Today’s Three “L”s: Location, Little Leverage and Long-Term View
- Mar 08, 2011
Location, location, location—known as the three “L”s—is what real estate professionals have long viewed as the key to success. However, today’s environment has changed the way potential owners and investors derive value in a multifamily property. Now, the new “Three Ls” are location, little leverage and a long-term view.
Historically speaking, the New York metropolitan market for apartment product has been stronger than the national market. For example, northern New Jersey has remained as strong as any other market in the country from an occupancy standpoint, even during the “Great Recession.” We can attribute this largely to the historical barriers-to-entry into this market—specifically, that there has not been a lot of product added, with very little new development of multifamily real estate. This is one of the few markets in the U.S. where old product that is renovated still generates high occupancy and high rent.
And while it is widely believed that multifamily real estate has weathered the recession certainly as well as, but perhaps better than, the other categories—hospitality, commercial, retail and industrial—what the sector has been missing is rent growth.
The past few years have witnessed deterioration in rent pricing and volume. Today, however, this trend seems to be fading. Rents are now stabilizing, and even growing, in some New York metro area markets, and many forecasts are predicting a continuation of this trend.
This stability is bolstered by a lack of any real competition for multifamily real estate in the region. For example, given the current financing environment, single-family homes are still out of reach for many prospective buyers. Current would-be owners cannot afford the larger down payments now required by most lenders, and many would fail to even qualify for the more stringent credit requirements needed to buy a home today. As a result, many families will remain long-term renters, and rental occupancies will improve nationwide.
Meanwhile, as the market gains its footing over the next few years, we will see more new development of rental properties across the U.S. in major population centers such as Chicago, Boston, Washington, D.C. and New York, and in states such as Oregon and New York, for example.
So where do the new three “L”s come in? If it were all about location, location, location, then we wouldn’t see so many multifamily properties—many of which are in great locations—flailing or failing across the United States.
That said, however, the big “L” cannot be underplayed. A well-maintained property in a desirable location with proximity to transportation, employment centers and quality-of-life amenities such as schools, houses of worship, shopping, etc. is the first step to a successful multifamily investment.
So what causes great properties in excellent locations to fail? The mistake of overlooking the other two “L”s: leverage and a long-term view.
In the early 2000s, many property owners thought that leverage was their friend due to the inflated market. They bought large communities or portfolios with little or no money down, expecting to build equity in just a few years from projected high rents.
When the market declined, however, rent growth slowed and, in many instances, even declined, forcing property owners to neglect necessary upgrades and maintenance like landscaping and other property improvements in favor of paying their inflated mortgages. Lenders have since returned to more sensible loan criteria standards, and many now require that owners/investors have at least a 25 percent equity stake in the property.
In some markets, it almost does not matter how old your product is because it will always be in demand. But this is not the case in all markets, such as the South and Southwest (where you need a fourth “L” in those markets—luck). In general, however, a key to success is the adoption of a long-term view of the value of your investment. When investing in multifamily real estate, owners must do so with a commitment to constantly improve the property, reinvesting profits year-over-year to keep the facility in top shape and continually attract new renters. The property has to give off the impression that it and the owner will be around tomorrow. It has been said that real estate is a patient investment.
So what can the multifamily industry learn from the northern New Jersey marketplace, in general? The northern New Jersey market is characterized by several real estate families that have traditionally bought multifamily properties and held onto them as long-term investments. In essence, they mastered the new “three Ls” long ago and we can learn much from them. They buy or build properties in highly desirable locations that offer access to public transportation, job centers and lifestyle amenities. Their properties are not highly leveraged. They keep a long-term view that values future profits over short-term gains.
Therefore, as long as you select good locations, keep leverage low and hold a long-term view, no matter what the market does, apartments will remain a solid investment now and in the future.
Alan Hammer is a managing member in the real estate practice of Brach Eichler L.L.C. in Roseland, N.J. The views expressed in this Perspective are the opinion of the contributor.