Show Notes

Cap rates fell a tenth of a point every year from 2010 to 2022, and then gave back a point or two in a hurry.

In this episode I caught up with Lane Kawaoka, who I met around 2016 and partnered with on a Huntsville deal a year or so later. Lane has invested in more than 10,000 multifamily units and returned over $45 million to investors, and he now runs what amounts to a multifamily office, placing capital with operators rather than running every deal himself.

We get into what broke in 2022 and the order it broke in, why the investors writing checks today look nothing like the ones who wired $100,000 after half a webinar in 2021, the reversion cap rate problem that makes conservative underwriting almost impossible right now, and where Lane sees signs of life. We also spend real time on the thing that decides these outcomes, which is the operator, and how he vets one by looking at how they behaved when a deal went badly.

If you’re sitting on the sidelines waiting for a signal, or you’re trying to get investors back into an asset class that hurt them, this conversation is a straight gut check from two people who took the same losses.

Key Takeaways

Two things broke, and they broke in order

• • Cap rates compressed a tenth of a point a year for twelve straight years, then corrected a full point or two.

• • Rising interest rates were the first dam to break, and floating rate debt took the immediate damage.

• • Stagnant and declining rents were the second, and that combination is what finished deals off.

• • A market coming down 20% or 30% wipes out common equity that sat in the top 20% of the capital stack.

• • Lane held roughly 90% of his net worth in real estate at the peak, and he says that concentration is also how he built it.

The money coming in now is different money

• • At the peak, investors wired $100,000 after barely attending a webinar and asking nothing.

• • Today’s checks come from higher net worth people, often owners who just sold a business for five or ten million.

• • They’re allocating 10% or 20% to real estate for exposure and diversification rather than chasing a hot sector.

• • When Lane tells them multifamily has been beaten up, the answer he gets back is that this is exactly why they showed up.

• • Most of them have never owned multifamily before, which changes the conversation you need to have.

The reversion cap rate is where the honesty gets hard

• • To make a deal pencil today you have to exit at roughly the same cap rate you bought at.

• • Underwriting school says hold that exit cap flat or push it wider, which kills most deals on the screen.

• • Logic says cap rates come down from here, and that logic is what the last two cycles rewarded.

• • Debt service, taxes, and insurance are consuming the cash flow that used to be there on day one.

• • With almost no cash flow in year one, the margin for error on every other assumption gets thin.

Watch concessions before you watch rents

• • Class A product is giving away three and four months of free rent in some markets.

• • Phoenix has been running four months free for about two years, which is longer than concessions usually last.

• • In my own Huntsville and Atlanta properties, occupancy is drifting up and concessions are starting to bleed off.

• • Rents are still flat, and the sequence goes occupancy, then concessions, then rent.

• • Once you can model 2% rent growth again, the same deal looks completely different.

The opportunity moved to the boring markets

• • Lane points at tertiary markets, the ones that saw no development during the run-up.

• • Phoenix and Austin are the markets he expects to stay quiet for another couple of years.

• • The Midwest names came up repeatedly: Ohio, Minnesota, Wisconsin, and similar places that had no crane boom and no crash.

• • Huntsville worked because it was an emerging market, and it passed Birmingham in population in the early 2020s.

• • Chasing a 25% rent year is exciting, and it’s a different activity from building long-term wealth.

You’re investing in the operator, not the asset class

• • Lane’s first question on any deal brought to him is whether you personally know the operator.

• • A track record only tells you something once it includes a period when things went wrong.

• • Operators worth backing are often ones nobody has heard of, and many of them decline retail checks of $50,000 or $100,000.

• • Below about a billion in assets under management, he treats operator quality as unproven.

• • You want to see how somebody handled losing money, because that’s the part you can’t learn from a pitch deck.

Syndication is the platform, and it travels

• • The process transfers across asset classes: educate yourself, build a team, raise capital, work with management.

• • Self-storage, mobile home parks, and light industrial run on the same machinery with different nuances.

• • With Claude in Excel you can have the Syndicated Deal Analyzer reshaped for another asset class in minutes.

• • The operators I watch who lasted 30 years ran several synergistic businesses rather than one asset class.

• • Going operational in five asset classes at once is a different mistake, so pick one and go deep.

Connect with Lane!

Email: lane@thewealthelevator.com