Investments in multifamily syndications or private equity funds are very common and can be very lucrative. They can also be seen as risky by more conservative investors.
This isn’t covered in the slide deck, but the video discusses one risk of these types of investments. Let’s say a group of investors purchases an asset for $10M using $2M of investor capital and $8M of debt. If the value drops to $8M after two years, the lender can mostly get their money back, but the equity investors stand to lose their $2M.
In spite of the risk, many multifamily properties have generated exceptional returns for their investors over the last few years. This is largely due to a phenomenon known as “cap rate compression” whereby multifamily buyers have been paying increasingly large amounts for the same amount of cash flow. This has allowed investors who are selling to reap large profits.
Seasoned investors tend to have the same concerns about multifamily properties: 1) This “cap rate compression” phenomenon is generally seen as being largely unable to continue and thus hurts projected IRRs. 2) These properties seem to be highly overvalued after seeing a huge runup over the last few years, 3) There’s an extremely large amount of “dumb money” chasing very few real deals, 4) and multifamily operators have the money, staff and fee structure in place and are therefore incentivized to keep doing deals, even if they’re weak or risky.
One thing that bodes well for these types of investments, however, is rising rents and underlying land values that are largely being driven by rising inflation. It’s up to each investor to decide whether the positive or negative forces will ultimately prevail and whether investing in this asset class is a wise move at this point in the market cycle.