In the ever-evolving landscape of commercial real estate (CRE), investment decisions are fundamentally driven by a set of critical questions:
- What level of revenue will this asset generate?
- How much will it cost to improve this asset to optimal revenues?
- What are the annual operating costs?
- What is the asset reasonably worth at exit?
These questions form the backbone of any sound investment analysis, with investors meticulously sensitizing these figures to arrive at a range of potential outcomes in terms of returns, typically measured by Internal Rate of Return (IRR) and equity multiple. However, in recent months, we’ve observed a fascinating shift in the multifamily sector that adds a new layer of complexity to this analysis: the growing importance of asset vintage in institutional investment appetite.
The Vintage Dilemma
Over the past 6-12 months, a clear trend has emerged in the CRE industry. Institutional equity investment firms have gradually shifted their focus away from older vintage assets. What began as a willingness to consider properties from the 1970s has evolved into a reluctance to even look at anything built before the 1980s.
This shift raises a critical question: What eventually happens to these 1970s assets if institutions aren’t buying and improving them through capital expenditures? Moreover, this trend seems to follow a historical pattern, with each decade of vintage falling out of favor as we experience economic contractions.
The Value Proposition
Despite this trend, there must still be 1940s, 1950s, 1960s, and 1970s vintage multifamily assets that attract institutional equity. The question then becomes: How compelling must the deal be from a basis standpoint for institutions to invest?
Intuitively, if a 1970s asset underwrites to a higher base case IRR and equity multiple than a brand new 2024 asset, one might think the older asset should be pursued. However, institutional equity often cites concerns about “what’s inside the walls” with older vintages, implying unexpected plumbing, electrical, and infrastructural work.
This uncertainty impacts both the upfront renovation budget, requiring additional capital expenditures and contingency relative to newer builds, and the annual repairs and maintenance from an operating expenses perspective, directly affecting NOI and value.
The Data Dilemma
At the heart of this issue lies the critical importance of data in investment decision-making. All the fundamental investment questions we outlined earlier are answered with a series of assumptions based on quantitative and qualitative data. If you lack confidence in the data behind any given assumption, you cannot be confident in your analysis or its output.
In working with clients, this is where we have found that going the extra mile of diligence is invaluable. Providing robust data analysis and market insights to your investors and capital sources is key; not only to secure financing but to ensure that the acquisitions make for sound investment opportunities.
The Modernization Challenge
Beyond the data challenges, there’s also the issue of modernization. Assets built several decades ago often don’t align with the stylistic and utilitarian preferences of modern tenants. Today’s renters have become accustomed to features like:
- Higher ceiling heights
- State-of-the-art amenities (e.g., saunas, gyms)
- Energy-efficient appliances
- Open floor plans
- Smart home technology integration
- Sustainable building materials and practices
Upgrading older assets to meet these expectations can be costly and complex, further impacting the investment calculus.
In conclusion, while vintage preferences in multifamily CRE investment are clearly shifting, the fundamental principles of sound investment decision-making remain unchanged. What has changed is the level of scrutiny and data-driven analysis required to make informed choices in this evolving landscape.
It is the job of the investor to consistently re-underwrite investment targets and alternatives, always staying attuned to market shifts and tenant preferences. As an active market participant, keeping in close communication with hundreds of sponsors and investors on a regular basis, VRC has found significant advantage in staying up-to-date on such dynamics. Maintaining deep market knowledge, data analytics capabilities, and actively navigating vintage-related challenges has helped our clients identify hidden opportunities and mitigate risks in older assets.
As the multifamily market continues to evolve, those who can effectively leverage data and market insights to look beyond surface-level vintage concerns will be best positioned to uncover value and generate superior returns.
If you have a current capital need, book a call to discuss a potential capital arrangement. Read our last Capital Spotlight: High Leverage Construction Facility With a Creative Takeout Proposition.