With what’s going on in the market, everything shifts. Because of that, there’s a lot of panic in the real estate industry. In this episode, Jack Krupey discusses whether real estate is overvalued or not. Although the economy is slowing, there is still a major labor shortage. Jack also explains that the down economy or recession causes people to downsize their budget. Although the economy is down, we still continue to have strong investments. Find out why by tuning in to this episode today.
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Is Real Estate Overvalued?
I’m in Europe. I have a meeting or two, and I’m also going to see one of my favorite comedians Bert Kreischer on his European tour. I was able to climb a trip around a show. Part of the thought of being a passive investor is that I can shoot across the pond for a few days, have a couple of productive meetings, and catch a fun show.
I want to talk. I’ve gotten a few questions on, “Is real estate overvalued?” and talking through things like how high can rents go. Is occupancy going to become a real challenge? There are a lot of panics out there. I want to talk through some of those things and my take on that and give a couple of updates on projects that we are actively invested in as well. Nothing’s better than a real case study regarding rents.
First and foremost, in the majority of the projects that we invest in, we’re forcing appreciation. We are buying that value-add product where rents are below market, where prior ownership maybe owned the asset for a long time, and wasn’t pushing to renovate. They would maybe slap some paint on it, keep the rent where it is, and put somebody new in there.
With the units that we’re involved with, we want to put in, in general, kitchens, baths, and flooring where rents can sometimes go up $300 to $500 a month. When you’re adding that type of value that $300 to $500 per month and you’re buying or selling at a 5% or a 6% cap rate, you can generally multiply the amount of increased profits by 20%. They’re raising rents by $5,000 a year with a 5% cap rate. You can multiply it by 20%. I’m not sure if my math is exactly right there, but either way. For every $5,000 increase, it’s roughly $100,000. It depends on if it’s a 5% or 6% cap as far as what happens if we have a recession.
You’re starting to see layoffs at big tech companies. Overall, that’s not generally our canon base. A great majority of our investments are in workforce housing. While the economy may be slowing in some circles, there’s still a major labor shortage. If you’re invested in the Southeast and the Sunbelt, that’s still an area where populations are arising and going where the jobs are.
The other thing that happens is if we have a down economy or a recession, people tend to downsize or lower their budgets. If we’re in an area where our apartments that are newly renovated are $1,400 a month, and the high-end class A was $2,000 or $2,100 a month, if people need to tighten their belts and downsize, they’re more likely to move down to the nicest class B apartment and pick up the $1,500 rent instead of their $2,100 rent.
Overall, regardless if there is a recession, we will continue to have strong investments. This came up in a conversation with one of our operators. The average Baby Boomer returns are 65, and there is still a worker shortage. That’s likely to continue for a number of years. Part of this whole inflation thing is that wages have had to go up just because there were not enough workers to fill the jobs.
We’re just chatting at lunch, and it’s a back-of-the-napkin type of calculation, but what he’d said was, “What does it take to afford $75 a month in extra rent?” You factor in a 40-hour week wage, and it works out to maybe a $0.60 to $0.70 an hour increase. That increase can support $75 a month extra in the paycheck. What we’ve seen, especially in these middle-class type jobs, the pay is going up significantly. I saw a sign when I was in California In-N-Out Burger, and it was $20 an hour for In-N-Out Burger.
There are a couple of case studies here. We have a project called the Jacksonville portfolio. The sponsors put in a few million dollars of their own money at closing. They’ve been continuing to raise the deal after closing, and we still have it available for those investors interested. Check out our website, JKAMInvestments.com. For that property, we’re seeing an 18% increase in rents without renovating a unit. When we have renovated units, the increased rent is going between 50% and 76% higher than the previous rent.
There’s an art and science here. We want to keep occupancy as high as possible, but we want some vacancies so that we can renovate units. It’s a balance of raising rent and keeping a good tenant in for another year versus pushing the rent to the point where a tenant moves out and we renovate and we can release the property at a much higher rate.
It’s a good exit in the fourth quarter of property Lionsgate. They sold at end of quarter three, and rents were up about 20% across the board. They sold into the higher interest rate economy here and still rely on an IRR of 36%, which was pretty awesome. One other data point here and another property we have is St. John’s Point. The average base rent has increased by $105 or 9% in the 2nd quarter. Rents went from roughly $1,128 to $1,233 in quarter 3. This is the highest based rent the property has ever achieved.
That’s higher than the budget, and it’s higher than all the proforma expectations. That’s one of our more stable properties. That wasn’t a super heavy lift. That wasn’t the type of building that was a bakery position. That was a building where we went in directly with Fannie Mae’s debt relatively low in value. That’s a slow and steady one and is performing well, and we have no interest rate risk because we have long-term fixed-rate debt.
The last update was one of our Dallas properties. They’ve renovated 48 units so far. On average, they’re $92 higher than the underwritten rents and $333 or 36% higher than previous rents. Those are all just great real-world real updates on properties that we are actively invested in, and we’re going to start doing more of that on the show.
There’s no substitute for real data on real deals. The feedback’s been good on that, so we’re going to continue to do that. Here’s one last case study here. I attended an event called Rays Fest, and Bob Fraser was one of the guest speakers. He gave some great knowledge of economics. I’m going to talk about that in more detail in another episode.
A couple of people have mentioned inflation, gold, and silver as an alternative to real estate. Other than there was a crazy run in the ’70s when the US went off the gold standard because prior to that, gold was regulated, and the price was somewhat fixed. Gold shot up crazy in the ’70s, but that was a once-in-a-lifetime thing because it had been deregulated.
If you look at commodities from the ’80s on, they’ve not outproduced real estate at all. They’ve not outproduced the stock market even. Something like silver or gold doesn’t pay a dividend. You’re sitting on it and waiting for the dollar to decline or for silver to shoot up in value. It’s not been as effective. What is effective is cashflowing real estate. To some extent, the worst case is the stock market at least still does better than gold or silver when you plotted over a twenty-year-plus period.
To me, the ultimate hedge against inflation is to have conservative leverage, but leverage on real estate where the rents can adjust every year with inflation. Expenses will go up to some extent. With fixed-rate long-term debt, that’s the ultimate hedge against inflation. Inflation is a transfer of wealth from savers to borrowers. If true inflation is something like 8%, in 10 years, things will cost double. In ten years, $1 will be worth $0.46. The biggest risk is to staying on the sidelines and staying in cash. It’s very difficult to time the market. Everybody should take a serious look at increasing their portfolio in alternative investments, and we’re here to help with that.
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