Make Apartments Boring Again


Brian D. Milovich

Managing Principal, Calvera Partners

I want to make apartments boring again.

Historically, apartments were a low-returning, stable, and steady investment. Developers got paid for taking on the risk of new construction. Value-add operators needed to execute well to narrow the gap with new construction. And modest rent growth kept existing investors happy so long as expenses didn’t grow even faster. Risk and return were aligned, and execution was properly compensated.

So much about apartments is boring. Traditional financing options are banks or the agencies (Fannie Mae, Freddie Mac). These are some of the most conservative lenders (people) on the planet. Creative, flexible, and risky are not part of their vocabulary. Operationally, apartments involve selling a highly commoditized product. That generally suggests little pricing power for the landlord, unless they have an edge. Speaking of the landlord, is there a less popular person in many cities?

Apartment investing was never a get rich quick scheme. It was an industry for people who wanted tax-advantaged, cash-flowing hard assets in their portfolio. And many owners self-managed their properties with a plan to hold them indefinitely. The cash flow and proceeds from refinancing allowed them to acquire more. Apartment investing was a get rich slow scheme.

The recent investment cycle turned apartment investing into a momentum-driven meme stock. Untrained operators who were savvy at fundraising became new real estate pros. They promised 20%+ returns with limited downside. They didn’t care about leverage. Or going-in cap rates. Or even basis (i.e., cost per unit or square foot). They thought the market would go up indefinitely. It was an exciting place to be. And at the time, many thought what was there to lose?

There’s plenty to lose, as many syndicators are now finding out. Those deals with 20% projected returns now have no equity value. Expired interest rate caps are causing syndicators to come up with millions of dollars or go into default. This has almost nothing to do with the underlying apartment property. It has everything to do with the price paid and how it was financed.

Apartments haven’t been boring for the past 5-7 years. These once high-flying syndicators are featured daily in real estate industry publications. Their falls from grace are being turned into social media fodder and generate countless clicks. This unfolding soap opera is keeping the industry engrossed while transaction volume remains meager. Yet this isn’t how it’s supposed to be.

I want apartment investing to go back to being a little sleepy. Why? There’s more alpha for sharpshooters. Time and again, we’ve seen many long-term owners not maximize their rents. They just cared about cash flow. Also low on their list were value-added renovations. Those owners didn’t want to spend money when the current cash flow was just fine. Groups like Calvera see this as an opportunity to bring apartment units into the 21st century and receive a premium rent for it.

A boring apartment market breeds vanilla underwriting assumptions. In 2021, not only did you have to pay a 3% cap rate to buy an apartment building in a good market, but you also had to assume double-digit rent growth. On top of that, expenses needed to be reduced, high-leverage bridge debt was put in place, and the property had to be sold in 3 years for the same 3% cap rate. This was wild! Apartments don’t perform like that, at least not indefinitely. I want to see normal underwriting so that when we’re bullish on a market, neighborhood, or business plan we can get creative and win the deal.

Investment returns need to come back to reality as well. Blackstone, widely regarded as the best real estate fund manager, has long-term net investment returns of 17%. This is for their series of opportunistic BREP funds. It seeks 20% gross returns and invests in everything (hotels, gaming, data centers, office, medical, multifamily, etc.), globally. Blackstone gets the benefit of special financing terms because of its size and can take on significant risk. For that, it has provided investors a 17% return on realized investments.

Apartment investing doesn’t warrant this level of return. Perhaps if you have a ground-up apartment development in a growing area, then a 20% return target makes sense. In a normal market, value-add apartment projects seek to achieve ~15% gross returns. If less work is done to a property, then ~10-12% gross returns are warranted. And if you just buy core properties and hold them, a single-digit return is a normal expectation.

The market lost its mind when it thought 20% was a standard return for doing minor renovations and selling an apartment complex 2-3 years later. Those groups who pitched this to investors and pocketed carried interest off those flips are losing assets today. They’re also not going to be interested by the size of their cut of a deal returning a normal 10%. They will turn their attention elsewhere, and the hot money will leave apartments alone.

My hope is that apartment investing goes back to being boring. This way, actual execution is rewarded, and risk is appropriately priced and valued.


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