“The deals just don’t pencil.”
You have probably heard that phrase a lot over the last few years if you have been in the real estate investing space as an active investor or even as a passive investor. For those that are new to space or not familiar with this phrase it is simply what an investor says when they are not able to find any investment opportunities that make sense to purchase based on their underwriting.
Underwriting is a deal analysis process where real estate investors do financial due diligence on a property to ascertain the current value, potential future value, and ideal purchase price. This deal analysis helps the investor have a preliminary view of the viability of the investment opportunity so that they can feel secure to sign a contract to make the purchase of the property. Once in contract a more rigorous review and testing of these assumptions would be made so the investor can have confidence to move forward with the investment or cancel the process.
If the deals are not “penciling” then there are naturally going to be less sales and purchases occurring in the real estate market. There are several factors that have led us to this point but now that we are here, we are going to focus on how to succeed and find opportunities even in this market.
Don’t be too pessimistic
One reason that some investors are not able to find any opportunities is that they are being overly pessimistic. If you have too negative a view on the outlook of the real estate markets in the future, you will likely not find any opportunity that would make you desire to move forward. Thinking that there is an imminent recession that is going to happen tomorrow and that interest rates will rise into infinity (and beyond) would be far too drastic a view for any investment opportunity to make sense. You would need to find the perfect diamond in the rough and if you have found it, don’t you think every other investor that is reviewing the same deal thinks the same?
Pessimism should be curtailed to a more reasonable and realistic view. As an experienced investor understands that markets operate in cycles and bad times never last.
Don’t be too optimistic
On the other end of the spectrum are the individuals that are too optimistic. Many times, you may have seen an investment property get purchased at a price that you deem untenable. It may be because that investor has some circumstances and knowledge of which you are not aware, or it could be because they are overly optimistic. You do not want to be that overly optimistic individual that believes rates are going to drop back to 2021 levels tomorrow. If you operate under that level of optimism, it is likely that you would make investment decisions that do not protect your downside risk.
If things do not turn out as you expect then you will be on the hook and lose a decent amount of money. It is better to underwrite investment opportunities with consideration for what could go wrong or the scenario that the market doesn’t operate as you expect.
Underwrite for the long term
One way to appropriately underwrite to address the downside risk in the current real estate market is to make investments that are long term (think 10+ years). Not everyone has the time, capital or patience to be able to make long term investments. This is understandable. You do not necessarily need to hold the investment for a long term, but you should underwrite your business plan such that the investment makes sense both in the near term and long term. If the market flips and goes a different direction than you expect you at least have a solid asset that you can hold unto until conditions improve.
Consider the contrarian view
Smart investors find value where other investors do not. One way you should be looking at deals is to think outside of the box and do things that other investors are not able or willing to do. This could be by repositioning properties for different uses or thinking of value-add ideas where other investor may not have considered that value proposition. If you are currently operating a building as student housing with all utilities paid maybe it may operate better if you convert it to long term rentals or vice versa. Managing income and expense is a shrewd investors path to success in this current real estate market.
Analyzing investment opportunities in this market
There is no expectation that the market is going to change overnight so as investor it is best that you learn how to succeed in the current environment. There are 4 principles you can use to guide yourself as you analyze multifamily investment and passive income properties today:
Don’t be too pessimistic.
Don’t be too optimistic.
Underwrite for the long term.
Consider the contrarian view.
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