reoYou might not have heard of the real estate owned (REO) market. That’s all right; neither has the secretary of Housing and Urban Development.

If you have, though, then you know that this is the rock-bottom path to homeownership or residential real estate investment. These are properties on which the occupant could no longer pay the note. Then a short sale could not be arranged. Then nobody was willing to buy it at a foreclosure auction. So the lender that got stuck with it has withdrawn its liens and boiled down the terms and conditions of sale to two short words: “as is”. Essentially, even the banks have walked away from these distressed properties.

And yet, just like any piece of real estate, there is such a thing as a price at which both a buyer and a seller can shake hands. Today, that price might be heading lower as the number of handshakes starts to rise.

Where we are, and Where we Were

Let’s roll the tape back a decade. The current economic expansion has been going on long enough that real estate investors with a decade’s experience entirely missed the Great Recession.

As the crisis dawned in 2009, Georgia Institute of Technology’s Dan Immergluck — then a visiting scholar at the Federal Reserve Bank of Atlanta — took a snapshot of the situation. As long as REOs could be chalked up to urban blight, then the “destabilizing impacts on neighborhoods and communities” wasn’t a problem. But when this class of real estate started to pop up on Forsythia Lane or Warbler Crescent, suddenly there it was a calamity.

“In general, in traditionally weak-market metros — many of which had substantial REO levels before the advent of the national mortgage crisis — REO tend to be relatively concentrated in central cities. Conversely, in regions where REO accumulated more recently and in those with high central-city housing prices, REO tend to be somewhat more suburbanized,” Immergluck found. “In particular, in the formerly ‘hot-market’ regions where home values have declined rapidly, a large majority of ZIP codes with ‘severe’ REO levels are suburban.”

Through 2009 and 2010, it wasn’t unusual to have 80,000 properties per month entering the REO market. That’s on top of about 250,000 per month that were auctioned off or fell into default. According to the HSH real estate portal, REOs comprised almost half of all transactions during that time.

Today, the volume for each of those situations is roughly one-seventh what it was when the economy was at its worst. 

ATTOM Data Solutions reports that, while foreclosures are still trending downward, that is not the case for repossessions, as REOs are otherwise known.

“There were 49,898 U.S. properties with foreclosure filings in November 2019, down 10 percent from October 2019 and down 6 percent from a year ago,” according to ATTOM, which then points out that REOs are heading the other direction. “Lenders repossessed 13,996 U.S. properties in November 2019 (REOs), up 4 percent from the previous month and up 22 percent from a year ago.”

While that doesn’t mean another recession — or even another nationwide real estate bust — is coming, that’s still a troubling statistic.

Hunting Houses, Finding Funding

Ten years ago, the internet was alight with stories — some real, some apocryphal — of homebuyers targeting such distressed communities as Cape Coral, Fla., or Detroit’s “greyfield” neighborhoods, putting the whole transaction on their credit cards. And why not? There was so much inventory, banks were willing to accept pretty much any offer that covered closing costs.

Supply is more constrained now, so the price per unit has gone up. Generally speaking, people aren’t buying REOs strictly on price anymore. An REO now goes for pretty much the same price as any other fixer-upper in the neighborhood.

There may be a few bucks to be saved, but that’s around the margins now. Essentially, the main distinction between an REO and a starter home is that the seller is a bank rather than a family that got too big for it. They can all be found via the same websites, listing services, and neighborhood real estate agents.

That said, there’s no shortage of professional flippers looking to acquire cheap properties to rehab, and they can often pay cash. People looking to buy their starter homes — as well as those looking to enter the REO market for the first time to make a profit — probably don’t. Retail banks and other mortgage lenders generally don’t stick their noses up at REOs, so conventional mortgages are one way to go. But it’s more typical, according to FitSmallBusiness, to keep up with the nimbleness of the cash-on-the-barrel investor, to get the funds through a hard-money loan then refinance later.

From House to Home – REO Style

reoUltimately, the whole purpose of the REO market is to get units off the bank’s balance sheet. For anyone who doesn’t work at the bank, though, the most obvious sign of a successful REO transaction is that the creepy house with the plywood windows and the Jumanji lawn is now the abode of human souls still attached to their bodies.

But what’s the fastest way to get that done? Here’s where the data conflicts with the received wisdom.

“Conventional wisdom in the mortgage servicing industry has traditionally defaulted to …: a neighborhood is better stabilized when a distressed property reverts back to the foreclosing lender [which] is more likely to get the property back into the hands of an owner-occupant, and owner-occupants have a more vested interest in neighborhood quality and stability than do real estate investors,” according to economist Daren Blomquist. “But a thorough analysis of data … shows that properties sold to real estate investors at foreclosure auction more quickly convert to owner-occupancy than those that revert to lenders at the auction.”

Even so, Blomquist’s June 2019 article noted his surprise that more than 40% of the REO properties sold through his portal’s “Day 1” program were soon-to-be owner-occupants rather than investors. Of course, that also means that the majority were sold to investors, suggesting that there is more than enough demand to make REO management and resale a profitable endeavor.

hawaii real estateGeographically, Hawaii is unique among U.S. states. The only state composed entirely of islands, it sits in the middle of the Pacific Ocean. Just below the Tropic of Cancer, Honolulu is on a latitude with Mexico City and Havana, nudging aside Key West. Fla., for bragging rights to being the United States’ southernmost city. A motorboat ride east of the International Date Line, Hawaii is two hours behind Pacific Time, a distinction it shares only with some barely populated rocks in Alaska’s western Aleutian Islands.

Who Lives in Hawaii?


Hawaii is the only plurality-Asian state in the Union — majority-Asian, depending on how you count people of mixed ancestry. Filipinos and Japanese are the largest ethnic groups, followed by pre-contact Polynesians. There are slightly more women than men living in the state, and roughly half the adult population is married. The median Hawaiian is 36.2 years old and the median resident of Honolulu is 39.7, in line with a national median of 38.1.

The entire economy is predicated on tourism. More than 14% of all employed Hawaiians are directly engaged in the sector, and most of the rest are in public-sector careers related to education, health care or government service. Within greater Honolulu — essentially the island of Oahu — there are also a lot of retail sales jobs and positions on maritime crews. It should be noted that the unemployment rate in Hawaii is persistently lower than that in the U.S. overall.

Considering that almost one out of three Hawaiians 25 years of age or older is a college graduate, one can surmise that there are lots of people willing to settle into underemployment if it means living the tropical lifestyle. The weather is nothing if not predictable. While Hawaii sees a lot of precipitation, it’s warm rain. ranks Honolulu first among major U.S. cities for the smallest temperature differences during a year.

Politically, Hawaii usually has a big, blue “D” next to it, but that’s not an absolute. Certainly, native son Barack Obama did exceedingly well in the Aloha State but, in 2004, George W. Bush came very close to adding it to the Republican column as he won his second term. Religiously, Hawaiians tend to be more secular than mainlanders. While there is a significant Catholic presence and a smaller Protestant one, roughly two-thirds of the population adhere to no religion. Most non-Christians who follow a religion are Shinto Buddhists.

Oahu is just one of eight major islands in the archipelago, arranged politically into five counties. (There is effectively no city- or town-level government.) One of those counties is a former leper colony that was closed off in 1969 and fewer than a hundred people are still alive there. Of the rest, more than two-thirds of the population lives in the City and County of Honolulu, otherwise known as the island of Oahu. So that’s where we’ll zero in.

Beyond the Tiki Bars

hawaiiMost of what you think of as Polynesian art and culture is pure baloney. “Tiki culture” was invented by Californians to reflect some idealized version of South Pacific hedonism. Even the Mai Tai — the rum-curaçao-umbrella concoction emblematic Honolulu’s touristy Waikiki Beach — was invented in Oakland.

There’s nothing magical about Honolulu. It’s just another city, with the same benefits and challenges as other cities. But, like all cities, it also has its own unique cultural flairs and neighborhood personalities.

(The weather is really, really nice, though. There’s no getting past that.)

There are 18 neighborhoods in Honolulu,” according to Norada Real Estate Investments, which focuses on the single-family market. “Some of the best … are Waikiki, Ala Moana-Kakaako and Hawaii Kai. Waialae-Kahala has a median listing price of $1.9M, making it the most expensive neighborhood. Makiki- Lower Punchbowl-Tantalu is the most affordable neighborhood, with a median listing price of $408,000.”

The single-family option is gaining ground at the expense of the multifamily market, and the stark economics of the buy-versus-rent decision appears to be driving it. Writing for Norada, Marco Santarelli reports that Honolulu is the single least affordable market in the U.S. for apartment rentals or condo purchases. This dynamic will get worse before it gets better, as a 1%-to-2% annual population increase is expected to lead to a shortfall of 26,000 units in the next decade. When you consider that there’s a baked-in need for rental units from the strong U.S. military presence and the off-campus housing needs of the University of Hawaii, the demand keeps piling up.


“Roughly sixty percent of Hawaii residents are cost-burdened renters, people who spend more than a third of their income on rent,” Santarelli continues. “Compounding the matter is that they’re competing with several large pools of renters who are almost immune to local economics, driving up rental rates.”

Such efforts as The Michaels Organization’s $41 million, 320-unit affordable housing project currently under construction in Ewa Beach will barely make a dent. Altogether, fewer than 1,500 new low-rent units come online in a typical year.

Still, low property taxes and a generally developer-friendly City Hall spur continued growth in the real estate market overall.

It should be noted that one unique feature of the Honolulu market is that multifamily real estate is almost an afterthought. While $608.8 million was invested in apartment construction in 2018, according to CBRE, that pales in comparison to the $1.6 billion funneled into retail and $2.4 billion into hotels.

Trouble in Paradise

So Honolulu is a much more nuanced place than the Elvis movies would have you believe. Contrary to trends on the mainland, crime is rising and air quality is falling.

There are geopolitical issues to consider as well. Honolulu Harbor is, as we’re reminded every December 7, a strategically important location. We now fight wars across the Pacific with tariffs on computer parts and soybeans rather than with aircraft carriers and heavy bombers, but tensions in the region are nonetheless tense. The fallout for multifamily real estate is that some investors — not to mention potential residents — are waiting for tempers to cool before committing their money.

“Overall across Hawaii, home sales grew 12.3% while prices fell slightly by 2.5%,” Gord Collins reports for property management software vendor ManageCasa. “Homebuyers may be waiting for the trade deal to happen before committing to buying in Hawaii. Yet, even with the tariff slowdown period, prices haven’t dropped much.”

Maybe that’s because of the one, immutable truth about Hawaii: Land itself is at a premium. There will never be enough paradise to go around.

Honolulu at a Glance

hawaiiPopulation: 953,000 (2010, Oahu total)

Unemployment rate (2019): 2.9%, compared with a national average of 3.7%

Average household income (2017): $138,492, compared with a national average of $48,150

Cost-of-living index: 172.3 (2019), compared with a national average of 100


greenwichLet’s start by saying the headline above is in no way facetious. Almost certainly, Reader, your boss has a 068xx ZIP code from Greenwich, CT.

Greenwich (pronounced “GRENN-itch”), Conn., is a town of 62,000 people and 16 yacht clubs. It is the wealthiest town in Connecticut and vies with New York City’s other exurbs and Silicon Valley redoubts for top honors nationwide. The closest thing to “industry” along this stretch of Long Island Sound in the Nutmeg State’s southwest corner is Blue Sky Studios, which does computer animation for Disney, although there might well be more florists per capita in Greenwich than anywhere else in America.

The majority of people residing in Greenwich are in finance, the professions or education, according to, and about a quarter of them eschew the excellent public schools and send their children to private academies. “Top executive” is one of the most frequently cited occupations, as is “other management”. So if your boss doesn’t live there, it’s very likely your boss’s boss does. And, considering that Greenwich’s environs are also dense with financial managers and other finance specialists, it’s even more likely that the portfolio managers of the institutional investment firms that own enough of your company to be listed on its annual proxy statement know what the Manhattan skyline looks like from Round Hill.

So if you didn’t get a year-end bonus, it was because the Greenwich stole Christmas. (Shame on you if you didn’t see that coming.)

Who Lives There?


There’s no sugar-coating it: Greenwich is glaringly white, like 80%. There are more than three times as many people of Asian origin than there are African-Americans. Japan, incidentally, is the largest source of immigrants to the town. The United Kingdom is second. There is a significant Latino population due to one neighborhood in the southwest corner that abuts the largely Spanish-speaking town of Port Chester, N.Y.

That said, Greenwich is not as WASPy as its reputation. It is far more Italian and Irish than you might expect. Most non-Catholic residents declare no religion — far more than identify as either mainline or evangelical Protestant. While there is some Jewish presence there, that community is far more concentrated in Stamford to the northeast and Westchester County, N.Y, to the southwest.

The majority of Greenwich’s population is comprised of college graduates. It is also older than most; the average age of 42.8 years is significantly higher than Connecticut’s 39.2 and the U.S.’s 37.8. Most residents — 52% — are female. We’re not sure what accounts for that, but the divorce lawyers’ dictum, “give him the pension, give her the house” might have something to do with it.

Politically, Democrats have the edge in Greenwich, as they do throughout Connecticut. That said, many of these voters are persuadable given the choice of an old-school Republican candidate. Mitt Romney and George W. Bush both did very well in Greenwich’s precincts. Donald Trump, not so much.

What do you Mean by ‘Greenwich’?

We recently wrote about what an imprecise term “Los Angeles” is. While Greenwich isn’t anywhere near the scale of the “72 suburbs in search of a city,” it does have its internal peculiarities.

There are seven Census-designated places comprising the Fairfield County town:  waterfront Byram, artsy Cos Cob, historic Glenville, moneyed Old Greenwich, primly suburban Pemberwick and fame-soaked Riverside, as well as Downtown Greenwich. Between them there are five ZIP codes and four MetroNorth commuter train stations. When you stick Greenwich under a microscope, you’ll find the CPDs subdivided into no fewer than 30 neighborhoods. That Greenwich neighborhoods have an average population of barely 2,000 tells you all you need to know about population density.

Depending on where you look through these 48 square miles, home prices range from exorbitant to surreal. The median value of a housing unit is upward of $1.1 million these days, or roughly four times the Connecticut average. And that’s if you’ve bought-and-held. If you’re looking to move to Greenwich today, you’re talking table stakes of $1.6 million.


The gap between existing and asking rents are similarly stark. Roughly one-third of Greenwich units are leased and, while the median gross rent is $1,322, the asking rent for vacant units is $2,440.

While the vast majority of Greenwich homes — roughly 17,000 — are single-family, there is some room for multifamily dwellings. About 3,500 residences are located in structures containing five or more units, the majority of which are in structures containing more than 20.

And while residential real estate can be an exceedingly seasonal business around the country, it’s not as cut-and-dried in Greenwich. If you don’t sell by the end of August, you don’t necessarily have to wait until April to find a buyer.

“The real estate market continues to see sales as the winter season approaches,” according to an early December article by Ken Edwards at the Connecticut Post. “[S]howings will taper off while the buyer pool gets ready for the holidays. The serious buyers will be out, however. Last week our local Greenwich MLS reported 11 real estate closings totaling over $21 million. The mix of sales included eight single-family homes, two condos and one multi-family home in Pemberwick.”

Greenwich Time reports that, in response to strong demand and in contrast to the town’s resistance to change, new apartments and condos are in the pipeline.

Even so, even an enclave as prosperous as Greenwich isn’t completely immune from the softening of the real estate market throughout the New York City gravity well.

Berkshire Hathaway Home Services’ Mark Pruner recently explained to an audience, that a local house that sold for about $9 million ten years ago would sell for $7 million now.

“That’s still someone spending $7 million on a house in Greenwich,” the Greenwich Free Press quoted Pruner as saying. “Too often we focus on the hole and not the doughnut.”

Greenwich at a Glance

  • Population: 62,000 (2013), little changed since 1970
  • Unemployment rate (2019): 2.9%, compared with a national average of 3.7%
  • Average household income (2017): $138,492, compared with a national average of $48,150
  • Cost-of-living index: 172.3 (2019), compared with a national average of 100


construction delaysIt’s not news that multifamily construction is bottlenecked. We’ve already documented in this space how construction delays are one of the issues exacerbating the current housing shortage. Builders would have to crank out 30,000 more units per year, we reported, just to keep up with demand. But the problem is likely to get worse before it gets better.

For this article, we took a look at some U.S. Census Bureau data about housing starts. Peeling away the small-scale projects that contribute to the headline numbers, we focused strictly on projects that are expected to add 20 or more apartments each to the landscape. Then, going with the rule of thumb that these projects typically take two years to complete, we compared how many units ought to have been completed in a given year with how many were delivered. It’s not pretty.

construction delays
Source: U.S. Census Bureau

The first odd thing about this graph is how steady and in-tandem starts and completions were in the early years of the Millennium — right up until the real estate market fell off a cliff. As the U.S. emerged from the Great Recession, completions exceeded starts, presumably because so many projects were put on hiatus as demand and capital dried up. But 20-plus-unit starts soon made up for lost time, and the number of big-project apartments completed in 2015 matched those promised in 2013 almost exactly, in the neighborhood of 250,000. Still, that was 50,000 more than in any year in recent history, and it soon became clear that the industry was reaching capacity. Last time that many units came online at once, The Godfather was still in theaters. This past year we reached the point where developers are getting shy about breaking ground on new projects until the current ones are farther along the pipe.

Things were bound to fray. The multifamily homebuilding industry has hit its ceiling, absent some massive public policy initiatives such as the Housing Act of 1949. (This paeon to government overreach and unintended consequences might have destroyed more homes than it built, but that’s another story.)

According to RentCafe, multifamily unit completion volumes are expected to be 8.2% lower in 2019 than they were in 2018, which were 8.2% lower than the year before. That supply trend is, of course, moving in the opposite direction of the demand trend.

“High construction costs and a narrow pool of skilled labor are just a few of the factors hindering the development of new apartment units,” blogs Florentina Sarac.

Must investors adjust their thinking to assume that a typical project is going to experience another six months or so of burn rate before the ribbon gets cut and that the cash stream won’t start flowing back until that half year is up? Do they have to face a new reality that the rate of return on a multifamily project will henceforth be lower than it has historically been?

Contributing Factors to Construction Delays

construction delaysThe short answer is “yes”. There’s more than one reason for the bottleneck, and all those must be solved before the industry is anywhere close to supply-demand balance.

Sarac cites Yardi Matrix as the source of those completion figures, and quotes a Yardi executive as suggesting that the decline “is part of a larger trend of developers gearing up for the next cycle.” There’s not much to support that, though. Construction contractors might put cash away for the next cycle, but they don’t turn down work. Plenty of time to rest during the next recession.

Considering how long this building boom has been going on, though, maybe the crews deserve a little break.

In a separate report, Yardi also posits that a major contributor to the slowdown is a spate of state-level rent control laws.

“After a period of below-par growth in housing stock, the U.S. needs more units built, but rent control moves the needle in the opposite direction,” according to an October 2019 paper.

It’s only three states, but two of them are New York and California — plus Oregon if it matters to you — and there are similar bills under consideration in other statehouses.

Even so, it’s rather simplistic to say that these laws are causing the slowdown all by themselves. There are, after all, reasons why they were proposed, passed and signed. Many people in these — and other — locations are rent-burdened. That is, they spend more than 30% of their monthly pay on rent. (That’s up from 25% a generation ago if memory serves.) That 30% figure is just a rule of thumb of how much you ought to pay, at maximum, for four walls and a roof. It’s pretty meaningless because rent could be well above 30% of pay for the poorest renters yet well below 10% for the wealthiest. It’s those people toward the bottom of the socioeconomic scale that rent control laws seek to protect.

So rent control doesn’t cause developers to stop building — it just causes them to stop building Class B, C and D projects. Just as there are limits to what poorer people can spend, though, there are limits to how many rich people are available to move in before the local Class A submarket is overbuilt. We talked a little about that here.

What’s Really Going on

The construction delays do come back to labor economics, but not necessarily a labor shortage.

“We aren’t facing labor shortages, but rather cost increases that are needed to ensure there aren’t any shortages,” Summit Contracting Group President Marc Padgett told National Real Estate Investor. “We have not seen an issue with the quantity of labor, but rather the cost of having it.”

A recent Forbes article reveals that, while average wages are currently rising 2.9% per year, those for residential construction workers are rising 5.0%.

The NREI article goes on to note that the typical delay on a two-year project is five months.

“Every week of construction delays results in a week of lost income, and another week during which the developer must pay the rising cost of the project’s often floating-rate construction loan,” Bendix Anderson reports.

Also, let’s remember that the two-year project plan is just an anecdotal historical average. As projects get bigger — and yes, they are — they’ll take longer to complete. A five-month construction delay on a three-year project might be more forgivable.

Reframing the Questions About Construction Delays

There will always be a preference for living in posh environs, and there will always be a preference for building big, new, shiny towers for those with the wherewithal.

construction delaysSo there’s no real crisis here. If your money is in limbo for a few months longer than you naively expected to have it tied up, that’s a good problem to have. After all, the same effects that are causing those construction delays on your financial return are also driving an insufficiency of supply to the market, which tends to hike up rents once the units are delivered.

The issue is at the bottom end of the scale. Everyone agrees that there’s a shortage of housing stock for lower-income renters, but industry and government seem to be talking past each other to solve this problem.

Rent control is at best an inelegant answer because, as it keeps the housing cost down for the tenant, it disincentives developers from building more units for those priced out of the market. As the Class B, C and D stock is aging past its knockdown date, it’s time for anyone serious about solving this problem to realize both price and quantity must be taken into consideration.

Are there ways to build units for less? Of course, there are. Modular construction and smaller floor space per unit come to mind. But this means governments must pass — along with or in place of rent control provisions — new building codes that would permit these. And if that doesn’t get the cost down far enough, governments are positioned to provide tax incentives and access to municipal services to serve as an in-kind partner in projects that further their objectives. A study commissioned by the National Association of Home Builders and the National Multifamily Housing Council calculates that almost one-third of the cost of an apartment building is driven by regulation, so there’s a lot of slack right there.

But even having government as a fully engaged government partner might not be enough.

We recently came across a University of Maryland study that renters could be classified as a natural resource (“prey,” the authors call them). And, just as any natural resource can be depleted, so can the renters. Is an economic model in which an entire class of people pays more than 30% of their income in rent sustainable? Or, at some point, will investors concede that a 3.75% cap rate is just about as good as a 3.76% cap rate?

There used to be a sharp divide between the commercial world of multi-family real estate and the white picket fence dream of a family living their lives in a single-family house.

But, just as with broadcast news standards or appropriate business attire, the rules around what constitutes a family home keep changing.

Boomerang buildings

It’s not news that grand old manors — or even modest but relatively spacious brownstones — get subdivided into multi-family units. This kind of rehabbing has been going on since at least the 1940s and typically provides living spaces for two or three or possibly four or more households. This might pale in comparison to the bouquets of new towers sprouting in city centers across America but, considering how tight the housing market remains, every little bit counts.

Which is why it’s troubling that so many buildings are moving the other direction. Homes that had once been single-family and subsequently divvied into duplexes, triplexes or quadplexes are boomeranging back into single units. Occasionally, even homes that were originally constructed as twins or row houses are losing their dividing walls. This countercurrent appears to have sprung up around 2013, started getting some press coverage in 2016, and has just kept building steam ever since.

To those in the real estate business, this might seem absurd: buying a building that could be generating passive revenue every month just for a little more space and privacy. I mean, why not just buy a detached home to begin with?

There are three answers to this: Location, location, location. Sometimes, if you’re trying to find a place near but not in an urban core, row homes and duplexes are just the housing stock available.

Second, why hire movers? If you already live in one of the units and you have a cordial relationship with owners, why not just buy them out when you’re ready to upsize rather than pack everything up and move out past the airport? If you don’t mind waiting until your neighbor’s lease is up, this might just be the sensible thing to do.

Lastly: a little more space and privacy. You can effectively eliminate disagreements about parking or taking care of the yard.

Deferring cash

And those who convert multifamily buildings into their own private domain shouldn’t bewail the loss of potential income. As New York-centric The Real Deal reports, they’ll get their money on the back end.

“Such homes have higher average price per square foot than two-family and three-to five family homes,” according to Dusica Sue Malesevic’s 2016 article citing appraisal firm Miller Samuel. “Last year [2015], the average price per square foot for single-family homes in Manhattan was $2,137 while it was $1,584 for or a two-family home, and $1,371 for a three- to five-family home.”

These urban homesteads generally range from 3,000 to 6,000 square feet. That is to say, it’s like having a suburban colonial a block from the subway.

Malesevic goes on to state that “the price increase was partially attributed to the well-established trend of multi-family homes being purchased for conversion into single-family homes.”

“It isn’t just individual buyers who are renovating multifamily buildings into single-family homes, either. Developers are getting in on the action, too,” according to a 2016 article in Professional Builder. “Greystone Development development paid $10.45 million for a New York apartment building in the West Village and spent two years renovating the10 apartments into a 7,000-square-foot, six-bedroom home. The property then sold the same day it was staged for $21 million.”

You can’t fight City Hall, but maybe you’re on the same side

That premium is due, of course, to scarcity and desirability — which has municipalities struggling to keep up from a policy perspective. For the longest time, communities have wanted to reduce population density and have zoned for single-family use exclusively. Depending on whom you were related to, you could get an easement to convert a garage into a guest cottage or your basement into an off-campus rental for college students. But there was no way City Hall was going to let you convert your Cape Dutch into three units for income while you retire to Sarasota.

But as the housing market continues its constriction, the public might be better served by having more units rather than fewer. Of course, it takes elected officials a long time to get the message and their deep municipality functionaries a long time to administer changes based on new direction. So, for the time being, it doesn’t appear to be much of a permitting issue to turn a multifamily building into a single-family home. But sooner or later, City Hall is bound to wise up. If you’re thinking of doing this, you might want to do it now.

Since taking office, President Trump has picked a fight with, well, just about every major U.S. trading partner, but he has shown particular hostility to China. We’re not saying China doesn’t deserve it. Their history of currency manipulation and intellectual property theft are beyond the pale.

But this isn’t the time for questions of moral hazard. We are on the brink of a trade war between the world’s two largest economies, and the corner offices of corporate headquarters around the world quake with trepidation.

Are we Making too Much of This?

Not so much the offices overlooking Wall Street. Each time an @realDonaldTrump tweet declares a new tariff, the stock market takes a small hit. Every time that Twitter account announces a resumption of trade talks, equities rise a tad. But those gains and losses net out over the course of a few trading days because there’s no real news there. 

At this point, we’ve been on the precipice of a trade war longer than most trade wars actually last. The worst part of the situation is the uncertainty, right? Isn’t not knowing what’s going to happen next with trade far more toxic to the economy than actual trade barriers? One would think, but it’s not.

One thing that must be acknowledged, regardless of one’s political predispositions, is that the current administration is riding the longest economic expansion in history. There’s a question of causality, of course. Presidents always get far too much credit for economic growth and far too much blame for contraction. Plus, there are those who say that Trump is taking bows for benefits that ought to accrue to decisions made by President Obama. And for the first year or so of the Trump administration, that case could be made. But at some point, Trump has to be ceded ownership of the burgeoning growth of both payroll and gross domestic product.

And economics professors can cry in their beers over this all they want, but the Trump economy is roaring despite his making all the “wrong” decisions. He has shown disregard for sound fiscal policy by busting the budget. As for monetary policy, he has harangued the Federal Reserve into cutting target interest rates when lower-volume voices called for leaving them alone or actually raising them. And, of course, Trump has defied the conventional wisdom that trade barriers are harmful to the economy.

Even if the conventional wisdom turns out to be right and trade wars are bad, that doesn’t necessarily mean that they’re equally bad for everybody. Bisnow’s Matthew Rothstein wrote a compelling argument about how commercial real estate could be the closest thing the U.S. economy has to a safe haven during a full-scale trade war. He points to the strength in REITs as compared to securities mapped to other industrial sectors.

Details Matter

Predictions of recession tend to become self-fulfilling prophecies, so nobody wants to press the Big Red Button unnecessarily. Still, it’s hard to imagine that the current sweet spot will last forever.

Already, there are warning signs that investors are getting nervous about putting their money in capital-intensive projects that involve hardhats and shovels rather than code or arbitrage. According to CNBC reporter Diana Olick, architectural firms are not pulling in design contracts like they used to. She quotes the American Institute of Architects chief economist Kermit Baker as saying “the ongoing volatility in the trade situation” is one contributing factor.

And let’s remember that this brewing conflict isn’t a trade war against Mexico which, although it has an outsized effect on the U.S., is really a middling economy. And it’s not a trade war against the European Union, which can be relied upon to abide by the same rules of the road as the U.S. endeavors to. This is a trade war against China. (Actually, the U.S. is in low-level trade wars against both Mexico and the E.U., but that’s not the headline.)

The People’s Republic is in the middle of a massive expansion of its economic clout, a program known as the Belt and Road Initiative. As part of that effort — and in part as a hedge against the devalued yuan — Chinese investors poured scores of billions of dollars into American real estate over the course of 2015-2016. According to private lender Jeff Levin, all-new Chinese direct investment in the sector evaporated in an instant.

Trump’s aggressive posture “alarmed China’s central bank, and to contend with slowing growth, it put the brakes on international capital outflows,” Levin wrote in Forbes. “The trade war between the U.S. and China continues to fluctuate, but the pullback of Chinese investors endures. In the first half of 2018 alone, Chinese investment in the U.S. plunged 90%.”

Levin goes on to state the obvious: that the most immediate impact of a trade war on multifamily real estate is that the prices of steel, aluminum, and other construction materials go up. And while it’s true that tariffs punish Chinese companies by making their intermediate goods more expensive, it’s just as true that they punish American end-consumers who ultimately pay that higher price.

The good news there is that the impact might not be nearly as bad as one might think. According to the National Association of Homebuilders, tariffs should increase the average multifamily unit cost by only $478. That, reports Jacob Passy of MarketWatch, is in contrast to the $6,000 to $10,000 added to the cost of a single-family home due to a new levy on Canadian lumber.

Even so, the availability of materials could become a much bigger issue than the price. As supply routes are disrupted, the effects ripple along the chain. According to Levin, trade tensions with China are at least partially responsible for delays that builders are seeing already, which adds another five months to what should typically be a two-year project raising a multi-tenant building. That’s five more months of contractors who need to be paid, as well as five more months when the entire economy could enter a recession and the entire project go belly-up.

Mixed Signals for Multifamily

One interesting take on this whole topic comes from Robert R. Johnson, a Creighton University finance professor.

“The specter of tariffs and escalating trade wars between the US and China … has led to US Treasury rates falling, leading other interest rates—including mortgage rates—lower,” he told Erik J. Martin of The Mortgage Reports.

Lower mortgage costs should more than counterbalance — if the NAHB’s analysis is correct — the added expense of material and labor. If that turns out to be the case, the result should be net-neutral to multifamily housing. Investors tend to be indifferent if the structure they financed is rented out by the year or sold off as condos.

And yet, there’s one aspect of the mortgage market that makes this line of inquiry a little murky. A substantial number of American mortgages have recourse to such federally chartered programs as Fannie Mae or Freddie Mac. To ensure liquidity in these markets, these entities issue bonds. These bonds are bought up by investors, domestic and foreign. China is a huge player in this market.

As long as the current Sino-American tensions stay focused on trade, the U.S. multifamily market should ride it out with little trouble.  But if it turns into an all-out economic war — that is, as soon as one side or the other begins to believe it’s losing — and notes get called in as direct investment dries up, then real estate might not be the safe haven it appears to be at the moment.

Houston, Texas, USA downtown park skyline at twilight.

Earlier this year, we described how a housing shortage in Houston, exacerbated by the devastation of 2017’s Hurricane Harvey, is driving up occupancy rates. We also spent a few words outlining why Space City might not be the most livable place: heat, humidity, flooding, crime and a stark divide between rich and poor.

Yet people — especially young professionals — keep moving there, despite all that plus the rising rents. We really owe it to Houston to tell that side of the story as well.

Follow the jobs

There’s a lot more to Houston than oil and gas, and the unemployment figures bear out that assertion. The energy sector is highly correlated to the economic cycle so, when the national economy enters a contraction, the oil patch tends to go bust. But that’s not what happened in Houston over the past dozen-or-so years.

Credit: U.S. News & World Report. Source: U.S. Bureau of Labor Statistics

Even though today its unemployment rate is marginally higher than the national average, Houston was actually a good place to wait out the Great Recession. Historically speaking, that’s not the way things generally go in Texas. It should also be noted that having lower-than–national-average joblessness isn’t necessarily a good thing in 2019. The U.S. is at the point where unemployment is below the long-term “natural” rate, suggesting there’s currently a labor shortage.

Houston has hedged its bets in the job market. It is “home to more than two dozen Fortune 500 companies, including Sysco and FMC Technologies,” according to U.S. News & World Report. “The region was ranked the top manufacturing metro areas in the U.S. The Texas Medical Center, the world’s largest medical campus, is home to more than 50 health care, education, and research institutions. Houston is also an aerospace hub with NASA’s Johnson Space Center.”

And jobs in Houston can be high-paying. “The average annual income is higher than what residents of many other major metro areas make,” U.S. News continues. “Those with a specific skill set or advanced degrees, such as in health care, aerospace or oil, and gas, can earn as much as $200,000 a year.”

Town with no gown

According to, the average Houstonian is 33 years old, a year-and-a-half younger than the average Texan. You can’t assign a gender pronoun to that unspecified Houstonian because, like a flipped coin that landed on its rim, the split is exactly 50/50. Most Houston residents have not attained a college degree, and non-married people outnumber married people. A plurality of the city is Hispanic, with one-fifth of the population born in Latin America. Black and white residents each account for roughly a quarter of the city’s residents.

But how many are millennials who moved there from somewhere else? The answer is a little surprising. “The six cities which lost the most millennials are New York, San Diego, Miami, Houston, Las Vegas, and Chicago,” SmartAsset reported in 2017. So what’s a writer whose assignment is to discuss how Houston is attracting millennials to do?

Find a more recent — and more authoritative — source. “Seven metropolitan areas — Houston; Denver; Dallas; Seattle; Austin, Texas; Charlotte, N.C.; and Portland, Ore. — exhibited annual net migration gains for young adults that exceeded 7,000,” according to the Brookings Institution’s 2019 study. Houston, according to the study, more than doubles that number.

Isn’t it odd that so many surveys of millennials’ movements assume they all went to college? Sure, they’re more likely to have degrees than was the case with their parents’ generation but, according to CityLab, that just means that one out of three graduated instead of one out of four.

It’s exactly those non-collegian millennials that Houston attracts. According to Brookings, fewer than 40% of young adults completed college.

But it’s CityLab that puts the finest point on just how blue-collar Houston’s millennials are. “Miami and Houston have smaller shares of educated Millennials than Detroit and Allentown, Pennsylvania,” Richard Florida writes for the news outlet.

But how does one explain why one study of Houston demographics show a high net out-migration of millennials for Houston and, two years later, another shows a high net in-migration? Anyone who’s raised millennials can offer one possible explanation: They’re native Houstonians who moved back in with their parents.

Where they live

Of course, that’s just a theory. There are neighborhoods that are luring millennials from other cities and, to some extent, from the rooms where their Friday Night Lights cast posters still hang.

The Gridiron is Houston’s principal millennial magnet, according to the Houston Chronicle. “The area, best known for its proximity to the Astrodome, NRG Stadium, and Holocaust Museum in Houston, is estimated to be one of America’s zip code (77054) with the highest percentage of millennial residents,” according to reporter Francisco Ramirez, citing a RentCafe study.

Other real estate sites name Montrose, East Downtown (“EaDo”), Midtown, Fourth Ward and Museum Park as other sections that have attracted young Houstonians. Still, millennials are learning the lesson that the difference between what they want and what they get might involve a 40-minute Uber ride.

“In terms of sheer youngster population, the Addicks area (77084) in northwest Houston was found to have the largest millennial population in the city,” according to the Chronicle, which defines millennials as anyone born between 1977 and 1996. “Roughly 32,600 millennials reside in the area, although they make up a smaller share of residents in the area than Houstonians from other generations.”

In other words, maybe those Taylor Kitsch and Adrianne Palicki posters will be staying up for a while.

Houston at a glance

  • Population: 2.3 million (2017), up 18.4% from 2000
  • Unemployment rate: 4.3%, compared with a national average of 3.7%
  • Average salary: $53,820, compared with a national average of $50,620
  • Cost-of-living index: 93.5 (August 2019), compared with a national average of 100

Sources,: U.S. News & World Report, U.S. Bureau of Labor Statistics[/vc_column_text][/vc_column][/vc_row]

buildThe demand outlook is imposing. “To meet growing demand, America needs to build at least 4.6 million new apartment homes at all price points by 2030,” the National Apartment Association trade group pronounced in 2017. “In addition, as many as 11.7 million older existing apartments could need renovation during the same period.”

The good news is that something like 700,000 units have opened up since that report came out, but even this frothy pace is still 30,000 less than what it needs to be to meet demand.

This might seem like a great problem to have, but why can’t we build apartments buildings as fast as we can sell them?

The Official Story

The first place we looked for the answer to this question was the NAA’s Barriers to Apartment Construction Index. It isn’t wrong, but let’s just say it’s saddled with a point of view.

The NAA summary of reasons “Why We Can’t Just Build More” boils down to one thing: It’s the government’s fault.

“Over the last three decades, regulatory barriers to apartment construction have increased significantly, most notably at the local level. Outdated zoning laws, unnecessary land-use restrictions, arbitrary permitting requirements, inflated parking requirements, environmental site assessments, and more, discourage housing construction and raise the cost of those properties that do get built,” according to the screed, which doesn’t explain how land-use laws that only went into effect in the past three decades became outdated so quickly.

The NAA is also quick to point to the permitting process, fees related to construction, rent controls, and all other government interference. It’s unclear if they’re saying that local governments shouldn’t be sending inspectors or if they’re saying that someone else should be paying for them. It’s also unclear if they understand that local governments have other business before them aside from greenlighting every project that involves a hardhat and a backhoe. City officials measure success in votes, not square footage, and people who already live in town want zoning laws to ensure that the character of their block doesn’t change too drastically. And then there’s the occasional voter who can’t afford rent on a new Class A building so relies on rent controls which, though inelegant from the economic modeling perspective, work in practice. That’s how you can find people to work in the building without a two-hour commute.

It always comes down to those pesky, inhospitable neighbors, doesn’t it? The NAA is particularly sour on an attitude called NIMBY which, as regular readers here are aware, stands for “Hey, We Were Here First.” In one recent, high-profile example, a grass-roots NIMBY movement kept Amazon out of Long Island City — not just without government intervention, but actually in opposition to state and municipal officeholders who were doing everything they could to seal the deal. The locals believed that this would price them out of their own neighborhoods.

Contravening this fact, the NAA makes the unsubstantiated claim — there’s actually a footnote attached to this assertion referring the reader to another tirade rather than an actual source — that NIMBY activism promotes the interests of high-income over low-income residents.

“While we do not yet have a measure for the impact of political activism on the process of adding new housing, especially the more affordable type, one might surmise it is correlated with income and wealth,” according to a 2019 report. But then again, one might just as easily not surmise that.

Wait, it gets sillier. Look at the relative weight the NAA gives to politics and profits, then compare that to your own experience of what drives any real-world business: “Specifically, political activism, along with profit margins on high-end housing, might explain why there appears to be a national trend towards approving only the larger high quality and higher-priced housing or rental units with the lowest densities.”

Partial Credit

The NAA does actually get around to publishing words that actually pass the sniff test. It discusses land, labor and construction costs. It also notes that not all land is ideal for housing, whether due to geological factors or environmental considerations. And it acknowledges that some of the most desirable areas targeted by investors in new construction are already built out by existing high-end housing stock, retail access, offices, entertainment spots, and green spaces — but isn’t that the reason they want to build there in the first place?

One undeniable factor the NAA highlights is what it terms “lost apartments”.

“Adding to the apartment shortage is the fact that every year, the nation loses between 75,000 and 125,000 apartment units to obsolescence and other factors,” it credibly asserts. “Most lost units are likely at the lower end of the market, disproportionately hurting the affordable supply that exists. This situation is likely to worsen going forward since more than half (51 percent) of the nation’s apartment stock was built before 1980, and without resources dedicated to supporting rehabilitation efforts, more stock will continue to leave the available pool.”

Still, the real answer to what keeps America from building more apartments faster gets us back to that hardhat and backhoe. There simply aren’t enough of the former, although we still have enough of the latter for now.

The Real Answer

Anybody can shingle a roof. Anybody can put up drywall. But when you consider the legions of electricians, plumbers, ironworkers, HVAC installers, elevator installers and all the other people who have specialized skills and are willing to turn wrenches 800 feet in the air, good help suddenly becomes hard to find.

The NAA reports that “Following the [2007-2009] economic downturn, many workers left the construction industry and have yet to return.” Again, the report doesn’t cite a source for this assertion, but it can be verified. The Association of General Contractors doesn’t get into the history of the problem, but it does recognize a severe, nationwide labor shortage that will probably get much worse before it gets better. Labor Department projections back that up.

And someone whose opinion matter has gone on the record as saying that hundreds of thousands who dropped out of construction work during the last economic contraction never returned to it, and those jobs have proven hard to fill.

“Construction is not an attractive industry to millennials. In addition, 600,000 workers left the industry during the great recession and have not returned,” John Wagner, national construction director at global insurance brokerage firm Gallagher, tells

The good news, though, is that there appears to be enough of the means of production to keep building up city skylines. A web search reveals that there are far more articles about shortages of crane operators rather than shortages of cranes.

But that could change. According to Construction Dive, Seattle and Los Angeles each have 49 tower cranes in operation on local sites. Eight other U.S. or Canadian cities have more than a dozen. And then there’s Toronto, with an astounding 120 temporary additions to its skyline. And let’s remember that cranes, just like the high-rises they enable, need to be built, and that’s neither cheap nor easy. According to the American National Standards Institute, there are only around 100,000 tower cranes in the entire world. So that’s inclusive of about 180 nations not in North America. And they also need to be shared with developers of office space, government buildings and anything else too big for fire escapes.

There could come a point when crane availability becomes a key constraint to the multifamily real estate industry’s ability to keep up with demand. In fact, we’ve seen those headlines before.

In 2007.

Not long after that, demand for new housing dried up. Crane operators very suddenly had bigger problems. Apparently, they left the business and never came back.

foreign investorWe Americans can get a little paranoid when it comes to foreign investors buying up our real estate. It seems that every time the market gets hot, overseas buyers exchange their more colorful currency for greenbacks and start buying properties in the U.S. During the dotcom bubble, it was the British and Germans. The boom before that, the Arabs. Before that, it was the Japanese. And yet our culture persists, and we still own the vast majority of the land in this country, even in the most welcoming — and highest-priced — port cities. It’s happening again now, though. Non-U.S. individuals, corporations and sovereign wealth funds are once again investing heavily in housing throughout the States.

Moving in

“Foreign investment volumes increased [in U.S. multifamily properties] by 29.3% in 2018,” according to a Bisnow article citing a JLL research report. Not to worry, though. The new neighbors are reflexively polite. “Canadian investors alone deployed $9.8B over the year, 31.5% more than the previous high in 2015,” Dees Stribling writes for Bisnow. “Beginning early last year, for example, the Canadian Pension Plan Investment Board and GIC, an organization that manages Singapore’s foreign reserves, partnered with Atlanta-based Cortland to buy up to 10,000 Class-B apartment units across the U.S. and remake them into Class-A units.”

Canada might be the largest non-U.S. player in the market, but it is hardly the only one. Other names on the leaderboard might surprise you. According to the 2019 report itself, “Rising 23.8 percent from one year ago, annualized cross-border investment activity remains near record levels at $14.6 billion. Canada-, Bahrain- and Singapore-based investors drove continued investment, contributing 67.5 percent of quarterly foreign capital in Q1 2019.”

Bahrain and Singapore are not the names you might expect to see on the list. According to the National Association of Realtors, these are not the nations that are buying up general residential real estate, which is primarily single-family. On that list, Canada comes in second to China, followed by India, the United Kingdom, and Mexico.

Bahrain has a population of 1.6 million, while that of Singapore is 5.8 million. So why are these countries with as many residents as Idaho and Wisconsin respectively gaining such an outsized footprint Stateside? While it’s hard to say for certain, it might have a lot to do with investments made by their sovereign wealth funds. Two of the top 10 in the world are domiciled in Singapore, with combined assets of $815 billion. Next to Singapore, Bahrain pales in comparison, but a $15.4 billion valuation will keep them from having to drive Uber. With that much money to invest, anyone might consider buying into a gleaming new addition to the midtown Manhattan skyline.

There are reasons for non-U.S. institutions to acquire space in America even if they have mere millions to burn.

The hype

One invaluable source for this article is a 2017 CBRE report titled “U.S. Multifamily Housing: A Primer for Overseas Investors”. If there’s one criticism to be had of it, it’s that it often explains why multifamily can be viewed as a better investment than retail or office space, rather than why the American multifamily market is unique from the perspective of a cross-border backer. You can see the full report if you want CBRE’s “10 Reasons to Invest in U.S. Multifamily,” but really only four are relevant once you’ve considered that criticism.

No. 3: Favorable regulatory environment. “With respect to ‘social’ housing, the U.S. has a lower level of subsidized/low-income inventory than many other countries. These properties require additional expertise on the regulatory environment, but represent only a small portion of the total inventory (estimated 5% to 10%).”

No. 5: Liquidity. Real estate is not an inherently liquid asset but, it is far less illiquid in the U.S. than in other corners of the world. According to CBRE, this is due to the enviable degree of access to mortgage capital here: “The availability of debt capital is important for investment in any commercial real estate sector. Leverage is used for most transactions, with acquisition financing usually in the 50%-to-75% loan-to-value (LTV) range.” The article also cites the diversity of sources of multifamily real estate debt: banks of course, but also life insurance companies, commercial mortgage-backed securities, conduit lenders and particularly government-sponsored enterprises: Fannie Mae, Freddie Mac and the Federal Housing Administration, major sources of debt capital for existing assets in the U.S., don’t have analogs in many countries.

No. 8: Short-term leases allow immediate adjustment to market conditions. American renters are so conditioned to one-year leases that they can be forgiven for thinking that’s the global standard. It isn’t. It’s a factor of the “American dream” of homeownership; it is assumed that every renter is temporarily sojourning in their apartment rather than calling it their permanent home. In other countries, even fairly well-off people consider renting more common. In Singapore, for example, the typical lease is two years long. In Germany, it can last lifetimes or even generations. So imagine you were born and raised in Germany and grew up with the impression that landlording was a dicey financial proposition because of all the tenant protections. Then you discover that, in the U.S., your contract with your tenants expires on an annual basis. That means you’re not locked into the relationship for more than 12 months. You can raise their rent unless local ordinance intercedes. Given cause, you can evict them.

foreign investor“In periods of high rent growth, the short-term leases provide owners the ability to adjust rents upward quickly,” according to CBRE. “More importantly, if the U.S. moves into a period of higher inflation, short-term leases provide owners with the ability to make upward adjustments to cover the increased costs of operations.”

No. 10: Third-party leasing and management options. In America, unlike in many other countries, owning multifamily real estate can be a passive, turnkey investment. “[T]he 50 largest multifamily management companies in the U.S. managed 3.2 million units,” CBRE reports, citing the National Multifamily Housing Council. “The largest 50 firms each managed at least 30,000 units; the top five are each responsible for more than 100,000 units.” These management companies not only provide tenant interface and local knowledge, but they also add a professional gloss to the process that most financial investors haven’t been steeped in. Whether the task is to coordinate vendor schedules or using pricing software to optimize revenue, sometimes it’s best to leave it to the pros, and an outsized number of those pros are focused on U.S. markets.

But let’s add one more reason why investors are looking at apartment buildings in the U.S.: immigration.

“A great deal of foreign investment is motivated by a desire to immigrate to the United States or to provide financial support to dependent students attending schools in the United States,” according to a 2018 Socotra Capital blog post by Adham Sbeih.

If deep-pocketed overseas investors are looking to reside permanently in the States, buying multifamily real estate can satisfy two requirements at once: making the case for EB-5 visas, and securing a place to live once they get here. We’ve seen this happen. We’ve also seen wealthy people from outside the U.S. buy up a block of apartments, assign one to a child studying at an American college, and collecting rent on the others. If the kid decides to stay in the States, she continues to have a roof over her head. If she decides to return to her home country, that’s one more unit available to rent.

The reality

Even with all these use cases and all these anecdotes, foreign investors ownership of U.S. real estate is far lower than you might guess. “Currently only about 4% of multifamily holdings are owned by non-U.S. companies,” according to CBRE. That said, the number might be rising, at least in the short term. “[I]nvestors from foreign countries accounted for $13.65 billion, or about 8%, of the $174.5 billion of apartment property sales that took place in the United States last year,” Orest Mandzy wrote for Trepp’s blog in April, citing another CBRE study.

And yet, that surge might end up being too short-lived to constitute a trend, if the NAR’s findings have any bearing. The Realtors look mainly at single-family properties, so their research presents a far-from-perfect leading indicator. That said, non-U.S. citizens’ purchase of American residential real estate has fallen off considerably in recent months.

“Foreign buyers purchased to $77.9 billion of U.S. existing-homes during April 2018–March 2019, a 36 percent decline from the level in the previous 12-month period ($121 billion),” according to the NAR. “The slowdown in global growth, tighter controls on the outward flow of capital from China, and a low inventory of homes for sale likely account for this huge drop.

A similar decline was seen among non-resident foreign investors. Combined, resident and non-resident foreign investors accounted for only 5% of the $1.6 trillion existing-home market over those twelve months, down from 8% in the year-earlier period.

So yes, the hot U.S. housing market has attracted capital from all around the world. And as long as the boom times continue, you can expect foreign investment to pour in. But cycles end and, when this one does, there’s every reason to expect a regression to the mean. But there are reasons why that mean isn’t 0%. There are reasons why overseas investors look favorably on U.S. real estate investment even in lean times. One reason is that it’s largely unrestricted. No matter how many tariffs Washington has placed on Chinese goods, it hasn’t told the Chinese — or the Russians, or the Europeans or anyone else not connected with state-sponsored terrorism — that they can’t buy up an entire time zone if they wanted. Just pay the taxes as if you were a U.S. citizen or, if you prefer, a 30% flat tax.

foreign investorsNow compare that with the byzantine real estate laws in effect elsewhere. “Changing rules and regulations in other countries are also effecting where global investors are choosing to put their capital,” according to UpNest. “France has levied new taxes on investors. London, which was long the international favorite has stumbled, and put new taxes on wealthy investors. Even Canada has begun penalizing foreign investors with new taxes, and fines for having a vacant property, in an effort to reduce foreign investment, and maintain affordability.”

In that case, as long as U.S. public policy remains friendly to foreign investors in real estate, there will be euros, pounds, yuan, Canadian dollars and whatever it is they use in Bahrain available for multifamily projects here.

multifamilyThe multifamily real estate market, in general, has occasionally lost sight of downmarket properties as we fixate on big, bright, shiny new towers.

But as enticing as high-end real estate is — not just to live in, but also to brag that you own a piece of — it’s not the whole story. We do a disservice to the broader population and, not inconsequentially, our investors if we don’t at least study how we could make as much if not more money from rehabbing existing housing stock.

The ABCs of Multifamily Real Estate

First, let’s make sure we’re all defining the classes of multifamily real estate the same way. While Seeking Alpha offers a good nutshell on the topic and Realty Moguls provides a slightly deeper dive, the best description we’ve seen of multifamily real estate’s class distinctions comes from the Commercial Real Estate Finance Company of America. Not to be lazy, but maybe it’s best just to capture CREFCOA’s bullet points verbatim:

Class A Multifamily

  • Generally, a garden product built within the last 10 years
  • Properties with a physical age greater than 10 years but have been substantially renovated
  • High-rise product in select Central Business District may be over 20 years old
  • Commands rents within the range of Class “A” rents in the submarket
  • Well merchandised with landscaping, attractive rental office and/or club building
  • High-end exterior and interior amenities as dictated by other Class “A” products in the market
  • High-quality construction with the highest quality materials

Class B Multifamily

  • Generally, a product built within the last 20 years
  • The exterior and interior amenity package is dated and less than what is offered by properties in the high end of the market
  • Good quality construction with little deferred maintenance
  • Commands rents within the range of Class “B” rents in the submarket

Class C Multifamily

  • Generally, a product built within the last 30 years
  • Limited, dated exterior and interior amenity package
  • Improvements show some age and deferred maintenance
  • Commands rents below Class “B” rents in the submarket
  • Majority of appliances are “original”

Class D Multifamily

  • Generally, product over 30 years old, worn properties, operationally more transient, situated in fringe or mediocre locations
  • Shorter remaining economic lives for the system components
  • No amenity package offered
  • Marginal construction quality and condition
  • The lower side of the market unit rent range, coupled with intensive use of the property (turnover and density of use) combine to constrain budget for operations

multifamilyAccording to Seeking Alpha, the rents you can expect from these classes vary as you go through the alphabet.

“Class A apartments in the nation’s one-hundred largest metros rented for $1,663 on average in January 2017, while rent for the average Class C ran $850,” the article reports.

But just because you’re getting paid twice as much for a Class A as opposed to a Class C, that doesn’t mean that it’s twice as profitable from an income statement perspective. And, from a capital investment perspective, the returns from a 20-year-old garden apartment complex with a new coat of paint could even exceed that of a new glass tower with lemon water in the lobby.

The Advantages of Workforce Housing Stock

No need to read the whole Harvard study on the current state of America’s housing. There won’t be a quiz. The important takeaway is this: As a nation, we added more than 1.2 million new units in 2018, and it’s not enough. The vacancy rate keeps falling, with the most recent nationwide reading at 4.4%.

“Meanwhile, the housing that is being built is intended primarily for the higher end of the market,” the study says. “The relative lack of smaller, more affordable new homes suggests that the rising costs of labor, land, and materials make it unprofitable to build for the middle market. By restricting the supply of land available for higher-density development, regulatory constraints and not-in-my-backyard (NIMBY) opposition may also add to the challenges of supplying more affordable types of housing.”

So there’s a serious unmet need for Class B-and-below housing.

Although a management company can’t get Class A rent from Class B apartments, the amount required to invest will likely be far less. Rather than breaking ground on greenfield construction — which is getting more expensive all the time — may be all that’s needed after a comparably low-cost acquisition is refurbished kitchens and baths, new HVAC systems and more contemporary signage.

“The modest returns of a Class A property with single-digit to low-teen internal rate of return (IRR) just isn’t enough when compared to the high-teen IRR results obtained when value-add is completed on Class B and C properties,” according to Blue Lake Capital CEO Ellie Perlman.

And let’s not forget that rents are a moving target, and it so happens that Class B rents are moving far faster than Class A rents. According to a rather data-intensive report from Bridge Investment Group, the investment case for Class B projects just keeps getting better when you factor in how much more rents in this class increase over the life of the asset when compared with Class A.

A Word of Caution

We’ve been largely silent about Class C and D so far, but that’s not because it’s necessarily a bad investment or even unpalatable from a renter’s or public advocate’s perspective. There will always be a need for low-end housing most obviously because there will always be poor people, but also because there will also be people who choose not to spend too much on rent at a given juncture in their lives. Maybe they’re new in town and are looking for a permanent place, or maybe they’re working on a six-month contract and $500 a month for a furnished studio near the job site is all they’re looking for.

These classes, though, are a bit off the beam of what Sharestates investors are looking for.

“Class C and D assets tend to be financed by local banks with little to no interest from secondary market lenders, according to CREFCOA, which warns investors to expect higher interest rates, shorter loan terms, lower leverage, and even personal recourse if the project fails.

Even with Class B, though, you might not get the same leverage or fixed-rate terms as you would with a Class A investment. And if your Class B project stands outside a major market, you might even get pushback about using the property as collateral and need to provide a personal guarantee.

It’s not Slumlording

Lumped together, these three less glamorous classes are often called “workforce housing” or “affordable housing,” and they serve an important social function. Not everyone can afford Class A and not everyone who can afford it sees the value of spending money on four walls that, during waking hours, they’re only going to shower and watch Jimmy Fallon at.

And while we’ve gone on about the opportunities to make a profit from refurbishing an old property, there’s really no need to do even that. Affordable housing advocates point out that these value-adds that move a Class C up to a Class B or a Class B to a Class B+ or A- have the effect of pricing potential renters out of the low end. Beyond merely maintaining the pipes and mowing the grass, low-end properties can serve as essentially passive investments.

Still, real estate investment is an imperfect market. Locations aren’t nearly as fungible as securities or mutual funds. Moreover, nobody on Wall Street ever had to be cautioned, “Don’t fall in love with a debenture.” It’s just human nature to want to be associated with a skyline-defining work of modern architecture than with a lump of poured concrete that dates predates America Online.

“With most new construction targeting the high end of the market, there have been some potential for excess supply to filter down to lower rent levels,” according to the Harvard study. “But with rental demand far outpacing additions to supply through 2016, this has not happened.”

So there’s a lot of pent-up demand for workforce housing. To meet it in a financially rewarding way, it just requires some investors to peer out of their ivory towers long enough to notice that not everybody lives in one themselves, or even want to.