Marterra Market Monitor - June

Marterra Real Estate Featured Lease Listing: 1127 E Balboa Blvd, Unit A, Newport Beach

2 Bed / 2 Bath / Newly Remodeled / On the Beach!!

YTD Activity

Home Sales Closed Units: 13

Home Sales Volume ($): $14,354,099

Residential Properties Leased: 48

Gross Collected Rent: $4,557,769.23

I wanted to start this month's market monitor with a quick note about real estate investing in general. Real estate is hard. It's supposed to be hard. After almost 15 years of low rates, the proliferation of real estate investing podcasts, and property values seemingly only going up and to the right, we are in the early stages of what might be a nasty correction for the multifamily and commercial real estate space. While some might be surprised to hear about distress coming in the multifamily space (everyone needs a place to live!), having competed for properties and having lost out to people paying prices that I could not rationally justify with the most aggressive of assumptions,

Over the last week or so, several articles have covered the spectacular fall of several large multifamily syndicators (investors who raise money from a collection of smaller investors). Most notably, the coverage has focused Applesway Investment Group, but Applesway is just the tip of the iceberg; there are countless similar groups in every market of all sizes that have been or are about to be zeroed out.

What is the common trait this group shares? In my mind, one thing, in general, is principals who entered the real estate investing space after the Global Financial Crisis and, as a result, did not earn sufficient scars to maintain discipline in a ripping market. These knuckleheads underwrote rent growth without paying attention to affordability, over-leveraged with floating rate debt (adjustable rates), and often assumed that operating expenses would remain flat in the face of significant inflation. Many of these groups will have to give their keys back to their lenders, creating distressed sales, which should put downward pressure on the once-favored asset class of multifamily.

“Beware of an old man in a profession where men usually die young.”

Real estate is hard, it is supposed to be hard. Next time you find yourself in a market where many participants view the market as easy, remember to keep your head on a swivel.

Single Family Transactional Market: Long story short - volume is still down, and pricing, at least in Coastal CA, remains resilient.

In other news (keep reading, this would be a game changer), a bill called the "More Homes on the Market Act" was introduced earlier this year by two U.S. House of Representatives lawmakers, Reps. Jimmy Panetta and Mike Kelly. The bill aims to increase the number of available homes on the market. To bring attention to the issue, the lawmakers have discussed what the bill would do if passed.

The bill would change the tax code to encourage more homeowners to sell their houses, increasing the supply of homes for sale. The current law says that single homeowners can exclude up to $250,000 in gains from capital gains taxes when they sell their homes, while joint filers can exclude up to $500,000 (when they've lived in the home for 2 of the last 5 years). The new bill would increase those amounts to $500,000 for single filers and $1 million for joint filers.

Residential Leasing Market: The leasing market remains soft, and we continue to see an uptick in late payments and rent checks bouncing. Raquel Jan, who leads our leasing efforts, recently commented to me that it's very hard to get qualified tenants these days. This weekend, I ran eight tenant screening reports for a property our residential sales team is leasing out, and I was shocked by the results of the reports. Across the board, the credit scores were pretty low, and 3 of the applications were from partner co-signers. Our credit screening reports are showing an increased frequency of comments regarding elevated credit card balances. The weakness in tenant screening reports is a good forward-looking indicator of future week consumer spending.

Mortgage Rates: The bond market is currently challenged with consumer spending higher than expected and income reports lower than forecasted. These conditions and above-target inflation indicate that the Federal Reserve might continue to increase interest rates. In this context, individuals seeking mortgages might consider a few strategies. They could exploit temporary buydowns on conforming loans, consider adjustable-rate options for jumbo loans (with a possibility to refinance if rates drop), or look into FHA loans, which are presently better priced than conventional loans, especially with decreased mortgage insurance premiums. Given the potential for rates to continue rising, buyers should consider locking in mortgage rates sooner than later, as they typically rise faster than they fall.

Grant Sedlak

VP of Mortgage Lending

310-924-0777

[email protected]

Commercial Real Estate (CRE): Last month, I reported that it's finally happening. "It" being distressed sale, as evidenced by the sale of 350 California Street in San Francisco for $60M (the previous sale price was $300M). While it is happening (it looks like the iconic Flatiron building in NY will sell for about $120M). It's not happening at any scale. Commercial real estate transactions are well below the 10 yr average.

What's The Good Word: We're amid Trucking Bloodbath 2.0 - is the title of the May 18th episode of Oddlots, a Bloomberg podcast about markets, econ, and finance. The TL/DR (too long/didn't read or listen in this instance) summary is that the freight market, which is typically a very strong forward-looking economic indicator, is screaming on high alert that the economic outlook, especially for the consumption component of the GDP formula. The freight market has not been this ugly since the global financial crisis. The Podcast is about 50 minutes and well worth your time.

Podcast Link

H/T - Adam Deermount at Ramser Development for the Podcast tip

Macro Observations: for those who have not looked at an economics book since college, here is a quick reminder of how we evaluate the economy. Gross Domestic Product (GDP) is a measure of the monetary value of final goods and services—that is, those that the final user buys—produced in a country in a given period.

GDP is calculated by the following formula:

GDP = C + I + G + (X – M) or in English

GDP = Consumer Spending (approximately 70% of the total in the US) + Private Investment + Government Spending + Net Exports (or Exports less Imports).

If the summation of these factors is positive, the economy is growing; if the summation is negative, well, then, my friends, we are in a recession.

I don't care about the exact GDP result when making investment decisions. I do care about whether GDP is likely to be very positive, positive, negative, or very negative, as this will give me an idea as to whether or not an investment will face economic headwinds or tailwinds.

With student loan payments set to restart in August, a significant amount of money will be pulled out of the consumer spending component. Private investment is down significantly due to higher interest rates, leaving government spending (which will depend highly on the debt ceiling negotiations) and net exports.

The Federal Government estimates the monthly impact of the student loan payment reinstatement to be approximately $37.8B PER MONTH (I have seen estimates as low as $10B per month). That is a lot of consumer spending getting wiped out all at once. I think the impacts of this are going to be widespread and dramatic. As the saying goes, the road to hell is paved with good intentions. This will impact retail sales, the rental market, hospitality, durable goods, and everything else the consumer touches in our economy.

A potential silver lining is that the economic impact might be severe enough to force the Federal Reserve to cut rates rapidly.

Project Updates: We have several ongoing projects; here is a quick update on two of them:

Mission Drive, Costa Mesa: having completed a few multifamily ADUs, we have the process down and are making pretty good time. We poured foundations about two weeks ago, and we are expecting a lumber drop today, so we will start framing. The structural design on these ADUs contain roof trusses (roof truss is a structural framework of timbers designed to bridge the space above a room and to provide support for a roof), which is being fabricated off site and will enable the framing to be completed quicker.

June Street, Hollywood: Remember when I warned that real estate investment is hard? This project is the poster child for how challenging it can be. When we raised the money to buy/develop this deal (back in early 2020), I told several investors a lot of things would go have to go wrong for us to lose money. So far, almost everything that could go wrong has gone wrong. However, we underwrote and structured the deal very conservatively. As a result, despite a pandemic, massive inflation, and unprecedented City delays/shutdowns, we are on the 1-yard line of having this property available for rent. Based on where we are standing today, it looks like our economics will be pretty decent. This Saturday, June 3rd, we are hosting a small rooftop reception for our investors who stuck with us throughout this journey.

Thanks again for reading, and I would like to thank our agents and property managers who provide valuable insights from their day-to-day in the field. Without you, this email wouldn't be very useful or interesting.

If there is anything you need: vendors, lenders, or others, please let me know. We have an extensive network of the best and brightest in the industry.

I geek off this stuff; if you want to grab a coffee or chat about anything related to real estate, the market, or investing, please do not hesitate to reach out.