Why buy in a rising rate environment?

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Just had an interesting conversation with long-term partners of ours that I think bears repeating here.

They asked the following (paraphrased) question: Why are you buying now, when interest rates are definitely going up and, therefore, values will be going down?

The premise of the question is totally reasonable. When rates go up, prices go down, all things being equal. So it seems a little to nuts to buy, knowing that prices will be under pressure.

We don’t like to thinks of ourselves as crazy, so why are we moving forward with acquisitions?

The answer is two-pronged:

  1. We are not static, buy and hold investors. We do incredible things to buildings to create very attractive yield situations for our investors… typically something like 7% unlevered.
  2. We are long-term holders

What this means is that we don’t care overly much about rates, at least so long as they remain within reasonable bounds.

If they do go up, then we’ll either borrow less or, in an absolute disaster scenario, not borrow at all.

This will hurt the investors’ IRR (since it’s much better to refi all the money out and return it quickly, rather than have it stay in the deal).

Because it hurts their IRR, it hurts Jon and me, because we don’t participate in the upside until investors get their money back and the promised preferred return.

But, as long as investors are long-term holders happy to get 7% on their money while holding onto multifamily land in well-chosen neighborhoods in LA, things will work out just fine.

The lesson, as always, is to buy good stuff, make it even better, and avoid over-levering. Do that, and things work out.

*Note: Obviously the numbers above are averages, not guarantees. Every investment involves risk. 

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