The pandemic has thrown the real estate market off of its axis which leaves us wondering, what trends will continue for 2022? Will markets continue to skyrocket? What will happen to interest rates? How do we invest in a market like this? Let’s take a closer look at where the multifamily real estate market is now and where it’s headed throughout 2022.
Where we’re at now in the real estate market
It’s pretty clear that we are now firmly in a seller’s market. This follows basic economic principles and happens when demand exceeds supply, meaning that there are many interested buyers, but the real estate inventory is low.
We are in the phase of the market that investors want most. Demand is high, prices have surged faster than any time in recent memory, and we are seeing valuations obtained over the last 2-3 years of ownership that would have previously taken 5-10 years to reach. This is great for real estate owners, yet frustrating for buyers. But remember, it won't stay like this…
When it comes to investing in real estate, it’s important to remember one key thing: real estate always moves in a cycle. From recovery to expansion to hyper demand to recession, real estate cycles are nuanced, and yet simple at the same time, if you know what you’re looking for.
Remember: The closer you get to the peak of the seller's market, the more you risk not being able to take advantage of it—because once the market turns, it can turn quickly.
Multifamily real estate will increase in value, and demand
Multifamily housing has always been a great opportunity and is especially so right now. We expect a continuation of this throughout 2022. The value of these properties depends on the market, but not in the same way as single family homes. That’s because the value of a multifamily investment is weighed by the revenue it generates. Don’t think of it as owning a residential property as much as it is owning a business.
To determine the overall value of a multifamily property, you need to analyze the cap rate and net operating income or NOI. This refers to the income after all expenses have been accounted for, with a couple exceptions. The cap rate is the ratio between the sales price and the NOI given as a percentage. The lower this ratio is, the higher the gap between revenue and sales price. It’s a quick gauge of where the market is trading these assets at, and we typically find it harder to make great returns in a market with the cap rate is very low (like around 3-4).
However, this doesn’t mean that you should pass on an investment opportunity with a low cap rate, you simply need to find a way to increase your NOI. If you can reliably do this, then it could be a great investment. The great thing about a lower cap rate is that it drastically increases the value of every dollar you add to your NOI.
For an example, consider a property that is making $100,000 net (NOI). If your cap rate is 10% (or .10 ) then your property value will be $1,000,000…pretty simple math ($100,000/.10 = $1,000,000). So for every dollar of NOI you make $10 of value. Let’s consider the same property at a 3 cap (3% or .03). $100,000/.03 = $3,333,333. That means that each dollar of NOI equals $33 of value! To reiterate, you make money in a high cap market by increasing your NOI.
You can increase your NOI in many ways, including:
Renovating different units to bring rents up to market value
Introducing paid covered parking
Installing storage units
Instituting a RUBS program
Mortgage rates will be on the rise
Mortgage rates, as expected, were already on the rise the second week of 2022 according to Market Watch. Forbes reports that inflation has been rising due to the pandemic, which caused supply chain issues and labor shortages throughout the US. In fact, the consumer price index jumped to 7% which was the largest 12-month gain since June 1982. Raising mortgage rates was inevitable as it is one way for the Fed to counter inflation, but it doesn’t mean that it’s time to stop investing in real estate!
As mortgage rates rise, which we are seeing more of over the last few weeks, this curbs single family home building and buying. With homes harder to buy, the rental market gains strength which results in not only more demand for rentals, but also higher rent prices.
We see this trend already and we don’t foresee any change to that trajectory in 2022.
The bottom line
To recap, we are in a seller’s market, so it could be a great time to sell if you have owned your property for at least a few years. Multifamily real estate is still a great option if you know what to look for and the demand for rentable living space will continue to rise, particularly as mortgage rates continue to climb.
As the saying goes, you can always make money in real estate. This is a truism that many might misunderstand, however. You can always make money in real estate, but you need to know what cycle you are in to determine how you are going to make your money.
In the current market, multifamily real estate is a good investment, but to make money you will want to focus on either new development or distressed properties that have robust value-add opportunities (which is our favorite option). If you can increase the NOI then you can immediately increase your value. It’s just good math. We will give one warning though: only go after distressed properties if you have the expertise to turn them around. It is a big project and many people have been overwhelmed by a project they didn’t understand the scope of.
How Hedgehog can help
Many investors are not comfortable with distressed properties, and this is why Hedgehog Investments pairs so well with real estate investing. In a seller’s market you want to sell and capitalize on the fantastic gains you’ve made, but many wonder where to put their capital after that. Unless you go after heavy value-add opportunities, then there aren’t places to put your money that can still get you the high returns you’re after.
That’s where we come in. Hedgehog gives 12-20% in returns with only a 12 month hold on your money. Many of our investors have sold their real estate assets and are holding the money with us, making great returns, until the buyer’s market comes back. Each year they assess if they are ready to start acquiring properties again, and when they are ready, they will shift some of their capital back into real estate. Hedgehog Investments is a perfect solution to navigating the cycles of real estate. Get in touch with our team so you can discover a better way to build wealth.