Back to the Future
Back to the Future
As a kid, one of my favorite movies was “Back to the Future”. In the movie, Marty McFly, played by Michael J. Fox, connects with Doc, played by Christopher Lloyd, a mad scientist of sorts, and is given the opportunity to travel back in time in a tricked out Delorean automobile powered by Plutonium. Not only is young Marty given the opportunity to go back in time, he is specifically given the opportunity to set things right for his parents who at the time were young high school students in need of direction from the future.
Anybody Home? Huh? Think, McFly! Think!
Sure, we’ve all had an “if I knew then what I know now” moment, but what about being able to go back in time and actually make the most of the opportunity? For investors, missed chances can serve as painful reminders of being too cautious or conservative in a market primed with opportunity. These reminders are especially painful in a market like today with sales prices reaching new heights on a daily basis.
So, What Happens in the Future?
While you don’t need numbers and statistics to understand that values in the multifamily sector have exploded, if you had $5 million, $25 million or even $50 million dollars and a time machine, you could go back just 20 years to 1995 and put together a portfolio of apartments that today would be worth more than three times what you paid for it. Yes, if only I had a briefcase full of $50 million dollars and a Delorean fit with a flux capacitor, after a brief trip back to 1995, today I’d be worth $150 million dollars! Ok, back to reality.
Portfolios Have Tripled in Value? Great Scott!
So maybe it’s no surprise that values have increased exponentially over the past 20 years, but just what has caused this growth? First and foremost, the population of Orange County has grown by over 23% since 1990. In that time, the median household income in Orange County has grown from $59k to $86k. Homeownership rates on the decline nationwide are even lower in Orange County, down from 55% in 2005 to 48% today. Now, more people are earning more and deciding not to purchase homes but to rent instead. This translates to a record numbers of renters, limited developable land and the result has been an increase in market multifamily occupancy rates from 94% in 1995 to 95% – 96% today, with rents rising along with a somewhat limited supply of suitable units.
A Bolt of Lightning, Only You Never Know When it Will Strike
Interest rates on the average fixed rate loan through Freddie Mac have dropped from 7.93% in 1995 to 3.88% today, further driving multifamily values through the roof. But with such solid fundamentals in place and a market that has more buyers than ever, one can’t help but wonder if we will soon see an uncoupling of the interest rate to capitalization rate relationship to market values. That is, will we see investors place less emphasis on interest rates and instead focus on other return measures in conjunction with market fundamentals?
For the time being, the correlative relationship between interest rates and capitalization rates is stronger than ever. And while the perfect storm of population and income growth, decline of homeownership and rise of rent affordability has helped multifamily emerge, it is largely the availability of cheap money and increasing investor demand for multifamily investments that is causing the fuss. We should see things slow down a bit when the Fed raises rates later this year or early 2016 but if not, well, maybe there really is something to this decoupling phenomenon.