Multifamily apartments are the gold standard for real estate investing, but as of late they have seen some volatility, especially those B and C class properties that require more renovation, as the cost of materials, labor and financing are being affected by inflation. Drawbacks from the Covid-19 pandemic are still lingering as many markets are continuing to be impacted by high delinquency, and although the eviction process has been improving it’s not yet back to pre-pandemic speed. Once non-paying tenants are removed, labor shortages have been extending the time it takes to turn and re-rent units, not to mention increasing costs have created budget challenges. However, values remain extremely high because of the low housing inventory and high borrowing rates that are keeping Americans renting much longer. We’ve seen explosive rent growth and high occupancy across the country, so those who already have multifamily assets under management, especially those who purchased at a great cost basis with fixed debt financing, will fair very well as long as they can weather the fluctuations of the stabilization process and upcoming impacts of an impending recession. Those who are seeking new multifamily opportunities, which now include increased competition from institutional and private investors chasing the aforementioned rent growth, will find it very difficult to cash flow, and must be cautious not to be overly optimistic in their underwriting with aggressive (perhaps unrealistic) appreciation projections to make a deal “pencil”.

Two stable investments we are prioritizing right now:

1. Turnkey Net Lease properties with essential business tenants and corporate guarantees, since they can offer both a hedge against inflation, as well as a much more predictable return. The nature of investing in these net lease assets is buying the building and land where a business is operating, and that business is the tenant. The lease is often structured so that the tenant pays the majority of the expenses. The Starbucks you got coffee from this morning, the CVS where you picked up your prescription, the grocery store down the street, or the salon where you get your haircut - these are all examples of businesses that sign net leases. These companies mostly do not own the properties and buildings where they conduct business - they operate their businesses and pay rent to whoever owns the properties.

While many businesses have net leases, in our case, we’ve taken our strategy a step further to focus specifically on acquiring properties occupied by essential business tenants: businesses that are most likely to remain open even during an economic downturn or global health crisis - tenants like dollar stores, pharmacies, auto services, or urgent/veterinary care centers. Additionally, the “net” in “net lease” means that the tenant also pays most, if not all, of the expenses in addition to the rent, like taxes, insurance, utilities and maintenance - so as those costs rise due to inflation, our bottom line is not as negatively impacted compared to properties where ownership is responsible for paying these expenses. On top of that, we look for tenants that offer Corporate and Franchise Guarantees - that helps give us the ultimate confidence that their rent checks will show up on time each month, even if the company decides to close these locations mid-lease. And finally, long term multi-year leases with built in rent increases create additional cash flow, higher property values, and another hedge against inflation. 

In 2022 we launched our first fund to purchase multiple net lease assets. So far we’ve purchased four of these properties (all in the last four months): three dollar stores and a veterinary clinic. We also have an accepted offer for what we hope will be our fifth net lease acquisition, and are excited to continue growing our net lease portfolio, based on all of the success we’ve experienced with this asset class thus far.

2. Medical Office is another exciting asset class that we have our eyes on. It’s relatively new for us and our network, however we’re intrigued because the trajectory for healthcare real estate is tremendous. With an aging population and increasing demand for more convenient non-hospital medical options, there is a strong forecast for growth across the Healthcare real estate sector. Did you know that people who are 65+ make 8 or more trips to the doctor each year? Not to mention, many Americans delayed maintenance or elective procedures during the pandemic, and would prefer not to return to large, crowded hospitals. Demand for “off premise” multi-tenant Medical Office Buildings (MOBs) has increased, and investors in this space are seeing consistent and healthy returns. In the last year MOBs had a 95% rent collection rate and 92% occupancy rate.

These medical tenants also normally have net leases, as we described above, where they cover most if not all expenses, with long term leases and built in rent increases. These tenants are “sticky,” meaning that they tend to stick around for an extended period of time because most have expensive equipment that’s difficult to move, and many medical practices rely on and build loyalty with their local community. Certain multi-tenant MOBs can also benefit from implementing a value-add strategy, whether they have under-market rents, vacancies, deferred maintenance, lack of branding/marketing – all of these examples provide opportunities for new ownership to raise the value of these assets. A multi-tenant MOB in a populated area, with the right strategy and operating team, can offer investors both steady cash flow AND forced value appreciation.

More Tips for Successful Investing in 2023:

Successful investing in 2023 will take some creativity. Deal sourcing, financing, negotiating and overall strategy will require outside of the box thinking and problem solving.

Deal Sourcing: Besides great broker relationships, we are now employing A.I. and advanced technology to find our deals, which gives us the ability to filter through thousands of deals in real-time, narrowing them down quickly and efficiently, ensuring we don’t waste time looking at anything that doesn’t meet our strict buying criteria.

Financing: With mortgage rates significantly inflated, many purchasers have lost buying power, and investors are struggling to find opportunities with attractive return projections, which is why we’ve been getting creative with our financing too. How? By pursuing seller-financing, where the seller acts as the lender, offering more favorable terms than a bank, like a lower interest rate. Another way to get creative about financing is to purchase deals with assumable debt at lower interest rates. These are two strategies we are using to circumvent the escalating rates offered by traditional lenders.

Negotiating: Negotiating will always be an integral part of the acquisition process, but now more than ever, with tighter deal margins, this skill is really being put to the test. Great negotiators will still be able to get solid deals done in this market, despite the present challenges. For us, that means demonstrating our position as credible buyers, knowing the ins and outs of the due diligence and contract composition process to prioritize the most favorable terms, and staying disciplined to negotiate below-market purchase prices compared to current market valuations. 

Strategy: For value-add opportunities, increasing ownership equity is the top priority. The most straight-forward way of doing so, is to purchase the property below market value, so you have additional equity built-in on day one. After purchase, the goal is to boost the Net Operating Income (NOI) by increasing revenues or decreasing expenses, since commercial properties are valued based on their NOI (when NOI goes up the value of the property goes up). More specifically, for every dollar increase in NOI, the value of the property increases $20: $10,000 annual NOI increase = $200,000 property value increase (assumes a 5% cap rate). Getting creative about ways to boost NOI can make or break a project - it’s not just about increasing rents, but also looking for other revenue generating or cost saving opportunities, like charging for reserved parking spaces or pet fees, switching to water efficient sinks & toilets, billing back utilities, and more. 

Conclusion: Net lease essential businesses and medical office buildings have already proven to be historically stable. Now, as we look down the barrel of recession, we’re having to get more creative to find great opportunities. By prioritizing acquisitions in these two asset classes, we’re focused on providing our investors with deals that will preserve their capital and generate steady cashflow, limiting the potential downside.

By Danny Bellish, Managing Principal, The Bellish Team