Podcast Summary: The David Greene Show - "Multi Family Bloodbath" (Episode 13)
Release Date: October 17, 2024
Host: David Greene
Guest: Andrew Cushman

Introduction

In Episode 13 of Real Talk Real Estate, titled "Multi Family Bloodbath", host David Greene welcomes his multifamily investment partner, Andrew Cushman. The episode delves deep into the turbulent state of the multifamily real estate market, exploring the reasons behind the current downturn, the impact of rising interest rates, and offering crucial advice for both current and prospective investors.

Understanding Syndications

Syndications Explained
David begins by introducing the concept of syndications, likening it to pooling resources for a Caribbean cruise. This structure allows multiple investors to collectively purchase large assets like apartment complexes, which would be unattainable individually.

David Greene [04:18]: "It sounds similar to how stocks are structured... but syndications are different in the sense that your ownership isn't really valued like a stock is."

Andrew's Perspective
Andrew elaborates, comparing syndications to buying shares of an LLC that owns the property, emphasizing that investors are limited to their initial investment without bearing additional liabilities.

Andrew Cushman [06:20]: "It's quite analogous in that you're buying shares. And just like with a stock... you're not liable for Google's antitrust activities or anything like that."

The Current Multifamily Market: A "Bloodbath"

Historical Monetary Policy Impact
The discussion shifts to the influence of monetary policy over the past decade. Andrew describes the period from 2017 to 2022 as a "spring break in Fort Lauderdale," characterized by near-zero federal funds rates which artificially lowered interest rates, making multifamily investments seemingly lucrative.

Andrew Cushman [09:43]: "It was the death knell for real estate and commercial real estate in particular, because with free money everyone was just running out and paying anything the seller wanted."

Rate Increases and Market Consequences
With the Federal Reserve sharply increasing interest rates from near 0% to around 5.3%, many multifamily properties became overleveraged, leading to negative cash flows and a stalled transaction market.

Andrew Cushman [16:31]: "All of these properties that people overpaid for, over leveraged, they have negative cash flow."

Key Real Estate Metrics: NOI and Cap Rates

Net Operating Income (NOI)
David clarifies that NOI excludes debt payments, focusing solely on the income generated from property operations. This is distinct from residential property analysis, where debt is included in expenses.

David Greene [17:32]: "NOI stands for net operating income... It's how much income is generated by, you know, me running and operating the property."

Capitalization Rate (Cap Rate)
Cap rates indicate market demand and risk associated with an investment. Lower cap rates suggest higher demand and lower perceived risk, while higher cap rates indicate the opposite.

Andrew Cushman [19:18]: "Cap rate is an indication of market demand for a type of income stream... higher cap rates typically mean higher risk and lower demand."

Impact of Rising Interest Rates

Transaction Market Freeze
Andrew notes that rising rates have severely impacted the transaction volume in the multifamily sector, with current activity levels below those seen in 2014.

Andrew Cushman [24:08]: "The transaction market has ground to a halt... it is just frozen."

Sellers and Buyers Struggle
Sellers are reluctant to lower prices despite decreased property values, while buyers are constrained by higher borrowing costs, leading to a standoff that stifles market activity.

Andrew Cushman [26:53]: "The reasons I think price decline is over... interest rates have not only stopped going up, they've come back down some."

Navigating Capital Calls

What is a Capital Call?
A capital call occurs when sponsors request additional funds from investors to manage distressed properties or cover unforeseen expenses.

Andrew Cushman [36:57]: "A capital call is a section of the operating agreement... we need additional funds to keep the deal afloat."

Investor Decision-Making
Investors face the dilemma of whether to contribute more capital or accept potential losses. Andrew advises evaluating the sponsor's credibility and the deal's fundamental viability before responding.

Andrew Cushman [37:07]: "Do you still believe in that sponsor and their ability to operate the deal? And then, is the deal in a position where you're not throwing good money after a bad situation?"

Red Flags in Capital Calls
Introducing third-party preferred equity can be a major red flag, indicating that the original investors may be diluted and further equity losses are imminent.

Andrew Cushman [44:59]: "If you see third party preferred equity or rescue capital, that's a huge red flag."

Advice for Current and Prospective Investors

For Struggling Investors
Andrew suggests that limited partners (LPs) should consider their position as both having already contributed funds and mentally preparing to write off the investment, treating any recovery as a bonus.

Andrew Cushman [50:41]: "My mindset would be... the money's already in... I'm going to ride this out and hope it works out."

Selecting Reliable Operators
Vetting sponsors is crucial. Andrew recommends thorough reference checks, understanding their underwriting assumptions, and ensuring realistic projections.

Andrew Cushman [52:36]: "Vetted that operator... ask for references... and ask about their most challenging deals."

Underwriting with Realistic Assumptions
Investors should scrutinize rent growth and exit cap rate assumptions to ensure they align with historical data and market realities.

Andrew Cushman [59:47]: "What's the rent growth assumption? Is it realistic based on historical trends?"

Criteria for Successful Multifamily Investments

Population Growth and Income Levels
Andrew emphasizes targeting submarkets with above-average population growth and rising median incomes, ensuring rental affordability.

Andrew Cushman [62:26]: "The two most important things are population growth and median income with affordability."

Avoiding High-Risk Properties
Properties in low-income or high-crime areas present significant operational challenges, including difficulty in management, hiring quality staff, and obtaining insurance.

Andrew Cushman [67:20]: "Higher cap rates on lower-class properties mean higher operational headaches and operational risks."

Conclusion

David Greene and Andrew Cushman conclude by reinforcing the importance of due diligence, realistic underwriting, and choosing trustworthy operators in navigating the current multifamily real estate "bloodbath." They encourage investors to stay informed, vet potential deals thoroughly, and maintain a long-term perspective to weather market fluctuations.

David Greene [71:26]: "The highest returns are almost always associated with higher levels of risk... the wise investor understands that."

Key Takeaways:

• Understand Syndications: Know the structure and your limited liability.
• Monitor Monetary Policy: Rising interest rates can significantly impact property values and cash flows.
• Evaluate Cap Rates and NOI: These metrics are critical in assessing investment viability.
• Be Wary of Capital Calls: Assess the necessity and implications before contributing additional funds.
• Choose Reliable Operators: Thoroughly vet sponsors to mitigate investment risks.
• Focus on Quality Investments: Prioritize properties in growth-friendly, high-income areas to ensure stability and profitability.

Notable Quotes:

• Andrew Cushman [09:43]: "It was the death knell for real estate and commercial real estate in particular..."
• David Greene [17:32]: "NOI stands for net operating income... how much income is generated by, you know, me running and operating the property."
• Andrew Cushman [24:08]: "The transaction market has ground to a halt... it is just frozen."
• Andrew Cushman [36:57]: "A capital call is a section of the operating agreement... we need additional funds to keep the deal afloat."
• David Greene [71:26]: "The highest returns are almost always associated with higher levels of risk."

Further Information:

• Invest with David and Andrew: Visit davidgreen24.com/invest to partner in multifamily deals.
• Follow Andrew Cushman: Connect with Andrew on LinkedIn.
• Subscribe and Review: Leave a five-star review on your preferred podcast platform to support Real Talk Real Estate.

This detailed summary encapsulates the essence of Episode 13, providing valuable insights into the multifamily real estate market's current challenges and strategies for navigating them successfully.