A healthy economy makes everybody happy; in society, in business, in government. In a healthy economy there are plenty of jobs, everyone has disposable income, business thrives, and there is plenty of tax revenue for both political parties to implement their pet agendas. One could also hope there would be less need to borrow so much money just to fund the government Budget each year as well.
But what’s wrong? Why after so long are their so many people still out of work, notwithstanding the faux Recovery and the “prosperity” that no-one can seem to identify, at least in their own lives, nor in the lives of most everyone they know.
The answer lies in a common mistake. Tragically for us, this mistake is being made by the Federal Reserve.
The mistake is, confusing correlation with causality.
For forty years now the Federal Reserve has attempted to stimulate the economy by loosening the money supply, which lowers interest rates. The economy has generally responded, though increasingly more slowly in successive downturns since the early 1970’s, to the point of where we are today, five years after the financial crisis crashing the economy. The Federal Reserve is still pumping $65 Billion into the economy every month, though it is failing to move the needle on job creation and unemployment.
We are finally learning now, at the end game of Federal Reserve economic intervention, that loose money supply is only correlated with job creation and economic prosperity, it doesn’t cause it.
The evidence is there for all to see. Three Trillion dollars of U.S. Currency put into circulation since 2009, and real wages have fallen, middle class America is shrinking, and government assistance is needed by most families just to get by.
But if the Federal Reserve trying to fill the ocean with money does not create jobs, what does?
Apartment buildings, being income producing and essentially businesses run by a property management staff, have always been able to be traded without you necessarily being local to the property.
This being the case, what is the best market to choose as the market you are going to focus on to do deals?
To be simplistic about it, the answer is the market where it will be easiest for you to get a property under contract at a price where you can add on your assignment fee and still have your resell price attractive enough that a new buyer (preferably multiple new buyers) will come in and eagerly take the property from you.
As usual with real estate, the easiest way to understand it is through the lens of supply and demand.
At the time of writing this (early 2014), money has been piling into commercial real estate in Tier 1 markets like New York City, Los Angeles, San Francisco, Chicago, and now Tier 2 cities like Houston, Las Vegas, Indianapolis, for 2-3 years now. When bond yields are so low, commercial real estate’s traditionally pedestrian return start looking pretty attractive.
First it was US hedge funds that figured this out, then it was international sovereign wealth and pension funds, and the buying began in earnest. That trend is probably hitting it’s peak right about now as the Federal Reserve tapers it’s bond buying each month and bond yields start rising again.
Nevertheless, so much money flowing into real estate markets around the US, buying up everything from the highest quality income property on down has created a lot of demand for property and pushed prices upwards.
If you are looking to wholesale apartment buildings then, what do you do? Which market do you choose?
If you are in a market where a lot of institutional capital has piled in you will see there are not many properties available on sites like Loopnet, what is available will have a high cost per unit, even with high vacancy and repairs needed. With a bit of investigation you’ll find market cap rates in the 5-6% range, maybe even lower. The brokers you talk to will be arrogant, and probably brush you off unless you are willing to pay 80-90% of their Pro Forma valuation (brokers are “Masters Of The Universe” when the money is flowing).
The current debt ceiling debate, and now government shutdown, though currently on a 3 month hold, may be the first crack in what is shaping up to be an unpredictable and ugly phase in the life of the U.S Economy.
There is the persistent and “annoying” fact that, since the Clinton second term, and before that, the Eisenhower administration, the U.S. Government has been spending more than it collects in taxes and other revenue. That is, every budget passed by Congress and signed into law by the President (excepting for the two periods mentioned) have been funded by borrowed money.
In 2012 the IRS collected $2.469 Trillion in tax revenues, and the Budget allowed $3.796 Trillion in spending. That’s a difference of $1.327 Trillion.
Where did the $1.327 Trillion shortfall come from?
Well, the Government raises funds by having the U.S. Treasury issue bonds; T Bills. When investors buy the T Bills, the proceeds go into the U.S. Treasury coffers and are available to the Government for spending..
Who buys T Bills? More to the point, who buys the T Bills that fund the $1.327 Trillion (and rising) Budget shortfall each year?
Mainly countries, like Saudi Arabia, China, Japan, and quite a few other countries with shaky economies who want to bolster their sovereign wealth funds with the perceived certainty and stability of U.S. Debt, along with individual investors. But the volume of these investors doesn’t account for the entire $1.327 Trillion. The T Bills that are not bought at auction are vacuumed up by the Federal Reserve.
Apart from the fact of Government deficit spending in the first place, the Federal Reserve involving itself into the situation causes even more problems. Like the bottomless cup of coffee you find in some cafes, the ceilingless credit card the Federal Reserve is making available to the U.S. Government to draw from, skews and distorts what should be the processes of responsible government.
With the President, all Senators and Congresspeople knowing the money is ever flowing, and there are no real limits preventing more borrowing (although they put on a good show every year with the debt ceiling negotiations), seeing the Fed is there to print money for any Budget shortfall, all kinds of self righteous, absolutist, ideological, self indulgent, finger pointing childishness is enabled in the behavior of the country’s political leaders. Democrats have their bloated welfare state, Republicans have their unaffordable low taxes. And when it comes time to negotiate something with real immediate consequences, like the debt ceiling, responsible negotiation gives way to a game of Chicken with the U.S. Economy.
Not all apartment markets are equal. Indeed, where you choose to buy and manage your apartment investments has a direct effect on how well you do.
Choose a market where all the factors in play support a profitable apartment investing experience, then buying and turning an apartment building around will go smoothly, and you will have a relatively easy time achieving all your objectives.
Choose a market where one or more key components of a healthy apartment market are missing though, and you will have a much harder time of it. Units will be harder to fill, turnover high, and projected values will not materialize, as you fight the headwinds of macroeconomic trends.
Making money is not difficult, for even the less experienced, when propelled by the tailwinds of a buoyant economy. So the question becomes, how do you find a buoyant apartment market to invest in?
Well, you can take other peoples’ advice, but that is always risky. Gurus are indeed “gurus” because they have something they want to sell you. So bear in mind, whatever advice you receive from a “guru”, it is part of an overall process that ends with you buying something from them.
You are much better off learning yourself what the factors influencing the health (or sickness) of an apartment market are, and then applying those to the primary and secondary multi-family markets across the country.
There are two advantages to taking this approach.
- You will end up knowing what you are doing. After learning what makes an apartment market tick, you will have the wherewithal to make data based decisions, and can proceed in a particular direction based on facts, rather than hearsay. And …
- Relying on your own analysis puts you in the path of opportunity when the opportunity appears, rather than when the masses have started chattering about it, and it probably isn’t much of an opportunity any more.
There are five characteristics of an apartment market that will help you determine whether it is a good place to invest. They are; strong population growth, young mobile residents, expanding employment base, tight sub-markets, and educated workforce. When you have these five factors ascendant in a market, you will have apartment investments that give you cashflow now, and equity growth in the years to come.