just can’t find many deals that make sense—the prices are too high.” As a result, plenty of borrowers are refinancing portfolio properties at lower interest rates and completing capital improvements. Those who are buying are mostly doing so through 1031 exchanges.
One of the great things about having a long-term commitment to the market is that you can be disciplined on the buy. Warren Buffett said it best: “Be fearful when others are greedy and greedy when others are fearful.” The current environment is one of “greed,” where purchase prices, cap rates and rental rates have all reached historic levels. While it still appears multifamily fundamentals are generally in favor of a continued bull market, it’s no secret that market conditions can suddenly change.
While it’s also true that the average price per unit in New York City has doubled over the past decade, prices do not rise every year. Consider 2001, 2008, 2009 and 2013, where prices were down 23, 11, 20 and 13 percent, respectively, from the previous year according to CoStar.
When the market is performing well, the potential for profit seems never-ending. But, even for those buying in New York City at the peak of an upswing, it often makes sense to be the tortoise rather than the hare.
Chad Tredway is the head of commercial term lending East at Chase Bank. He can be reached at email@example.com.