I know what you’re thinking. This guy is trying to spin the headlines of SVB into a multidimensional real estate investment story. This must be clickbait.
I understood. But I hope you’ll take the opportunity to tell me two ways that SVB and other major bank failures could potentially benefit multi-faceted syndicators and investors. Then you can decide whether my title has merit or not.
Like all of us, I watched the news unfold rapidly this past week. Silicon Valley Bank went from giving bonuses to closing up shop within days. There is no need to retell the gory details here.
But as I considered the bad news coming out of this hopefully local but potentially more significant situation, I realized two potential bright spots for multigenerational syndicators and investors. Not just current players – but those eager to move into the currently overcrowded space.
My short term thesis is speculative, so I freely admit that I could be wrong on this. But I’ll put a trust flag on my long-term discussions below because I believe these results are virtually inevitable.
Near-Term Impact for Current Syndicators and Investors
Jerome Powell testified In a semi-annual visit to Capitol Hill last week, “if, and I emphasize that no decision has been made on this, but if the totality of the data indicates there is a need for rapid tightening, So we’ll be ready to scale it up.” The pace of rate hikes,” Powell told the US House of Representatives Financial Services.
The conclusion for many Fed watchers was an interest rate hike from 0.25% to 0.5% on March 22. This is no surprise as Powell is a protégé of 1980s Fed chairman Paul Volcker (who raised rates to 20% on the eve of Reagan’s presidency) and the Fed has had difficulty reining in inflation. Has been
Silvergate Bank collapsed at about the same time. Followed by Silicon Valley Bank the next week. Then Signature Bank last weekend. Now water is thundering in Credit Suisse’s pond.
While onlookers blame the decisions taken by the bank management, SVB’s position was clearly matched by rapidly rising interest rates. phenomenally fast.
Check out this graphic showing the pace of these increases compared to previous periods:
Although the Federal Reserve’s actions were designed to prevent inflation, I doubt that bank failures were an intended result. The speed of these three failures and the way it has dominated the news cycle has created widespread fear.
“Which bank is next?”
“Is my deposit safe?”
“How will this affect my credit line or mortgage?”
How can this situation be good in the short term
A lot of multinational deals are in big trouble. Low, floating rate debt was the drug of choice this past season as syndicators looked for every way to pencil deals to edge out overzealous rivals in the race to the bottom.
someone with prepayment penaltyFloating rate debt provided a more accessible outlet for syndicators looking to add value and plan to sell quickly. This strategy has generated billions in profits for investors in recent years.
But floating debt is back to bite syndicators and investors in this season of rising interest rates. Balloon interest payments are crippling cash flow, locking up investor distributions, and putting investor equities in dire straits.
Lenders are demanding much higher reserves as a result of the rising estimated cost of renewing the interest rate cap. A syndicator friend pointed out that one of his deals has historically required monthly reserves to renew the interest rate cap at around $2,000. His lender has increased that same monthly escrow to $70,000. (You read that right.)
Syndicators/investors in both floating and fixed-rate debt are facing additional losses as rent growth has stalled in most markets. This is having a profound impact on net operating income and values. This is a blow to operators looking at NOI as their potential bailout for falling prices due to the extension of cap rates. This is a real headache for those planning to refinance or sell soon.
We’re hearing stories every week about syndicators cutting distribution and discussing margin calls to avoid total losses. We recently heard of a syndicator paying $30,000 a month out of his own pocket to keep a deal afloat.
While I have no way of verifying this figure, a knowledgeable attendee at last week’s Best Ever conference said in his newsletter that he believes that about 30% of conference attendees are multifamily deals. They are in trouble on one level or another.
That’s why the situation is serious. Where is the so-called silver lining from the bank crisis?
As I said, the Federal Reserve should certainly keep the bank’s failures in mind as they determine their next move on March 22. If the Fed decides to slow down, delay or stop (or even reverse soon) an interest rate hike, it can provide one. Relief for over-stressed multifamily syndicators and their investors.
This relief may include relaxed rate cap reserve requirements, less cash flow bleeding from debt service, less damage to valuations, a higher chance of a successful refinance, and less chance of a capital call or losing the deal back to the lender. may involve. (Obviously, this may just delay the inevitable for most.)
While some still believe Powell and the Fed will move forward with their plans to raise rates, others think the job is delayed. Goldman Sachs said publicly They believe the Fed will not raise interest rates next week in light of this crisis.
It won’t take long to see if this plays out to be a ray of hope for the near future. But more definite long-term hope will take years.
Fed interest rate hike and bank failures give long-term hope
In 2016, I published a book on multifamily investing humbly titled “perfect investment, However, I’ve been kidding myself about it since 2017 or so.
I keep saying, “The right investment is not right…if you have to pay a lot to get it.” And I would add: “…if you have to use a floating rate loan to make ends meet.”
It’s been hard to find pencil sharpener deals. Indeed, it has been difficult to get multiyear deals. On-market or off-market. The competition has reached new levels. If you’ve followed my writing, you know that I believe this is for the following reasons:
- Increased syndication acceptance due to relaxed regulations from the JOBS Act.
- Viral visibility and popularity due to social media and other online platforms.
- An explosion of gurus that emerged out of nowhere this decade. Some people who were not in real estate prior to the Great Recession may be considered “neuros” by some.
- Increased investment from Wall Street’s casino exits and international investors.
- increased popularity of 1031 Exchange sometimes with inflated values on replacement properties.
- A rising tide that lifted all boats for a decade—until the tide turned out and exposed Warren Buffett’s skinny dippers.
Of course, the sharp interest rate hike has slowed down the multiyear investment frenzy considerably. But these bank failures could result in lenders raising underwriting standards – starting now.
Community and regional banks, which provide access to credit to many real estate developers and syndicators, may be reluctant to originate new loans. Especially in the short term when the threat of a bank run and higher rate hikes looms large. (Note that multifamily syndicators have options to obtain agency loans from Fannie Mae, Freddie Mac and HUD that would not go away in a bank crisis or increased interest rate environment.)
Worse yet for many, these banks may prohibit renewing fully executed real estate loans. A friend recently visited a local banker, who showed him a thick manila folder containing performing loans that he has no plans to renew this year.
So, as above in the near term, the situation is grim. So where is the so-called long-term hope from the bank crisis and Fed rate hikes?
As is the case with any recession, one long-term effect will undoubtedly be the declining level of multi-family supply to meet the rising demand. We already have a record number of multifamily properties coming online in 2023. But the National Apartment Association and the National Multifamily Housing Council say that America needs to build 4.3 million more apartments To meet the demand for rental housing by 2035.
how much is that? This is an increase of about 20% over the current national supply. If you want to think about the current supply that has been built up over about a century, consider that it needs to increase by 20% over the next 12 years.
And if a Fed hike due to bank failures adds to the brakes in the current manufacturing pipeline, the 12-year window will soon drop to single digits until 2035 (if this recession lasts through 2026, for example).
Silver Lining? I would definitely say yes.
An aggressive Fed and a potentially tighter credit environment, as well as the possibility that many popular syndicators will go out of business in the next cycle, may be a better environment for many of you eager to get in the business.
But you may not have to wait until the next cycle.
Many distressed multi-deal deals will fail in the coming year or two. This can provide opportunities for you to get distressed deals from distressed operators or banks at much less than the appraised value.
Do not get me wrong. I absolutely will not be amused by anyone’s failure, and I hope you feel the same way. But it is a fact of life in every market cycle. And this will result in the creation of more wealth than can be acquired in most cycles.
i’ll close with a Citation From Howard Marks, The Master of Profiting from Distressed Assets. It will pay for us to listen closely now and then when the tide turns again in the next cycle.
“In bad times, securities can often be bought for prices that underestimate their merits. And in good times, securities can be sold for prices that exceed their merits. And yet, most people Compelled to buy enthusiastically when the cycle drives prices up and to sell in panic when prices go down.
More from BigerPockets: The State Of Real Estate Investing In 2023
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Note by BiggerPockets: These are the views expressed by the author and do not necessarily represent the views of BigPockets.
