With with the Federal Funds Rate at 2.5% – a 100 basis point climb in less than a year – real estate investors must adopt new strategies to find great deals in this tight economy.
These strategies include finding new lenders to partner with, exploring uncharted markets, and developing operational strategies to make deals work.
In this article, I’ll focus on how professional sponsors do all these things and more. Because instead of sitting on the sidelines, astute investors prepare new battle plans to face these changes head on. And some are excited about new opportunities in this new economy.
How do pro sponsors find lenders in a tight economy?
When the markets tighten, professional sponsors don’t stop growing their portfolios. If they can’t find deals with IRRs in the high teens, sponsors adjust their strategy to find the best deals possible.
This presents a challenge of course. Not all lenders are comfortable funding projects with returns in this range. Especially after almost a decade of double-digit growth in real estate, underwriting practices must catch up to the current climate.
Therefore, sponsors must now look for lenders who are familiar with the types of projects they bring forth. In the multi-family space, buildings with less than 50 units require an investment plan that is completely different than a plan for buildings with 100 units or more.
In this market, professional sponsors know that tighter margins require a solid plan of action.
Where do pro sponsors find deals in a tight economy?
We’ve covered 18-hour cities in past articles, but it’s worth repeating here. That’s because 18- hour cities is all about the geography of jobs – a key metric that helps you find deals.
Geography of jobs explained
When jobs first expanded, the economies of the major cities (or gateway cities) were the ones that grew the fastest. These are places like DC, Boston, New York, San Francisco, Oakland, the Bay area. Gig-city economies like these were powered by tech jobs and as a result – saw meaningful employment growth, rent growth, and economic growth.
In other words, when you follow the jobs, you find large population groups of workers. And these types of migrations are a powerful force for any economy.
Consider that this same population group and the jobs that attract it are now growing outside of these major cities. In secondary or tertiary cities like Reno, Boise, Orlando, Vegas, Tampa and Phoenix – we’re seeing knowledge workers create new lives in these new cities.
These are the people with disposable income who drive those economies further. They are the people who rent homes and fuel real estate development.
How to study a city’s “playbook”
The best advice on tracking locations comes from Jeff Adler – the VP of Yardi Matrix. He likes to study what he calls a city’s “playbook”.
This type of analysis puts the focus on the fundamental nature of how that city is changing. It looks at what precipitates a change in the fabric of a city. Is it education? A new industry? Or perhaps it’s driven by the combined effort of various parties.
Adler has identified 4 main components to consider when analyzing location:
- Public and private partnerships
- A friendly business environment
- A community environment
These 4 components attracts and retains talent, technology, and an educated workforce.
Seattle was driven by technology, but it wasn’t on purpose. It fell into it by the expansion of Amazon and the massive workforce this tech giant attracted. But other cities are creating their own “playbooks” to follow. And becoming intentional about what outcome they wish to create.
Phoenix – which was basically a low-cost, low-skill level market – is now transitioning. Same goes for Salt Lake, Indianapolis, Columbus, Ohio, Tampa, Orlando, Pittsburgh, Philly, Minneapolis and Kansas City.
In downtown Detroit, you’ll find an emerging group call the Green Shoots. Led by Dan Gilbert, you’d be surprised by the amount of money he’s put in to try to bring Detroit back from the brink. It’s still early stages, but there’s an example of a city undergoing major transition where the entry points are attractive to understand.
And it’s important to note that transitions can take a long time. It took Austin 30 or 40 years to put together all of the components, but in the last decade, Austin has become a boomtown.
The point is, investors always have a choice of entry point. How much risk you want to take versus how much return you want to look for in order to achieve your objective, is a personal choice. Which means, even in tight economies, IRRs in the high teens are possible in places where traditionally you wouldn’t venture.
Insider tip to predict an emerging market
Something to consider when finding real estate deals, is to pay attention to the plans of major companies in big cities. In a technology company, for example, when it’s time to broaden the employment base, ask yourself whether the company will grow their employment base in their home office or expand to a new area?
Recently, it was brought to my attention that Salesforce has capped the number of San Francisco employees they will have and is hiring all its new people in Indianapolis. That’s a big deal if you’re a real estate investor considering where to invest!
It’s during these tight times that investors must remember the biggest advantage of real estate investing – it is perhaps the most creative investment tool out there. You can change asset type, location, and even sponsors who specialize in certain strategies.
There’s no reason to stop growing a well-diversified, profitable portfolio when the economy shifts. What’s needed is a level-up in education to understand where the opportunity lies.
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