The Multifamily “Bomb” is About to Blow

Dave:
Hey everyone, welcome to On the Market. My name’s Dave Meyer and I am your host, joined with Kathy Fettke today. Kathy, what’s new with you?

Kathy:
Oh, well, I am just so excited to hear what Brian has to say. He is just a brilliant investor and I think a lot of people are going to learn so much from this interview.

Dave:
Yeah, I’ve gotten to meet Brian a few times now, luckily, but he’s like one of my original people I looked up to when I joined BiggerPockets. He’s just been around for so long and has been so smart and for so long. It’s a treat to be able to talk to him

Kathy:
And he speaks in a way you can understand. He boils it down into basics. His voice needs to be out there more helping protect investors and syndicators because it’s rough waters.

Dave:
Yeah, absolutely. And just so everyone knows, we are going to be talking today mostly about multi-family investing, and that does have implications for the whole real estate investing industry. But just to be clear, what we talk about, Kathy, Brian and I in this episode, is not the residential market. There are differences between multi-family and commercial markets and the residential markets. Brian does a great job of explaining that, but just want to make that clear before we jump into this. But it’s super, super interesting and if you want to just build out your knowledge as an investor, the concepts that Brian talks about that form and inform his opinion about the multi-family market are applicable to investors of all types. Definitely pay attention and as Kathy said, he makes these really important complex topics super easy. We’ve got an excellent, excellent episode for you. We’re going to jump into it in just a second, but first we’re going to take a quick break.
Brian Burke, welcome to On the Market. Thanks so much for being here.

Brian:
Thanks for having me here, Dave.

Dave:
Well, it’s a pleasure to have you on. For those of our listeners who don’t know who you are, could you provide a brief introduction?

Brian:
Yeah, absolutely. I’m Brian Burke, President and CEO of Praxis Capital, longtime BiggerPockets member. I think going on 10 or so years now. My company invests in multi-family housing across the US. I’ve been doing this for in the multi-family side, about 20 years. Started out as a single family house flipper, did about 725 or 750 house flips. But now our core business is multi-family. Our portfolio topped out about 4,000 units.

Dave:
Wow. Well, yeah, when I started working at BiggerPockets, you were one of the OG forum members that I remember really looking up to and you were too modest to also mention your book, The Hands-Off Investor, which is one of my favorite books. Really great introduction to investing in syndications. If anyone’s interested in that, you can check that out from Brian as well. But we’re here obviously to talk about the tumultuous economy and state of the multi-family market. You have a pretty interesting opinion about what’s going on here. Can you give us a brief synopsis of what you think is going on in the multi-family space as we head into 2023?

Brian:
Well, I think we’re in for quite a change in the market from what people have become accustomed to. The prices and rents in multi-family space have really only gone in one direction for about the last 12 or 13 years. And I think a lot of people thought that that was the way it always is and was always going to continue. But I’ve seen this movie before and it’s kind of back in like ’05-’06, right before the big housing crash. I just remember people talking about how, “Oh, my plumber bought a house and made a hundred grand in one year, and so I’ve got to go buy a house.” The whole thing subsequently came crashing down and it’s like when everybody is doing it then you know that there’s probably a problem soon to follow. This also happened in the dotcom bust, the 2000, when everybody was investing in stocks.
Next thing you know it came crashing down in a ball of flames. And what I’ve noticed over the last three or four years we’re getting into this everybody’s a multi-family investor. Everybody’s a syndicator, and the space was becoming overcrowded and overheated and I thought that we’d probably see quite a different looking market coming in not too distant future. Well, that got pushed even sooner thanks to recent actions by The Fed and of course the bond markets that have driven interest rates up. That’s been kind of the spark that lit the fuse, and I think the bomb is starting to go off.

Dave:
Wow, bomb going off. That’s a little bit scary. Can you say a little bit more about that, just generally … Maybe actually, let’s take a step back and just provide our listeners with a little bit of foundational knowledge here. Why is it that you think … Well, first, do you think that the commercial multi-family market is different from the residential market and what are some of the key differences you see?

Brian:
Yeah, they’re completely different and they can be entirely disconnected. And I get this question all the time about, “Oh, you’re a real estate investor, what’s going on in the market?” And it’s like, what the heck is the market? There’s really no such thing as the market. Multi-family trades on a different cycle at different amplitudes than single family, than hotels, than commercial. Even within itself. You could have multi-family doing great in Tampa, Florida, but doing absolutely terrible in San Francisco. That actually might ring true now as a matter of fact. Single-family prices can be falling while multi-family prices are increasing. They’re completely unrelated and it’s really impossible to try to put a nexus between them that’s going to stand the test of time.

Kathy:
Brian, you’ve been really cautious and you have really timed things well. It’s been really incredible to watch you and watch your company grow. I know we would run into each other in events and I would always pull you aside and say, “Brian, what are you, are you working on? What are you doing?” And we would both be extremely concerned about the underwriting that was happening over the past few years and the deals people were doing. They’d come across my desk and I was like, “This doesn’t make sense.” And I would go to you and say, “Is it me? Am I just not seeing the opportunity?” But how have you been able to navigate, let’s just say the last decade and time things so well?

Brian:
Kathy, it’s not you, it’s me. Just always know that. Yeah, I don’t know, maybe I have a sixth sense about these market cycles. I don’t know. But I’ve managed to navigate them fairly well over the years. I basically stopped buying real estate in about ’04 and a half, and then by ’05-’06, the market completely catapulted and it went in the toilet. I managed to avoid the worst of that, managed to somehow be lucky enough to acquire a rental pool of about 120 rental houses in the San Francisco Bay Area in 2009 and ’10 right as it was bottoming out, rode that up until those prices doubled and a half, and sold the whole portfolio as the housing market was starting to slow just a little bit. I’ve managed to figure out the timing more often than not.
Of course I’ve certainly been wrong my share of times, but I think it’s just a matter of staying in tune to what’s going on, recognizing the signals around you. And sometimes it’s not like you can point to one specific data point and say, “Oh, I read it an article that this or that is happening or this is going to be 0.7 and then I’ll sell when it’s 0.8.” That kind of stuff. It’s not like that. It’s just a matter of a kinetic sense of what’s going on around you, being aware of your surroundings. I think maybe this came from my background in law enforcement before I was really a full-time real estate investor, always wondering what’s the next bad guy hiding behind the corner ready to attack you as you come around. I look at a lot of news and information and articles and data points and also just a sense of when things are just getting too overheated or too cooled down.

Kathy:
What was the bad guy this time around, like over the past couple years? What were you seeing around the corner?

Brian:
What I was seeing was two things. A massive interest in acquiring multi-family coupled with high leverage, risky debt. To put that into practical example, when we would go to acquire property, let’s say we’re putting in a bid on a 200 unit apartment building and we crank on it as hard as we can and come up with the highest price that we can and we submit an offer only to find out that there’s 35 other offers, half of them with hard non-refundable earnest money deposits, some of them over a million dollars and asking the broker about the financing structure that the other buyers are doing, finding out, “Well, they’re all using bridge debt, which is high leverage and short term.” And when you see that kind of stuff happening that it’s time to sell and things are topping out. And that’s exactly what we did. And when we put our first property on the market and we had, I don’t know, 17 or 18 offers, we knew that our thesis was more than just a casual observation.

Dave:
You obviously have seen a lot of demand, but that was even according to your timeline, that was even before The Fed started raising interest rates. Is that right?

Brian:
Oh yeah. This all started, early 2020 is really when it started. Then COVID hit in early 2020 and it kind of instantly shut the market off. For about four or five months we just sat on the sideline. We didn’t really want to buy anything, we didn’t really want to sell anything. It just didn’t seem the time was right and then things started to really take off. And it was interesting to watch because come third quarter to fourth quarter of 2020, market activity was way hotter than it was even pre COVID. Rent growth took off a lightning storm. We kind of were able to recognize some of those patterns of what was causing it and how we could benefit from it. And that was the final nail in the coffin, so to speak, for us. And that’s when we made the decision to essentially sell everything that we could, keeping only our highest quality best properties remaining behind in the portfolio.

Kathy:
It seems like multi-family or at least a lot of multi-family deals are sitting on quicksand today just sinking. I mean, what are you seeing out there from people you talk to and what are the challenges that some of these operators are facing?

Brian:
Well, some of the operators who financed conservatively and bought, let’s say any time before 2022, even in early 2021, I’m not really hearing much about challenge. Occupancies are holding very steady. For our portfolio, for example, we’re getting our proforma rents, the rents that we expected to get when we initially underwrote the property we’re getting, in some cases we’re getting more. Occupancies are holding in the mid 90s just like we expected them to do. We’re not seeing really any stress in that regard. And I don’t think any of our fellow owners that are in a similar situation are either. The ones we’re seeing the most challenge is coming from basically two sources. People that bought early this year, call it Q1, Q2 of 2022, paying 2021 prices, but ending up getting stuck with 2022 interest rates, seeing some stress there. Then owners that bought a little bit before this year, maybe one year ago, two years ago, that used high leverage financing and they didn’t get a chance for the rent growth to catch up or their renovations to really reach a critical mass to increase their income enough to cover far higher interest rates.
And one characteristic of that bridge debt is the interest rates are floating and they’re generally floating at a pretty wide margin over the index. SOFR index at the beginning of 2022 was five hundredths of 1%. 0.05 of 1%. And now SOFR is, I think it was like in the mid twos or mid threes even. It’s gone up a lot. If your loan is 300 or 400 basis points over SOFR, you’re now looking at close to 8% interest rates when they probably underwrote to a four or maybe a four and a half and they don’t have the cash flow to cover it. I’ve been hearing a few stories about some operators requesting loan modifications, some requesting forbearance to stay out of foreclosure, only just now beginning to hear talk about people who are reaching maturities or needing to refinance and are finding that to be difficult. I think we’ve only barely cracked the door open on that scenario. That’s going to be the next shoe that drops in my opinion.

Kathy:
I mean, and what does that look like? I mean, are banks being lenient? Are they offering the forbearances?

Brian:
I don’t know. I think so to a certain degree. One thing a lot of people don’t know is I had started a bridge lending company five years ago and we did $2 billion with a B, in loans in that five years, one billion of which was in 2021. I sold that company as well.

Kathy:
Geeze, Brian. You are a baller.

Brian:
But I’ve been talking to some of the people I know in the industry and finding out that, well, first of all in the loans that we made are still doing quite well thankfully, but our lending was quite a bit different than some of this larger CRE bridge product that we’re seeing. But I was just having a conversation a couple days ago with a warehouse lender. These are the folks that do the loans to the people who do the loans. And I am hearing a little bit of talk about a little bit of patience for borrowers who may be running up against a maturity be yet are still paying, but if they’re not paying there’s likely not to be much leniency.
Now the challenge that we have is some of these borrowers aren’t going to be able to pay and as rates have gone up so much, if the cashflow isn’t there, they’re going to have problems. I mean, we had two of the properties, actually three properties that we sold in 2021. We had brokers unknowingly come to us this year trying to sell us those properties because the sellers were trying to get out because they used high leverage financing and they’re having trouble. It’s definitely, I think the cracks are only starting to appear right now.

Dave:
A couple of weeks ago for the people who listened to this show, you might have heard a show where Ben Miller, who’s the CEO of Fundrise was on, James and I interviewed him and he has a similar take as you do Brian about the state of multi-family. And he said he was fearful that there’s just going to be a lack of liquidity and for not just the two cohorts you describe, but also people whose commercial balloons are coming due and who also people who bought five or seven years ago and that people are facing not just banks who are not wanting to extend loans, but there’s just not enough money out there to cover some of the needed liquidity. Are you seeing that at all?

Brian:
I haven’t seen that yet. It certainly could become an issue. I would say that lenders are becoming more conservative and whenever lenders become more conservative, that means that there’s less capital flow, right? This could become an issue. Now I think you’re going to see this issue materialize more in other sectors outside of multi-family to a greater extent. If you have a portfolio of shopping centers or office buildings and you’ve got a commercial maturity coming, yeah, maybe there could be a liquidity issue to refi because values haven’t really gone up. In fact, arguably, you could say that office maybe has become a little bit stressed and capital may be difficult to obtain there. But in performing multi-family assets, Fannie Mae and Freddie Mac are the backstops for the biggest finance years out there in that space. They’re always going to be there. Now to what extent we don’t know.
I mean, they do have lending caps every year. They’re not even going to come close to it this year after two or three years of constantly hitting it. Where it used to be if you wanted to get a multi-family loan from Fannie or Freddie, you better not try to do it in October or in November and December because they were reaching their cap and you’re probably going to have a challenge, but now they’re not even going to hit their cap. If you bought seven years ago, man, you’re going to be fine because values in multi have gone up so much in seven years that assuming you hadn’t previously refinanced and stripped out all your equity, you should have a ton of equity to be able to qualify for very low leverage, probably 40 or 50 LTV takeouts. I don’t see any issue there. Now, if you bought two years ago using 85% to cost bridge debt and maybe it’s a class C property and you’re suffering from delinquent collections and that sort of stuff, then your takeouts could be a little more challenging.

Kathy:
It seems like you’ve been very disciplined in your buy box and obviously, so what are those fundamentals that you follow that have worked so well for you?

Brian:
Well, now the fundamental is a flight to quality. I haven’t always had that as a element of our portfolio. We certainly had our phase of doing class C, maybe even C minus type stuff. I think the experience has taught me to think a little bit counterintuitively from what some people believe is they say, “Well, I want to invest in class C because when the economy goes south, class C does the best because the class B people can’t afford the class B, so they move into class C and class A moves to class B and class A suffers.” That’s the thesis that you’ll hear. You’ll hear, “Oh, it’s workforce housing and everybody needs a place to live.” And I just don’t buy into either of those two theses. On the class part, I feel like in my experience, the class C tend to perform the worst in the downturn because the resident profile is generally the one most impacted by layoffs and wage cuts and other things.
Then what ends up happening is they stop paying rent and then they have really nowhere else to go, so they don’t leave. You have to wait all the way through an eviction and that can take months. And now when they leave, they don’t leave it in the best condition. And now you got all this turnover cost and it just eats you alive. Whereas your class A, they’ll discount their rents and do some concessions, but they’ll stay relatively full. In my experience, class A tends to do better in a downturn. Our buy box has been more of a shift to a flight to quality. I think just looking at things like crime statistics, school ratings, income, all these different factors help guide us to sub-markets where we feel we have the highest likelihood of actually collecting our rent. And that really does make a difference.

Kathy:
And how will you know that it’s time for you to jump back in again?

Brian:
I’ll start to see signals. When you start to see more distressed sales, you start to see a couple REOs coming out, these are bank owned properties, you’ll know it’s really time to hit it. But to get a little bit earlier, I think when you see more and more people talking negatively about the business, that’s probably about a pretty good time. I remember in ’09 when the market was just in the toilet, the residential market was terrible. And I was at a family office conference and I had just given a presentation about what we were going to do next, which was we were going to be buying single family homes to rent out. We’d been flipping like 120 houses a year. And it was great business while there were all these foreclosures. But I said, “We’re shifting to a buy and hold model at least for some of our portfolio.”
This guy comes up to me and he goes, “You got it all wrong.” He’s like, “You don’t know what you’re talking about. This is not the time to buy rentals. This is the time to be flipping. It’s crazy. You’re catching a falling knife. What are you even thinking?” And this guy was supposedly this sophisticated, this guy, family office guy, and it’s like, “Oh yeah, whatever.” Well, I said, “Look, I think houses are going to double in value in the next five years.” “Oh, that’s just ridiculous.” Well, I was wrong. They didn’t double in value in five years. They doubled and a half in value in five years. And that really was confirmation it was the time to do it. When people were telling you it’s the absolute wrong thing to do, that’s when I figure it’s the right thing to do.

Dave:
We’ve talked a little bit about performance in terms of cash flow and whether people are going to default. Where do you see valuations for multi-family properties going right now? Because the data, I’m not involved in the day-to-day in the way you are, but I look at the aggregate data that every commercial real estate investor looks at, the cap rates haven’t really expanded to the point I would expect them to at this point in the cycle. Is that what you’re seeing as well?

Brian:
Yes and no. It’s an interesting, there’s like two parallel universes right now. There’s like reality and then there’s dreamland and there’s just enough people that still live in dreamland to obscure what’s really going on in reality. Here’s what I mean by that. I had a broker in the Phoenix area call me about six months ago. This was just as the market was starting to turn and he said, “Well, what are your thoughts on the market?” And I said, “Well, the mere fact that I haven’t heard from you for in two years and now you’re calling me tells you everything you need to know about what’s going on in the market. Obviously buyers have vaporized or you wouldn’t be calling me” because he’s trying to say, “Hey, are you a buyer, right?” I asked him, I said, “I cannot justify paying 300 a door for 1980s value add product. That’s just not making any sense.”
And he’s like, “Well, now we’re starting to take that same stuff out for 250 a door.” The same stuff they were taking out three months prior for 300 a door they’re taking out for 250 a door. Right there, there’s a 10 to 15% price cut and that was overnight. It was like a light switch. And people may not realize that that happened if they aren’t paying really close attention to the market. Now, the interesting part about that was even though prices fell from where they were in January, February, March, they were still up from where they were in say August or July or August of 2021. There was this really rapid ramp up here in the third and fourth quarter of ’21 and first quarter of 2022. Then second quarter is when everything kind of fell off a cliff.
Well, now you start getting brokers calling and you’re saying, “Look, three cap isn’t a thing anymore.” And, “Well, we’re getting offers and this and that.” And what’s happening is there’s just enough people out there that have a 1031 that they have to close out or they raised $500 million and they got to get the money out because it’s sitting there burning a hole in their pocket. There’s just enough of them. There’s so few sellers that there’s this little minutiae of transaction volume that’s taking place and is still taking place at these ultra compressed cap rates. Well, guess what? As soon as those buyers spend their money and then they go away or more sellers need to sell because they need to sell, then the real pricing is going to get discovered. We’re in this little phase of price discovery where there’s a wide bid ask spread resulting in almost no transactions that transactions that are taking place are just, as you said Dave, they’re still kind of in that high threes, low fours and that’s not going to stick.
It’s just not going to stick. The thing that people got to think about is if a cap rate was 4% and it goes to 5%, you go, “Oh, cap rate’s moved 1%, no big deal.” But guess what? From four to five is a 25% decline in asset value. It is actually quite significant. And I think you’re not only going to see that. I think there’s a really good chance that you see multi-family even in good markets, could be in the high fives or touching in sixes and maybe even go a little higher than that.

Dave:
Thank you for explaining that. I still am just I guess the 1031 money and these institutions that have money to spend, but I just don’t understand the bull case here. Do either of you know a coherent argument about why multi-family values would go up in the next couple years, which would justify buying at a cap rate that’s about what bond yields are right now?

Brian:
Well, the argument I usually hear is, well, everybody needs a place to live argument. That’s one of them, which by the way is BS because just because everybody needs a place to live doesn’t mean they’re going to rent your apartment. They could live with their parents, they could move in with their friends, they could double up. It’s about household formation. Not everybody needs a place to live. I think that plays a part in it. But the other theory that I hear is interest rates are going up, which is going to cause house payments to go up, which is going to cause more people to stay in the renter pool or enter the renter pool, which is going to place more demand on rentals, which is going to force rents up and rents going up is going to force up values. That’s the thesis that I hear.
And certainly one could argue there’s merit to that thesis, that could in fact take place, but it’s going to be difficult because the rents have already gone up. And this is the part that people tend to want to dismiss is that there was a massive increase in rents over the last two or three years. Some markets, I just read Phoenix was up like 80% in five years or something like that.

Kathy:
Wow.

Brian:
And I know that some people say like, oh, that can never continue. And some people say, “Oh yes it can.” I’ve seen both happen and it probably will continue, but it’s going to take a while and there’s going to have to be this leveling off and kind of a chance for everybody. Okay, cool off, just let this set for a minute and then we’ll get back to rent growth later. That period could be six months, it could be six years. I mean, that’s the part that nobody knows right now.

Kathy:
Yeah, I mean, Dave, to answer your question, I also hear inflation and lack of supply and there’s just not enough out there, so we got to get it now. And I could tell you I spoke, I did that debate at the Best Ever Conference in, I think it was February or March, and the debate was are there going to be more sales, commercial sales this year or less than last year? And I was on the side of it’ll be less. The audience voted that it would be more before the debate and I had to just pound it. I’m pounding the podium saying, “Are you not listening to The Fed? Do you not see what’s coming?” The fact of the matter is they didn’t, they had no idea. And we just talked about it earlier, people now know who The Fed is and maybe they’ll pay attention. But just in March I looked at a group of thousands of multi-family investors who had no idea what was about to happen.

Brian:
And it did happen. The sales in the first half of 2022 were greater than the sales in the first half of 2021. However, sales in the fourth quarter of 2022 are going to round out at around 30 billion or … Yeah, 30 billion. Compare that to last year’s fourth quarter was 130 billion. It’s down, I don’t know, what’s that? I’m not that good at math. 70%? It’s a down a lot, right? It’s happening already. And that’s going to continue. I think you’re going to see very light transaction velocity for at least the next couple quarters.

Dave:
Brian, what do you make of the increase in multi-family construction of late? We’ve seen it go up a lot. I actually saw something today that said it’s at the highest rate since 1973, and there seems to be a good deal of inventory that’s going to come online over the next year, I think particularly in Q2. How do you think that’s going to add to this complex market that you’re sharing with us?

Brian:
Well, it’s going to change things only very regionally. There are some areas that really have no development. Case in point, late last year, I bought a three property portfolio of multi-family assets, which you think, “Oh my God, late last year, a terrible time.” Well, but it was a kind of a distressed sale. We really got a good deal on it. But really one of the things that really drove me to it was it’s located in a county that has had a moratorium on multi-family construction for like 15 years, and they’re the newest properties in the county, and there’s only 11 properties over a hundred units in the whole county. And it’s a very populous county, a suburb of Atlanta. I didn’t have to worry about multi-family development coming in and overrunning us. And that was an important consideration. You go to Phoenix, Arizona and they’re building left and right, but that isn’t necessarily a wrong choice.
I mean, there’s people moving there left. What really matters most is looking at construction to absorption ratios, how much is being constructed versus how much is being absorbed and how many people are moving to that area? And this is one of the reasons why I constantly preach buy in markets where people are moving to and avoid markets where people are moving from. It’s kind of almost as simple as that. And Kathy asked about my buy box earlier. That’s criteria number one. But you’re going to see some markets that may suffer from additional inventory. Your question as to why, it’s kind of like, okay, the multi-family market’s starting to suffer. Why are all these builders building stuff? Well, don’t forget that in order to build something, it takes two or three years, or if you’re in California, two or three decades of preparation to get a property to the point where you’re pounding nails.
When things are going great post COVID, you’re like, “Oh my gosh, there’s demand everywhere. There’s rent growth everywhere. We got to build, build, build. It’s becoming too expensive to buy. It’s cheaper to build than it is to buy. Let’s do that.” They start going down that road. You get past the point of no return. And inevitably, and this is why I hate development, by the time you actually finally start hanging windows, the market goes to crap. That’s what we’re seeing. You’re going to have some of this inventory coming online at the worst possible time. That’s going to create some stress in some markets. But you also have a lot of projects that maybe they’re approved and they were about to start, but they haven’t actually started running tractors yet. And those guys might not get financing. And you might see a lot of those properties pushed back or canceled entirely. The jury is still out on how that’s going to affect things, but it’s only going to affect things regionally. I wouldn’t try to put a national opinion on how that’s going to change things.

Kathy:
Would you invest in new construction multi-family?

Brian:
Oh heck no.

Dave:
I love somebody who just gives a straight answer. No, no caveats.

Brian:
Yeah, no. Well, actually, okay, here’s a caveat. When you say, would I invest in new construction, if a project was completed and we had the opportunity to acquire it, yes, and we’ve certainly been in the running on doing this before. We actually had one in contract. Then is kind of a funny story. We had a property in contract, great market, just about to complete construction. We would’ve had to do all the lease up and everything. The seller defaulted on the purchase agreement because they decided they wanted to keep the property because they thought they could sell it for more. And that was middle of 2021. I wouldn’t want to be them and having to explain that decision to their investors today. But I guess maybe I dodged a bullet. I do like high quality assets, new properties have less maintenance requirements, and so I would like to buy newly constructed properties that are done. Would I want to go in and build one? No.

Kathy:
Yeah, too much risk.

Brian:
Been there, done that. Not in the multi-family side, but I’ve built a self-storage facility and it was one of the worst experiences of my life. And it has nothing to do with self-storage. All your self-storage guys, you don’t have to defend your industry. I still believe in it. But what happens is you get past the point of no return, and then everything kind of goes against you. And that’s what happened to me is once I started building, steel prices doubled and that doubled my construction cost. There’s nothing you can do about it. You have to finish and you have to press on. And that’s the problem with development. Things change during the process, and it doesn’t always change in your favor. Sometimes it does.

Kathy:
Investors just really need to understand that new construction is probably the riskiest investment.

Brian:
That’s right. It has to match your risk profile, and you have to be willing to wait. It’s nice to start getting your cash flow returns quickly in development projects. And Kathy, I know you do these. I know this.

Kathy:
And it’s not been easy.

Brian:
It is not easy. It’s hard. It’s stressful. It’s a lot of work. And it’s not instant gratification. I mean, it’s nice to see beautiful buildings being built, but from a financial perspective, it takes a long time to realize the result if it’s realized at all. And I’m too old for that.

Kathy:
I know. I mean, our early projects, we were getting land for 10 cents on the dollar and you could make it work. But I just don’t know how people pay high land costs and high construction costs and high debt costs and make it work today. No.

Brian:
I don’t either. I don’t either.

Dave:
Brian, this has been great, and we do have to get out of here soon, but I have a large multi-part question for you. This is going to be a big one.

Brian:
Hit me, Dave.

Dave:
All right. We’re in the beginning of 2023 and everyone listening is learning a lot from you, but what they really want to know is what they’re supposed to do. I’m going to ask you a two-part question. What should people who want to sponsor multi-family investments do, or what advice would you give them in 2023? Then for people who invest passively, in syndications or in multi-family deals, what advice would you give to them?

Brian:
Okay, so for the first group that wants to be the active participant and sponsor multi-family investments, I will tell you a couple of things. One, it is so much easier to lose a million dollars than to make a million dollars. Always keep that in mind because your primary job, you really only have one job. There’s the old saying, you only have one job. Well, you really only have one job. Don’t lose your client’s money. Keep that forefront in your mind and make sure that when you’re preparing to acquire a property and launch an offering, that you have a very high degree of confidence that you’re going to have a successful outcome and that you’re not going to lose your client’s money.
Because if you do, if you get in too early, it could be the end of your career and you don’t want that to happen. If you want to do this and you want to do this for the long haul, it’s okay to wait until you’re comfortable that you’re going to have the best odds of producing a successful outcome. That’s preferable than to start too early, screw it up, lose your clients, and then now you’re out of business and you’re never going to make a comeback, right?

Dave:
And Brian, is that to you, would that be waiting through what you called the pricing exercise that we’re in right now?

Brian:
Yes. Get through the price discovery. Let other buyers figure out price discovery, start to get some direction to the game. The way I put it is I’m watching this game from the grandstands. I’m not playing on the field right now, but I’m going to place a bet on the outcome of the game, but I’m going to wait until I can see some kind of trend in the score. Who do I really think is going to win this game? Then I’ll place my bets. I’d rather do that than to bet beforehand, before I even know who the players in the game are going to be. I think it’s okay to sit back and watch. For the passive investors out there who are looking to invest in passive syndications, I would say look very closely at offerings that are being launched right now and listen to what the promoters are saying.
And if it doesn’t pass the smell test and you feel like those folks are losing credibility because they’re promoting something that you feel is not appropriate for the time, pass on it and make a note of who those groups are and watch them and see what happens. There’s no reason you have to make a quick decision, watch and wait, and you’ll start to see some of these groups may vanish in the wind. You want to invest with the groups that survive through whatever it is that’s going on right now. Those are the people you want to invest with. Don’t be the test case. Don’t feel like you need to let them learn on your dime. Go with proven skilled operators that have been through a market cycle or that survived this one before you place any bets. This is a time for caution and it’s a time for diversification. Whatever you do, don’t put all your money in one offering with one sponsor and hope and pray because that’s about the worst strategy you can come up with right now.

Kathy:
And to just add to that, Brian, if you’re an accredited investor, take the time and spend the money on having your CPA review the documents and your attorney review the documents. Because a lot of times these documents aren’t well written, that’ll tell you right off the bat that maybe something’s wrong.

Brian:
Yeah, I love the offering documents that are riddled with spelling errors and grammatical mistakes, and these sponsors are going to put their best foot forward while they’re trying to raise money. And if that’s their best foot, just what happens after they get your money could be kind of scary. Yes, review carefully and certainly there’s a whole bunch of red flags. If you want to know what they are, you could read The Hands-Off Investor because they’re all listed in there. I mean, I took 30 years of experience in this business and rolled it up into 350 pages so that people wouldn’t have to make these mistakes on their own. They could see where all the hidden skeletons were in the closets. It’s all listed in there.

Dave:
Great. And Brian, is there anything else you think our audience should know about the multi-family or broader commercial market in the next year that you think they should pay attention to?

Brian:
Well, one thing to pay attention to is what’s happening at other sectors of real estate. For example, net lease, commercial, industrial, office, don’t discount that stuff as either A, not a place to invest because perhaps it could be or B, unrelated to multi-family because they are in some respect related. If those assets start throwing off really attractive returns, capital is going to flow to those assets, and that’s going to mean a longer recovery period for multi-family, it’s going to mean that cost of capital for multi-family projects is going to change. When you start seeing cap rates in say office or retail or whatever, starting to climb into the sevens or eights, you can’t think that multi can hold at a four and not be impacted by the competition of those dollars getting shifted to other asset classes.

Kathy:
Woo. Mic drop.

Dave:
All right. Well, I guess if that was the mic drop, we got to go. All right. Well, thank you so much, Brian. This has been insightful and we really appreciate this. Everyone listening to this and Kathy and myself included, I’m sure appreciate sort of the sober look and a real realistic understanding and you lending your knowledge to us about what might be on the horizon here on the multi-family market. If people want to learn more from you, we mentioned your book or want to connect with you, where should they do that?

Brian:
Yeah, just one thing before I get to that is I do want to say I’m not all negative Nancy. There is going to be a positive side to this. Don’t look at this as this is doom and gloom. This happens. This is a market cycle. We’re in it. It will bottom out. Things will get better and there will be some massive opportunities coming down the line, and those opportunities will be much better than they would’ve been had this not happened. There is a positive side to this. To learn more about the positivity side of it, you can learn more about me on my website for Praxis Capital. It’s PraxCap.com. It’s P-R-A-X-C-A-P, .com. Of course, you can find me on BiggerPockets in the forums answering questions. And I’ve got an article, I think it’s going to be published on the blog soon. That’s going to be along the lines of this conversation. Also check out Instagram, @InvestorBrianBurke, and the book is at BiggerPockets.com/syndicationbook.

Dave:
All right, great. Well, thanks again, Brian. We really appreciate it and hopefully we’ll have you back in a couple months and you can give us an update on the multi-family market.

Kathy:
Yeah, we expect the alert when it’s time to dive in.

Brian:
There you go. I’ll bring it.

Kathy:
All right.

Dave:
We got to get Brian on here once a week.

Kathy:
I want him to be my personal mentor.

Dave:
I know. I invest a lot in multi-family. I know you do too. Having him on is selfishly very just to hear from him.

Kathy:
Absolutely.

Dave:
What do you think about all this? He’s saying there’s this pricing exercise or price discovery going on. What do you think? What’s your gut tell you about the state of housing? A year from now, where will multi-family be?

Kathy:
Well, I mean, I don’t want to even laugh. It’s not funny. I think there will be blood in the streets, and a lot of us could see that. I know a lot of people felt FOMO. I know people who did 20 acquisitions this year, and I would just kind of scratch my head. Again, it me, am I not seeing it? But I think Brian, I’ve just followed him for years and he has so much wisdom and insight that unfortunately I think he’s going to be right, that there’s the positive and negative. The positive is a year from now it will be a good time to buy, and the negative is there will be a lot of loss.

Dave:
Yeah, I think that’s true. I asked that question about what case someone who’s bearish about multi-family right now can make, and I guess what you and Brian shared makes some sense, but to me it doesn’t pass the sniff test. I just think the evidence that valuation, that cap rates are going to expand, I just don’t see how that doesn’t happen and valuation doesn’t fall 15, 20% in multi-family. It just seems like we’re heading for that in the next couple of months.

Kathy:
Market shifts are really a great opportunity to study psychology, honestly, because there’s just people grasping to what they’re hoping will be the case or what has been over the last few years and just able to read the market. It is just an incredible skill to be able to do that. And it’s actually imperative if you’re going … Especially if you’re going to be managing other people’s money. Now in some cases, obviously there’s things you can’t see. We couldn’t have predicted a pandemic and then the supply chain issues and all of that, but sloppy underwriting, that’s more predictable.

Dave:
Totally. Yeah. And it’s interesting what he said, and we’ve had a few other guests on here say the same thing, that they were already starting to feel like the market was frothy in 2019. You can’t predict COVID and can’t predict Russia invading Ukraine, but if they were already seeing the tea leaves as frothy and then you get this frenzy and pandemic, I can see why someone like Brian is like, “Nah, I don’t want any of this.”

Kathy:
“I’m out.” Yep.

Dave:
Well, yeah, I mean, I never root for anyone to lose their shirt, so I hope that there is, that people don’t suffer any significant losses from this, but at the same time, if smart people like Brian and you believe that multi-family valuations are going down, we should discuss that and be honest about that and warn people that to be cautious over the next couple of months and potentially wait until this uncertainty has sorted itself out and there’s more clarity and stability in the market.

Kathy:
Yeah, I love what he said about let other people do the repricing. Wait until it lands and you know what the real values are.

Dave:
Absolutely. All right. Well, Kathy, thank you so much for joining us and thank you all for listening. We do have something for you today. We forgot to mention this up top, but next week, Kathy, James, Jamil, Henry and I are going to be debating a document I wrote called The 2023 State of Real Estate Investing. It’s just a analysis of what happened in 2022, and I lay out a couple potential different scenarios for 2023, and we’re going to debate it. If you want to download that ahead of the debate so you can follow along and maybe form your own opinions ahead of the debate, you can do that on BiggerPockets. It’s for free. It’s BiggerPockets.com/report. Go check that out ahead of next week’s episode. Again, thank you all so much for listening. We’ll see you next time for On The Market.
On The Market is created by me, Dave Meyer and Kailyn Bennett. Produced by Kailyn Bennett, editing by Joel Esparza and Onyx Media, researched by Pooja Jindal, and a big thanks to the entire BiggerPockets team. The content on the show On The Market are opinions only. All listeners should independently verify data points, opinions, and investment strategies.