The Effects of Market Dislocations on Multifamily
Multifamily real estate returns are primarily a function of price and future income growth. Like any other investment, assumptions about the investment’s future define its current, informed price. So, investors must consider today’s best available information to form the most objective, informed assumptions about future income. Prudent investors will balance those assumptions with the reality of uncertainty; knowing today’s best available information about the future will never amount to a perfect prediction. Below, we depict examples of how an irregular market dislocation, also known as systematic risk, affects the performance of a multifamily asset.
In the first chart, we show a property purchased prior to a dislocation, such as an unexpected economic downturn. The example illustrates how assumptions of future income (proforma rents) reflect the best available rent projections, which are typically positive in favorable locations. When the dislocation occurs in Year 3 of the property’s hold period, it results in a gap between the expected and actual property rents. This gap can reduce property cash flow, investor distributions, and the property’s value at the end of the hold period.
In the second chart, we show the same example property purchased during a dislocation. Here, future income assumptions are able to account for market softness, reflect the best available rent projections, and inform more accurate pricing for the asset that could not have been available prior to the dislocation.
Generally speaking, the prices of assets purchased during a dislocation should decline as a reflection of the new assumptions of future income. Although no investment is free from unexpected future dislocations, assets acquired during a dislocation are more likely to conform to expected cash flows and investor distributions over the near-term compared to an asset purchased with an entirely different set of assumptions previous to a dislocation.