June marked the 10th anniversary of the most recent U.S. economic expansion, but many of the nation’s most prestigious economists don’t expect us to have an 11th. The reasons range from an escalating trade war with China, dropping manufacturing activity and deep auto industry layoffs to the inverted Treasury yield curve. Commercial real estate indicators aren’t ominous yet, but private real estate investors need a clear view of the risks they may face and must recession-proof their multifamily properties now.
Having the right investment manager is key to risk management in uncertain times, as their business plans will be predicated on assumptions that are achievable — even in a downturn. Also, they will have purchased the asset using reasonable debt levels and will have a risk management strategy for the investment.
Below are three tangible strategies that top-tier managers utilize to recession-proof a multifamily portfolio.
1. Think Diligently, Act Locally
Just as “all politics is local,” so is real estate. In their Beige Book, the Federal Reserve governors said real estate activity is declining in some regions even as others pick up the pace. Much of that activity centers on multifamily real estate: 319,000 apartments (subscription required) are due for completion this year nationwide, which the Wall Street Journal determined is the most new units in about three decades. Local conditions should dictate new multifamily purchases and impact investors’ efforts to recession-proof already-owned properties.
In many markets, capital is chasing assets — the apartment supply is driven not as much by renters looking to relocate as by investors looking for deals. Caveat emptor, or buyer beware. As private real estate asset managers, our team developed an objective risk model for acquisitions and applied it to existing assets. One goal was to see if their market fundamentals were still solid. The most recession-proof markets were regional business centers with broad-based economies. Multifamily real estate in those cities was well positioned for continued population and job growth. For example, Houston has already emerged from an oil industry recession, according to a 2018 University of Houston report. Growth in health care, finance and other sectors picked up the slack.
From our experience, city selection is important, but not sufficient enough to guarantee the success of any one multifamily property. Even in thriving cities, specific submarkets will outperform the broader city. It is a manager’s job to identify these submarkets. Examples are West Midtown in Atlanta or the West Loop in Chicago; both of these submarkets have outperformed their broader cities.
Most important of all are a property’s advantages within its submarket. Proximity to jobs, transportation and walkable retail will drive rental demand in any economic environment. Properties with good locations can be reinvented through targeted capital investments and superior service in any economic environment.
2. Audit Apartments To Spot Income Opportunities
Apartment owners should audit their buildings’ physical space to see if they can support rental growth. Every multifamily property owner should create a spreadsheet showing apartment unit size, contract expiration and annual increases. This rent roll will indicate not only leasing progress, but also market demand — which units are in line for rent increases and which might first need renovation.
If apartment renovations are deemed necessary, use leverage responsibly. Recessions reward owners who have not stretched their credit to the breaking point. Managers should set aside reserves to cover debt service if top-line revenue drops, rather than subject investors to additional capital calls.
Debt can be rolled over into new borrowing only so many times before banks start demanding a premium or dictating more onerous terms. A drop in top-line revenue could result in a loan default and put the property ownership at risk.
3. Give Tenants More — They’ll Reward Attention to Detail
Top-quality owners of multifamily real estate develop programs to ensure positive experiences for their renters. These experiences encompass a property’s physical, virtual and service elements.
For physical differentiation to remain competitive, properties’ units and common areas should exceed those of competitors. Owners with long-term strategies can benefit from capital investments in recessions thanks to lower labor and material costs. Areas for strategic investment include common areas, from multifaceted fitness centers (with yoga studios, exercise rooms and more) to cardio and strength training equipment with 24-hour access.
Services are the newest way differentiate properties. Dog-walking and concierge services are highly valued in higher-end communities. Virtual trainers — a hotel-style amenity that actually started in upscale apartment communities — make workouts more productive and keep fitness amenities competitive economically. Events provide opportunities for renters to form communities with staff and each other, leading to higher lease renewal rates and giving operators the ability to push rents.
Virtual elements include the website, social media and ratings from renters. Multifamily properties’ virtual identities have become critical to their actual performance. Ratings are the first credential potential renters check, and websites and social media are their virtual front door. These areas must receive constant attention and investment.
As competition becomes tougher, local management should focus on retaining tenants. Like any other business, it’s easier to keep current customers happy than to worry about finding new ones. Better tenant relationships will lead to more contract renewals. In turn, positive renter reviews and word of mouth will draw new tenants.
But the true key to out-performance in any market condition is service. Staff in a well-managed multifamily property should already be client-focused. That means knowing tenants by name, keeping the premises in tip-top shape and responding quickly to complaints. A resident portal on the property’s website can simplify rent payments and maintenance requests.
Bottom Line: Act Fast And Before The Fact
A downturn is hard to predict, but trouble looms on the horizon long before economic stress brings it to the doorstep. Due diligence is an ongoing and critical process for all property owners. Using all three strategies and reacting quickly to potential risks properties face will strengthen a portfolio, no matter the economy’s direction.