Are Multifamily Properties In A Bubble?
MyEListings' markets and economics editor and creates content about global macro events and their impact on US commercial real estate.
One of the problems with investment terminology is that it gets used by humans, and therefore suffers from the same issues that beset the use of language in general; meanings can shift on the fly. And so it is that we find ourselves comparing events and processes we know are called ‘bubbles,’ to current events. We then decide whether current events belong in the same little box with the same label as these ‘bubbles.’ It is therefore informative to extract the relevant effects of things we know as bubbles, for comparison.
What’s in a name?
According to Investopedia, a housing bubble begins with a supply-demand imbalance that takes time to resolve. Meanwhile, speculators arrive on-scene, driving demand, and thus prices, higher. Higher prices lead sellers to materialize, which signals the speculators to exit, leading to cascading prices as their nimble (fickle?) liquidity dries up.
In complexity science, this phenomenon is known as ‘self-organized criticality,’ and it is a hallmark of some complex adaptive systems, which are very large-scale systems of inter-dependent inputs such as economies, governments, societies, etc. What investors are really wondering when they ask if an asset class is in a bubble is whether an avalanche is imminent, not whether this sequence of events fits into a box labeled a ‘bubble.’
Between Timing And Direction: Is An Avalanche Imminent?
In investing, it is difficult to exploit both the timing of an event and its direction and magnitude. This is because the analysis that goes into whether something can take place, and if so under what circumstances, is different from the analysis that assumes it will happen (which could be wrong) and speculates as to when. If an investor focuses on whether, and bets something will or will not occur irrespective of time frame, he can deploy capital in such a probabilistic way that only the least likely outcomes cost capital. If his analysis is sound, the timing can be gamed. Focusing on timing, however, assumes something will occur on or about a certain time. Trying to game both of these reduces the number of possibly favorable outcomes for the investor, hence one must be exceptionally lucky to be right on both counts consistently over time.
The Problem of Popularity
The popularity of particular investing ideas, particularly among non-professionals, often invites frothy speculation. Looking at past bubbles, it is informative to observe how an idea’s popularity in the eyes of an average member of society is correlated with the magnitude of its eventual implosion. During the dot com bubble, for example, investing in tech stocks became a sport discussed in elevators and at parties; in Bakersfield and Birmingham, not just New York and LA. The more amateurs are attracted to investments orchestrated by professionals, the greater the risk a critical state will develop, and collapse will occur.
What Does Collapse Even Mean?
Journalists tend to use emotionally charged terms in their copy to influence readership. This is why we don’t often see headlines announcing sunny skies ahead or that markets could stage a mild decline in the next year. We don’t read or respond to non-change. We want to know what will change with some meaningful magnitude. Therefore, journalists tend to predict hundreds of collapses for every 3 actual collapses. If you’ve never lived through an asset bubble while invested, you probably have an entirely different idea of what one means than someone who has. Most people envision a collapse of asset prices as an event that arrives with such force that it breaks containment and cascades systemically to the point that a critical mass of investors are ruined and cannot recover, destroying capital, asset values, and morale in the investing public.
Is A Multifamily Property Collapse Probable?
There is a growing perceived problem with unsophisticated investors proliferating in multifamily syndications, but there is also a growing tide of regulation being proposed at several state levels to regulate it further. In the meantime, we are beginning to see multifamily deals that typically younger syndicators structured at very low cap rates when interest rates were right at the tail of their historic lows, and that no longer make economic sense in the current environment. We are also hearing a growing din of accusations against certain syndicators who market to and attract unsophisticated investors, for fraud and other unsavory alleged happenings. But this is nothing new. There is a consistent balance to be struck in an economy between hiring experience and conveying experience (the explore/exploit dichotomy), and learning experiences tend to happen at the school of hard knocks.
Watch For Tells
All considered, multifamily would appear to be the CRE asset class most susceptible to negative surprises, as its rise is predicated upon 20-30% rent increases for the foreseeable future, and although higher interest rates do not directly affect rents in real time, they do feed back through the economy to cause them to rise in time. One interesting tell we can borrow from more liquid markets is to observe the ‘talking of one’s book.’ This is when fund managers go on TV and in written publications to tell the world about how optimistic they are about what they’ve already invested in. In the dot com bubble, this sounded a lot like ‘a lot of money on the sidelines is going to hit the market after Labor Day,’ at which point the market resumed its downward trajectory after consolidating all summer. This is eerily reflected in Berkadia’s recent victory lap/prognostications concerning multifamily and could signal the coal mine of the canary’s passing.
The fact it references ESG (environmental, social, governance) compliance as a facilitator rather than an impediment seems to add weight to any argument they are talking their books, and that valuations should decline overall; however, this does not imply a ‘collapse,’ or a ‘bubble’ in the traditional sense. Markets today are more robust in several ways than they were even a decade ago, and as such might not be as fragile as they’ve been known to be in the past. Additionally, foreign capital seems extremely inclined toward dollar-denominated assets as the world’s demographic inversion comes to bear upon it, and this is likely to increase, which ought to cushion any selling, at least to a degree.
Conclusion
In liquid markets, we tend to recognize several classes of metrics in evaluating them. There are economic fundamentals, chart-based technicals, and the psychological metric, which can often get overlooked. Market psychology, however, is an important and often discounted measure of what is going on in a market.
Yes, interest rates have risen, and yes, this is injuring the viability of properties purchased and syndicated at low cap rates, in many cases by novice syndicators and investors. The potential for speculators to exit and leave a glut of supply overhanging is therefore palpable, but this would not appear on the surface to be of the magnitude on its own to lead to what most investors would term a ‘collapse.’
Other recent articles
Article Search
Share
All Article Categories
