The past few years have been rather dynamic for the economy and the world of multifamily investing has been no exception. From the uncertainty of Covid, to the aftermath of a historically fast escalating market, to the equally fast rate hikes of 2022. Staying on top of the market has been a full time effort. Now as we head into 2023, many people are wondering where the market will take us during the new year. Here are a few of my thoughts on this question and how I think investors can use them to their benefit.
1. Inflation will finally start to subside and interest rates will then stabilize
The Fed began raising rates March of 2022 with the intention of continuing until a halt was brought to the rise of a 40 year high inflation. As rates are increased, the ability to borrow becomes increasingly more difficult which creates a headwind against economic growth. While this would normally be viewed as a bad thing, the increase in pricing must be tamed or else many will wind up in a permanent state of not being able to afford basic necessities. As the economy has and continues to slow, there will be a number of layoffs from companies seeking to control targeted levels of profit. This will result in an increase in the unemployment rate. Throughout 2023, we will see the unemployment rate increase which we cause an official (some would say we are already there) recession in the economy. It's important to understand that the fed will stabilize and hold rates high only once they believe that inflation is truly under control and its continued decline is certain.
2. Rent increases will return to historical norms
The past two years, rent increases have been extraordinarily high. Too high to be sustainable for an extended period of time. As a function of inflation starting to subside, these historically high rent increases will also start to subside. This is important to consider and review when underwriting multifamily deals particularly for 2-5 years in the future where rent growth is more of an unknown.
3. There will be some opportunity for acquisitions
The past year has been particularly difficult for syndicators trying to find and close new deals. The combination of dealing with higher interest rates than we have seen in recent times combined with the uncertainty of how much they could increase while a property is under contract led to a much lower transaction rate in the second half of 2022 compared to early 2022 or 2021. As if this wasn't enough of a headwind, buyers had to deal with sellers who were still looking for top of market pricing that was not longer achievable with the rate increases. Now that rates are likely close to leveling off and sponsors have a better idea of where they can get financing, we will begin to see a larger volume of transactions. The opportunity will be in purchasing properties who have loans coming due or that have simply been mismanaged in recent times making them ineligible for a refinance. While I do not expect these deals to be pennies on the dollar, I do think they will be at a 15-20% discount from pricing we saw at the top of the market and that this pricing will quickly return to those levels once rates begin to decline making it a prime time for investors to place capital.
4. We will still benefit greatly from bonus depreciation.
As 2022 came to an end, many sponsors with deals repeatedly announced to investors that this was their last chance to receive 100% bonus depreciation. While this is unfortunate news, the good news is that you can still get 80% bonus depreciation in 2023! It's also important to remember that while the bonus depreciation is 80%, investors will still receive all the benefits of accelerated depreciation in the first five years of ownership, just not everything in year 1.
So what do these four things mean for the average passive multifamily investor? We all know that they key to smart investing is to buy low and sell high. However, it is interesting that despite this information many investors are reluctant to jump in on an opportunity when the market environment is less certain. My encouragement to investors who are looking to passively invest is to stick to the fundamentals and continue to invest in opportunities as they appear. Many sponsors sold deals over the past year that they bought during uncertain times in Covid. Those investors benefited tremendously from their disciplined approach to investing and I believe in a few years we will have similar stories from investments made in 2022/2023.
There are many important considerations when evaluating a multifamily deal and we make it our mission to careful vet each of these items. If you would like to learn more about passively investing in multifamily, please check out our free ebook "Achieving Financial Freedom Through Multifamily Investing."