In the Great Recession, millions of borrowers with weak credit and little reserves had loans with high rates. In a horrifying spiral, many lost their jobs and then their homes or fourplexes. The market was flooded with foreclosures and short sales. My friends, clients, and competitors bought local homes at massive discounts. They expected values would rebound when the recession ended. The plan worked. Some tripled their net worth.
During those years, my wife and I had several years of cash on hand. We didn’t buy any houses or condos at half price. I hoped apartments would be discounted. The truth I ignored was that apartment investors had better income, more reserves, and loans with moderate interest rates. Their income property generated positive cash flow. Local apartment prices were stable. We kept our cash. It was one of my biggest fumbled opportunities.
In the Great Recession, the huge home price drops were caused by bad federal lending policy, limited accountability, and massive fraud. Trillions were lost and the laws were changed to minimize that risk.
Everyone makes choices using rules of thumb based on beliefs and prior experience. They don’t work in all cases, all the time but they work most of the time. Rules of thumb, formally called heuristics, simplify life and allow people to quickly decide which options are worth further investigation.
When applied appropriately, they can guide in using mental bandwidth prudently and effectively. When misapplied blunders occur. That’s what I did during the Great Recession. I didn’t consider what made home prices drop while apartment values held steady.
A friend of mine is smart about risk and reward. For more than a decade, he has guided families to prudently limit risk. He helps them avoid potential disasters by paying a known, small cost. His logic has reduced financial risk by assessing the likelihood of various outcomes. He sells insurance.
He uses logic wisely. Occasionally, he invests in houses or fourplexes. It is possible to buy a fourplex with a negative cash flow, but buildings with five or more units require bigger down payments to ensure positive cash flow after making the mortgage payment.
Investing in San Diego County Apartments
Recently, my friend asked my opinion about a multifamily asset with ten apartments in a ZIP code where I have unusual strength. It seemed like one of the two best opportunities that I have seen in the last year. I suggested an offering price. He was willing to offer about 2/3 of that amount, about what the asset sold for seven years ago. That price did not even receive a counter. What was he thinking?
My buddy used a rule of thumb that worked well for homes in the previous millennium before our county had a 100,000 rental unit shortage. 50 years ago, I paid 16.9 cents a gallon for gas. That does not mean I’ll ever pay that price again. It would be great to buy at ancient prices. His rule of thumb led him astray because it is not relevant for San Diego County apartments today.
If he continues to use the same rule of thumb, my smart friend is not likely to buy an apartment building above four units in this county. Market reality blocks his fantasy. For a generation, government regulations required large down payments so that the property income would exceed the loan payment. Most local owners have the highest cash flow ever. Inflation boosts owners’ positive cash flow. Local owners have no reason to sell at a discount.
In effect, my smart friend may ignore a superior opportunity, hoping against market forces for the best purchase in the next generation. I wonder what would he tell his clients if they said they didn’t want insurance because they didn’t expect to have a fire or an accident.
In the last 30+ years, I have asked about 100 millionaire clients what their biggest mistake was. Not a single one said, “I overpaid by 1-2%.” Almost all of them regretted declining a property by less than 1%. Most regretted their choice after prices rose 5-10% usually within 18 months.
In San Diego County, apartment prices have increased 8% annually for 30 years, through four recessions. Most sensibly priced local apartment properties receive multiple offers from millionaire buyers. Local multi-family investments are a low-risk escalator to wealth.
Markets without a pent-up demand for apartment rentals see apartment price drops. Detroit, Los Vegas, Tucson, and 50 other cities lack a 100,000 rental unit shortage. San Diego is among less than 10% of the U.S. markets with a huge shortage of rentals. If this county doubles apartment construction for a decade, we would still have a rental shortage.
Use your rules of thumb to make decisions of all kinds. Just be sure to check whether your rule of thumb fits your current challenge.
Terry Moore, CCIM is an investment real estate broker with a proven history of success in creating value, 1031 (tax deferred) exchanges, and building wealth through apartment investments. He has taught at UCSD, National University’s MBA program, the Appraisal Institute, SD County Tax Assessor, California Association of Realtors and is a National Certified Commercial Investment Member. For more information contact Terry at [email protected], call 619-497-6424 (Direct), 619-889-1031 (Mobile) or visit www.SanDiegoApartmentBroker.com. (License #0091851).