05.13.21
A Perfect Storm To Leverage Equity For Acquisitions
Equity is not static. At a simple level, the equity you have in your building is the difference between its market value and what you owe on the loan. The price you originally paid and the amount you initially borrowed have nothing to do with your current equity. Creating wealth in real estate is about timing and leveraging your equity. If you are an investor interested in growing your multifamily portfolio, this second quarter of 2021 brings three factors that create a perfect storm for leveraging your equity to buy additional properties: investor perception, pandemic-induced lender constraints going away and interest rates.
Investor Perception
Market value shifts up or down based on rents and expenses, but also on investor perception of the direction of the market. In this second quarter of 2021, the generally held perception is that while the economic impact of the pandemic will be felt for several years, we have statistically turned a corner past the worst. The perception of a market headed in a recovering direction — as well as rents returning to pre-pandemic levels — is creating investor demand for multifamily, resulting in increasing property values.
If you own an apartment building, you should have a broker, lender or appraiser give you an opinion of value. The result will most likely demonstrate a jump in value. Assuming you have a loan on the property, this means a probable substantial increase in your equity. This creates a moment in which your equity will potentially increase at an abnormal rate, which is the time to tap it and leverage it into the purchase of another property.
Lenders Are Lifting Pandemic Constraints
For the past year, lenders have created constraints on deal flow. At the very start of the pandemic, agency lenders required borrowers to escrow 18 months of property taxes and interest payments to qualify for acquisition loans. This additional capital requirement constrained deal flow. Another example of lender constraint is a deal we worked on last summer in Chicago: We had a sale contract for $21.5 million and the building appraised for $22 million. At the final stage of approval and based on fear of the continuing economic impact of the pandemic, the loan committee arbitrarily decided it would loan only on a $16 million value regardless of the appraisal.
Since March 2020, lenders and appraisers have been worried about the risk of commercial real estate and multifamily. Although multifamily has not been as negatively impacted by the pandemic as other commercial property types like office and retail, apartments have been much more conservatively valued over the last year. However, the effect of stimulus packages and the roll-out of vaccines are combining to lessen lenders’ fears about multifamily operations. The most recent data suggests that renters are now returning to the market this spring. These trends are not unexpected. Previous lender constraints are already beginning to be lifted. I expect this trend to continue during the second quarter. By the third quarter of this year, I expect multifamily lending to be back to normal.
The result of this is that refinancing your property should be a much more streamlined process than at any time in the last 14 months. Lenders are much more ready to move capital into the market, which means it is an opportune time to pull equity efficiently from your investment, and you should be able to do this more quickly and efficiently than at any other time in the past 14 months.
Interest Rates Are Still Very Low
Interest rates are a big part of the window for timing pulling your equity. The amount of your loan will be determined by the appraisal but also by debt coverage ratios. Interest rates are a big part of debt coverage. The lower your interest rate, the higher the loan-to-value ratio you will be able to achieve — meaning you can borrow more. This allows you to tap more of the equity that has been created. Interest rates remain at historic lows, but I predict that rates will go up by the end of the year.
These three factors — investor perception, lender constraints lifting and interest rates — are the perfect storm creating a jump in your equity and favorable conditions to tap it. If you own three to five buildings, you can probably tap enough equity right now to buy an additional building without adding any additional capital.
Now is the time to buy the next investment in your multifamily portfolio. The second quarter of 2021 through the end of the year is a window investors will look back on and say, “woulda coulda shoulda.” Don’t wait.
The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
