April 22, 2022
It is probably self-evident to most investors that asset management is a critical component of any real estate investment, especially in times of economic recession.
However, I believe that it has often been overlooked lately due to the seemingly unstoppable increase in real estate values — particularly multifamily — that we have seen in recent years. The fact is, even the most incompetent operators have been able to make great returns simply due to cap rate compression.
Suppose you bought a property in 2016, sat on your hands for two years, and then sold it. In this case, you were almost guaranteed to make a decent profit in most markets. Even more so in hot markets such as Texas, Arizona, and Florida, where multifamily syndicators have been most active.
However, even before the COVID recession hit, cap rate compression had started to level off, and investors could no longer count on that factor alone to increase values.
Despite sponsors presenting deals to investors as “off-market” acquisitions, and claiming that they were purchasing below market rate, the fact is that almost all multifamily deals of 100+ units (and often even those less than 50 units) were fully marketed by brokers and attracted multiple market rate offers.
Responsible operators reflected this reality by underwriting higher reversion cap rates and projecting lower total returns.
In this scenario, where everyone is essentially paying the market rate, how can sponsors generate superior returns? The answer of course is asset management.
The asset management continuum runs from completely passive (i.e., a third-party property management company does everything) to fully active (the operator self-manages, or has their own management company).
Since most syndicated deals are managed by third-party property management companies, investors may wonder what difference asset management makes. After all, the day-to-day operations are handled by the management company.
The fact is, even the best third-party property managers are primarily reactive, not proactive. Each regional manager probably has at least 8-10 properties in their portfolio, so the amount of time they can spend on any given property is fundamentally constrained.
While any property of 50+ units likely has full-time on-site staff, they are focused on daily tasks such as work orders, leasing, renewals, tenant relations, etc. They do not have time for strategic planning or managing large rehab projects.
The importance of active vs passive asset management is also impacted by the type of deal. A yield play (e.g., a property that is already operating smoothly and does not require much rehab or operational improvement to attain its potential) may be fine with very little active management by the operator.
However, a value-add play will require much more active oversight. Many multifamily property management companies are good at leasing, marketing, and other day-to-day operations, but are much weaker when it comes to overseeing large multifamily CapEx projects and renovations.
Therefore, active multifamily asset management is extremely important during the initial repositioning phase of a value-add deal. In my short time as an asset manager, I have found that the manager performs best when allowed to focus on their core competencies, and does not have to juggle extensive rehab and construction projects on top of that. In future posts, I explore various aspects of asset management in more detail in this article.
It is clear that we can no longer rely on a rising tide lifting all boats. Many deals done in the last year were purchased at top-of-market prices, and have little wiggle room for declining rents and occupancy. Those sponsors who underwrote their deals conservatively and focused on optimizing asset management will come out ahead once the dust settles.