Sam Rust: But historically, the common knowledge or common practice has been, well, you've got to inflate your exit cap rate by 10 basis points for every year that you hold. That was true when rates were really low. Rates are not really low anymore. Rates are really in the 20-year average right now. And so that doesn't necessarily mean that you can just bake in overly aggressive underwriting, where you're anticipating you're going to buy at an 8 cap and sell at a 6 cap.
Whitney Sewell: Sam, welcome back to the show. We're looking forward to diving in again. You and I haven't done a show, recorded anything together in a long time.
Sam Rust: Yeah, it's been a minute. Good to get back in the seat, as it were. Yeah, there's always things happening. So even though you and I are dialoguing on a fairly consistent basis, it's fun to take a little bit of time and create some content here and share some of the things that we're seeing in the multifamily space.
Whitney Sewell: For sure, honored to get to do this and hopefully help the listeners and investors that are listening as well. You and I have talked a lot as we do often, our team, and actually I get asked this often too. just about what we're reading, what we're paying attention to, what we trust, you know, as far as taking in information that helps inform our decisions, right? You know, is what markets we want to be in or what we're buying. And I thought it would be great for you to be able to highlight some of those things. The listeners know that I ask most guests at the end of most shows that are, at least if they're an operator or somebody in the space, like, what they expect to happen over the next six to 12 months. And everybody says, well, I don't have a crystal ball, right? And I say, well, I know you don't have a crystal ball. However, what you believe is going to happen affects what you're doing today, right? You know, depending on what you're taking in, the data you're taking in, that helps you decide whether you should be buying or selling or raising rents or what you're going to do. And so, you know, you specifically take in a ton of data personally, which is so beneficial. And so why don't you start by highlighting maybe even some of the data that you trust and where you get it, and then let's dive into some of the trends that you see happening.
Sam Rust: Yeah, I collate data from a lot of different sources looking for interesting voices. I try to consume some contrarian data. I find a lot of that on Twitter or X as it's known now. Follow a lot of folks that are big in data like RealPage or CoStar. That's where you get some consensus. But then I also talk to a lot of operators, follow a lot of operators. And so I'm picking up a lot of anecdotal pieces of information as well from both small and large operators across the country and trying to curate to folks who are in the Midwest and the West, as those are two markets that we're particularly focused on. It's very interesting right now. There's a coalescing of vision around what's going to happen really over the next three years. The exact timing of all of this is going to have a massive impact on the outcomes for certain groups. But I'll just share that in brief here. So 2024, we're going to have higher deliveries. We've been talking about this a lot internally and externally at LifeBridge Capital. There's a huge construction pipeline that's cresting right now. We're going to have record deliveries for the last 50 years happen in 2024. And this is due to so much of the easy money environment of 2020, 2021. Great demand. It was a fantastic time to put starts in the ground. There was a ton of developers that started a lot of projects, and those are all coming to fruition. So that's going to cause rents to probably go down, especially in the first half of the year as that product gets absorbed. Then moving into 2025, we're going to see lower deliveries, solid rent growth likely, a better rate environment, and somewhat higher transaction volume. That's properties that are actually getting bought and sold. Obviously, the exact timing of that is going to be dependent on what Jerome Powell does, the strength of the economy as a whole. But at this point, there has been some pretty strong indications that interest rates are about as high as they're going to get in this cycle. We've seen the 10-year move somewhat. We're recording this on President's Day. And so we've seen the 10-year bump up a little bit over the last 10 days or so. But the federal funds rate, which heavily influences the 10-year Treasury, probably isn't going to get bumped over the foreseeable future. Inflation is still trending down. So the Fed is likely to start rate cuts. by end of summer. I think it will happen sooner. But regardless, it is going to happen. And we're going to see slow cuts probably. That's going to move. So if we acknowledge that that's likely to happen sometime over the next 24 months, that leaves us in a really interesting position in 26, 27, where we're going to have possibly record low deliveries of product. which is going to lead directly to higher rent growth, we're probably going to be in a position where rates are going to be lower than they were even in 24 and 25. That's anticipating somewhat of a slowdown in the broader economy, which will require some form of stimulus, which will drive money back into the system, some form of quantitative easing. Whether that's the right thing or not is not really part of this discussion. It's just what will likely happen. And historically, we go through cycles. And those cycles usually include some sort of liquidity crunch, which will likely happen over the next year or so in some section of the economy. And the Fed will respond by flushing the market with cash to keep the financial system lubricated. And so 26 and 27 is going to be By consensus, anyway, it's kind of the kickoff of the next bull cycle where we're going to start to see rents grow, NOI grow significantly, property valuations grow significantly, because you're going to have the tailwinds of good operations and positive macro trends as well. The trick is obviously to execute in this environment where people are buying into kind of the same meta-narrative and just position. We want to see what is those meta-narratives, and we've kind of sketched that for you here, but then how can we drive performance at individual properties and business plans that we're putting together that take into account what we believe to be likely to happen, but we're controlling at that individual asset level for as many of those factors as we can and trying to set up that property to succeed regardless of what happens, again, within some form of deviation from the mean. We're not anticipating the world to collapse and end. That's a different set of investing criteria altogether. But assuming that things are relatively normal, we're in probably the trough of valuations right now from a real estate perspective, which is leading to massive gulfs in expectations. Sellers are still thinking their properties are worth what they were 18 months ago. Buyers are looking at the current lending environment and say, I want to build a 10-year business plan around debt at 6%. That's creating a pretty massive value gap between buyers and sellers. We are starting to see that gap close. We were bidding on an asset in one of our core markets, newer construction, and it ended up being taken off the market around a 5% cap rate for an all-cash offer. We haven't seen that in some time, and it wasn't a 1031 exchange. That was some group that came in, decided they loved the market. They were willing to take a bet that rates were going to come down. They're probably going to hold the property for 6 to 12 months, all-cash, then potentially refinance it into lower rates. And we're starting to see groups that are talking about making bets like that. That's not our strategy at LifeBridge Capital. But it is interesting to see that strategy start to come back into the marketplace. I think near term, over the next three to six months, the movement in interest rate is going to say a lot about the viability of that strategy and whether more groups are going to pile in. But functionally, what the market needs to return to some degree of normalcy, just from a transaction volume standpoint, is capital flowing into the space. There is a ton of capital on the sidelines. And it's really going to take a couple of fund managers deciding that they really believe there's going to be a bull market in 26, 27, try to front run that by trying to buy assets today. And that's going to push liquidity into the space. So we continue to want to be strategic in how we're evaluating buying opportunities. We would love accretive debt. We would love a little bit newer assets. Those are some things that we're evaluating and ready to pounce when those opportunities present themselves in the broader marketplace.
Whitney Sewell: Yeah, no, that's incredible. You know, you mentioned setting up properties to succeed, some of that. And I was thinking about, you know, we've had conversations with a number of operators who are just having difficulty right now as well. And I thought maybe you could even, for some of the maybe newer listeners or newer investors that are listening, maybe you could highlight some of the, why some operators are having difficulties now, but how that's really informing us on how we're buying assets moving forward as well.
Sam Rust: Yeah, the most consistent through line is anybody who bought assets from back half of 2021 through the middle of 2023 and put floating rate debt. The market anticipated the Fed to raise interest rates. But I think if you look back at, call it tail end of 2021, the expectation was that the Fed might be able to push up by 250 basis points. they actually ended up pushing up by almost 550 basis points. So the move was much higher in magnitude than was expected. And that's a fundamental problem for servicing debt payments on properties. Most of these groups had interest rate caps. A lot of those interest rate caps are going to expire this year or next year. And so that's going to lead to some sellers that have to either refinance or transact, which I think is going to lead to more volumes in the back half of this year, 2024. You also had inflation hit in kind of a lumpy way. One of the first things that was inflated across the country was rents. There just wasn't enough product. There was extreme household formation happening across the country. People wanted to move out. They didn't want to live with their family anymore. They didn't want to move back in after college. And so the household formation numbers were kind of anomalous and significantly larger than historically we've seen, which led to fantastic rent growth. What happened after that was slowly we saw payroll numbers start to go up. Then cost of goods went up. That happened in 2021 and 2022. And then in 2022, we started to see property tax valuation start to catch up in a pretty meaningful way. Then we saw insurance, especially in some of the southeastern states, which is where a lot of these value-add plays Originated was in high growth southeast markets those markets tend to have seen insurance rates go up significantly more than national averages through a variety of high dollar storms and some other things that have happened in that insurance market and so. What we saw was a perfect combination of debt service going up, as well as hard costs going up. You have to have property insurance. But many people saw a doubling overnight of their insurance costs. And that combines to really pinch cash flow. We are seeing insurance costs normalize. A lot of people in the groups that I follow or people that I know specifically are seeing rate increases in the single digits. And some people are even seeing rate cuts, depending on where they are in the market geographically. So that's good to see. We're going to see property tax valuations take a pause. Again, this depends so much on local jurisdictions. But broadly, property values are not what they were 18 months ago, which is going to filter through the system and result in lower property tax bills. Although generally the governments are slower to give decreases than they are increases. So that's caused a lot of the – I'll call it lowercase D distress that has been seen. We're also seeing lenders be very willing to work with sponsors. Everybody believes that the environment is going to be better in 12 months. Most lenders don't want to take properties back. They are motivated to work things out with their sponsor and get to an environment where either a sale or a refinance is more feasible, just given macro factors, most importantly, interest rates.
Whitney Sewell: I want to transition just a little bit, Sam, with the last few minutes that we have here, because I wonder your take on this as far as, you know, what you know now, you and I invest passively in a number of projects, right? And look at other operators, you know, deals and things like that. That helps inform us, but we're interested in investing, too. But I wonder, what, if anything, has changed for you as far as maybe the way you invested passively? For the passive investor listening right now that's learning about our industry, what has changed for you as far as how you're looking at these deals as a passive investor, say, from two years ago to today?
Sam Rust: I honestly don't know if there's a lot that has changed. We have, we did take on some floating rate debt, um, on a couple of deals late in 2021, early 2022. And we've learned some lessons from that, you know, kind of paradoxically now is the time to actually go do floating rate debt. Um, you believe rates are going to come down. I prefer certainty. Um, and I think that's a lesson that, We knew intellectually, and we took some risks, and now we know for sure that certainty in most circumstances. I want to be careful as an investor, even of my own funds, of just boxing myself in to axioms that may not always prove true. An example of that, and something that I've changed that may surprise some folks, is I'm personally curious what sponsors are doing with exit cap rates right now. But historically, the common knowledge or common practice has been, well, you've got to inflate your exit cap rate by 10 basis points for every year that you hold. That was true when rates were really low. Rates are not really low anymore. Rates are really in the 20-year average right now. And so that doesn't necessarily mean that you can just bake in overly aggressive underwriting, where you're anticipating you're going to buy at an eight cap and sell at a six cap. But especially when you're looking at newer properties, you can get into a negative feedback loop where you might have an opportunity today. And we've seen these deals, especially coming from developers who need to sell properties because they've got expensive construction financing. They're willing to sell at an in-place six cap in core markets. It might be a little bit of a smaller deal. You're not seeing that yet on 150 units on up, but some of those smaller deals at a six cap, You're probably, it's not a responsible underwrite to say, well, that's going to sell for a 6.5 to a 7 cap. I mean, you could underwrite that way, but you're probably not going to land any deals. And you're also missing a lot of value capture, which is you're buying in a distressed situation today from this developer, and you're probably going to be able to sell at a six cap or maybe even less. So there's a difference between what I will underwrite to and what I think will happen. We talk about this a lot in our deal webinars. But that's one of the things that I'm looking at as I'm evaluating sponsors is, are they just reflexively going to, well, it's got to go up by 10 basis points every year, Or are they taking a look at this specific asset and building a business plan that takes into account where we are in the macro cycle? And to be clear, that's probably going to have some inflation of the cap rate, but it might not be 10 basis points a year.
Whitney Sewell: Now, I'm grateful for the color there, as I know a lot of investors listen, and if they haven't been investing for a number of years, they're just maybe more concerned about getting in now, and some see it as an opportunity to get in now, but are just trying to evaluate different operators and what they should be looking at. There's so many different parts of a deal. But anything else you'd leave us with as far as the multifamily trends or advice for passive investors before we close out?
Sam Rust: Yeah, I think that this is something that gets spoken fairly often, but a lot of folks will look at the bottom line. What's the IRR on this deal? And that's really tempting, right? I've evaluated some investment opportunities where it's like, this is a 45% IRR. I mean, instantly, I get red alarm bells going off in my head, what is going on here? But there's a siren song to it, too, where we're reflexively drawn to that higher rate of return, but figuring out a way to quantify your risk-reward calculus, right? And make sure that you're looking at the sensitivity analysis that sponsors are putting out. I think that that's a really important piece. At LifeBridge Capital, we're looking at a lot of newer deals that maybe don't pencil out to the high-teen IRR of some of the value-add deals that we accomplished back in 2019. We're just in a different part of the cycle, and so we want to We're putting a little bit more of an emphasis on predictability and a little bit less on overall return. There will come a moment in the cycle, potentially in about 18 months, where there's going to be a lot of these quote, unquote value add deals that are going to trade. And there's probably going to be another value-add play. But with where interest rates are and where we are in the market cycle, that's not the best business plan, in my opinion, from a risk-reward perspective, all things being equal. Again, that's a general statement that doesn't speak to every single deal that's out there. But broadly, I think the opportunity is more in partnering with developers and taking on new product, running it well, and looking for more of a long-term hold that delivers. I'm going to be really broad here, but a 12 to 15% IRR to investors, or maybe even a 10 to 15% IRR, but with a lot of predictability around it. So that's what we're seeing in the market. That's what I want to drive towards, is we're building our investment thesis and evaluating opportunities. And I think it's really important. We're seeing a lot of folks who've been investing for the last five years, you saw both the ups and the downs of investing in real estate. Yeah, and so I think the overall environment has a much, we all have a much better understanding of what happens in a down market and how predictable or unpredictable cash flows can be, especially as macroeconomic factors seesaw back and forth from expansive to restrictive so quickly and so drastically.
Whitney Sewell: Sam, I'm always grateful when our calendars can align and we can get you on the show. So grateful for the insight today. I appreciate you very much. I hope the listeners will go to Life Bridge Capital where, you know, Sam actually is writing some blogs now and some other team members are writing. information as we put out information to help educate our investors. Hope you will go there and sign up for the LifeBridge Capital newsletter. We're putting quite a bit of work and time into that now to add value to you. So go there. You can always email us at info at LifeBridgeCapital as well. We'd love to hear from you. Have a blessed day. Thank you for being with us again today. I hope that you have learned a lot from the show. Don't forget to like and subscribe. I hope you're telling your friends about the Real Estate Syndication Show and how they can also build wealth in real estate. You can also go to lifebridgecapital.com and start investing today.
