Author:

Paul Monsen (Opus Connect Member)
Director – Real Estate Lending at Maxim Commercial Capital

Opus Connect – Investing In Multifamily.
In Mid-November, Opus Connect and Sklar Kirsh hosted a panel discussion that consisted of Neil Schimmel (President & CEO, IMG), Max Sharkansky (Managing Partner, Trion Properties), Henry Manoucheri (Chairman & CEO, Universe Holdings), Jerry Fink (Managing Partner, The Bascom Group), and Adam Peterson (First Vice President, CBRE), and was moderated by George Lintz (President, Bellaire Partners, LLC.).

The subject was investing in multifamily real estate in Los Angeles and the greater United States. Topics included valuation metrics for the current cycle, untapped West Coast markets, LP equity structures, and how to invest in a late-cycle market.

Intro
Adam Peterson kicked off the panel with a boots-on-the-ground perspective on why Los Angeles continues to be a premier investment market. He noted that there are still several attractive markets and asset types, including Long Beach, Highland Park, and rent controlled properties. Adam hedged his advice with a warning about overbid markets, particularly West LA/Santa Monica. He also noted that rent control tenants are getting smarter.

Acquisition Metrics
The mention of West LA quickly brought up the topic of cap rates. General consensus held that tier one market cap rates range from 3-5% and secondary markets providing a slight premium of 4-5.75%, with overheated markets commanding sub-3% rates. Continued cap rate compression has forced investors to rely on other investment metrics, particularly dollars/unit, gross rent multiples (GRM), and asset quality. Cap rates are still important, particularly for exit underwriting. Investors are underwriting to a 4.5-5.5% exit cap for Tier 1 properties, with another 100 basis points added for secondary markets.
Universe Holdings is focused on SoCal properties in the $185k – $325k/door range. IMG likes partially renovated buildings in B+ to A markets that they can bring to market standard. The Bascom Group won’t buy anything with >15GRM.

Operations/Rents
Rent/sf can be misleading in multifamily. One panelist explained that he checks Rent/SF but always focuses on the gross number. Very few renters are doing the math to figure out rent/sf. The average renter is focused on the gross dollar impact on their bank account. Mr. Fink noted that any units priced below $2k/door in LA will rent immediately, regardless of size.

Investor Structures & Returns. 
Panelists were all seeing LPs demand preferred returns of 6-9%, with a 75% (LP) / 25% ( GP) split thereafter, avoiding waterfalls if possible. Bascom detailed another popular structure: 10% pref, 20% promote to a 15% total return, then a 30% promote thereafter.

Trion’s LPs are focused on the deal’s return on cost, and want a 2x multiple on their equity, with a high teens IRR over a 3-5-year period. Further, investors are deeply scrutinizing all underwriting assumptions.
However, the panel admitted that those return profiles are increasingly difficult to achieve. Typical deals today provide a 1.6-1.8X return on equity, an IRR from 12-16%, and yearly cash on cash returns of 6.5%-8%. Mr. Manoucheri pointed out that larger institutions and foreign companies are squeezing out local investors in primary markets, as they are willing to accept down to an 11% IRR.

Investment and Growth Philosophy
Each panelist’s company is continually torn between two competing goals: 1) beat the market and 2) scale. Option 1 is increasingly difficult because competitors have flooded the market while option 2 is beneficial to the company but brings lower risk-adjusted returns. So, each panelist tries to find a niche, i.e. Trion’s focus on tired assets, the East Bay Portland, etc., while IMG needs to have “boots on the ground” experience and fosters local relationships.

2008 Recession & The Next
Mark Weinstein, Founder and President of MJW Investments, added to the panel’s insights by noting that prudent use of leverage is vital at this point in the cycle, with an eye towards long-term holds.
Adam Peterson further pointed out that while LA as avoided the worst of the last downturn, all panelists are actively avoiding C properties and tertiary markets at this point.

Additional Takeaways.
Don’t buy from smart brokers for smaller investors.

Buying off market deals can be more trouble than its worth because they hear 3% cap rates and think that’s what their property should demand.

Trion Properties is bullish on digitizing property & asset management. 90% of their renters pay online.

At this point in the cycle “you don’t need to make money, you need to not lose money.”