How much have commercial real estate prices declined? Are the properties we are buying today discounted? Neal Bawa, CEO of MultifamilyU, shares his knowledge.

Tell us about the operations of this property and how were you investing in 2020, 2021, 2022?
For that property, I must be honest and say there is no horror story to tell. The property did what it was supposed to do, we bumped rents by $175 from the very beginning to the end. On the last day, we had rents $176 dollars higher. So, the property did what it was supposed to, it also stayed highly occupied. You might say, it doesn't sound like a typical property, where are the horror stories? The answer is this, by stepping outside of the metro, we were able to buy the best property in this small market. We didn't have to be stingy; we didn't have to buy a really bad property in a bad area, we just bought a very nice property in a very nice area, it just wasn't in Atlanta. As a result, our process of actually running the property for years was fairly straightforward.

What about today? Things have changed dramatically since COVID. In December 2019, probably three months before COVID, cap rates were low, but they weren't crazy low so we probably bought the property at around 4.7 cap or 4.6 cap but if you fast forward to six months, nine months after COVID, cap rates were completely insane. Many people don't know the answer to this question which is, when do you think cap rates in the United States for multifamily were the lowest, which means the highest prices? The answer is March 2022.

We had a few months of rent decline when COVID started, and by July, people were starting to bottom out a little bit. By Q3 of 2021, there was a buzz that was building because all of a sudden interest rates were at zero. So in Q3, people were buying, Q1 people were buying, all of 2021 people were buying and it drove up the prices, and by the end of Q1 2022, the prices were completely bizarre. What we have to do is we have to stop buying. When you look at the number of properties that we bought during the 2021 and 2022 timeframe, it's one and a half, one of them was our property, and one of our partners needed to exit, so we exited them and bought it back. We didn't buy much then because we just lost belief in our ability to create value for investors. And I'm very glad because, during that time, we had access to such a filthy amount of money that there's no doubt we could have bought a property every month, easily. Investors were just literally throwing money at us, it felt bizarre because everyone was making money at that point, properties were going up and people just thought they would keep going up. We decided we're not going to invest in ultra-hot markets anymore so we are not buying in the Austin's, the Phoenix’s, Atlanta is a little bit better in terms of its cap rates being a little more reasonable, but I'm also talking about something more recent.

How much have prices declined?
Another question that I think everyone should be asking that I don't see enough is, how much have prices declined? When you ask that question, you have to go back to the first question, which is when was the peak because whenever you measure a decline, you have to always measure it from the peak. First, you have to know where the peak is so that you can say how much of a decline there is. In March or April 2022, the peak is well known because CBRE has published that and a bunch of other people have published articles around that peak. We looked at our underwriting from those days, and we were losing a lot of offers, we were still making offers because you have full-time employees, and their job is to make offers even if they're losing them. We looked at the going-in cap rate in that month for the offers that we made. None of them were offers we won and one can say that we were conservative because we didn't win any offers and we didn't even get into best and final so it's nice to look at that benchmark. And then we looked at the offers that we made in November of 2023 so now the gap between the two is about 20 months and the difference is the offers we are making today are 37% lower than the offers we were making in March. Does that mean that the market is discounted by 37%? No.

The bottom line is, it is fair to say the market today is 37% lower than March 2022. But if you average it out with the average of 2020, 2021, and 2022, then the market is probably down 17- 18% because there was this very brief peak where prices became completely crazy and that was Q4 of 2021, Q1, and Q2 of 2022, so the peak was not very long. So, we're at 37% down from the peak, should prices be going down as much? Is this still the right price? Will they even go down further? And so, we do the math on that and say, what is the right price? Forget about what the price was in March 2022, a bunch of us were completely out of our minds. Let's talk about what is a reasonable price for an asset. When supply and demand are fairly imbalanced, there are still a lot of people that are interested in buying, I don't think that goes away for multifamily so one has to give some props to that.

What is the right price for today's properties?
In the absence of crazy interest rates, what is the right price for our properties? The right price is about 15% higher than it is today and at some point, we will return to that price, we are never going to go back to 37% higher, probably not for the next five to 10 years. Another COVID-type event has to occur, which will happen, the world economy is increasingly fragile. The only thing banks know how to do when bad things happen is to cut interest rates to zero, so it will happen at some point, but until that next Black Swan event occurs, prices are about 15% above where they are today. What causes them to go to that level is simply interest rates dropping by about 150 basis points from where they are.

And so today, anyone that is purchasing multifamily is in a very good position and has to do nothing, no rehab to get a 15% bump to whatever that appropriate median price is and we estimate that it will take 18 to 24 months for the market to get there.

It's all about the timing. You are timing the market when you purchase a property today, and the way to improve that timing simply is that you somehow still go for bridge debt by waiting until about April of next year (2024) to close on the property. We'll talk about that because it's a fascinating angle. But even if you go for fixed debt, which most people are right now bidding on fixed debt, you're still locking in that 15% because the only reason properties have dropped by 37% is interest rates. The demand is equally high.

Recently, I bid on a property that had 34 offers. This was at the beginning of November 2023. The beginning of November is usually the last time that you can close on a property before the end of the year so there tends to be a little bit of a rush there and then after that, it quietens down because you can't close before the end of the year and you can't get the depreciation benefits.

Neal Bawa