William Pastuszek, Shepherd Associates

Multi-family real estate – MFRE for the purposes of this article – has been and still is a nice place to be if you are to be in real estate. With the surge in housing in most markets, landlords are happy with full buildings and tenants paying whatever the asking rent is. This scenario plays itself in many New England markets.

Investors love multi-family. Can’t lose. But lately, some observers are sounding mild alarms about the continued unbridled growth in MFRE in the Greater Boston Markets.

What are some of the main general concerns that we should have about MFRE markets?

The Fed has moved rates up and they will continue to tick up as the Fed tried to balance growth with an interest rate cushion against the next recession. The Fed promises to be transparent and predicable. Predictable is good. Risk is inevitable. Uncertainty is bad. The Fed is not the problem.

There’s plenty of money available to buy or refinance. Bankers can’t resist lending on MFRE. The best lenders compete robustly, not only for the best deals but for deals. The rest of the pack hopes to tie up some deals with enough pot sweetening and appraised values high enough. There may be too many partygoers to fit in the room. This is a potential problem. Undisciplined debt helped create the last downturn.

A major investor survey suggests that the beginnings of a correction may be in the offing. It reports that enthusiasm seems to have throttled down since end of 2015. The sense is that pricing is at or near peak levels in most major metropolitan area markets. The influence of aggressive foreign investment signals caution. Too much money chasing too few deals will breed what might look like a market bubble in hindsight.

Anecdotal evidence suggests many equity investors and lenders are laying back or at least trying to buy and lend smarter, both of which are hard to do in a market of limited inventory and toothy demand. The smart ones are happy with their take this time around. Seasoned investors who find prices to be increasingly unsustainable in an uncertain future let the rookies, speculators, and investors investing at any price rush in. That sort of activity at a market peak is a problem waiting to happen.

Investors worry about the future. With not a lot of upside on rental growth and with no meaningful cap rate compression, investors may be thinking that there isn’t much else to be extracted from this particular MFRE lode.

The long run of cap rate compression has generally slowed to a crawl at most levels of the market. Cap rates, with some local and specific exceptions, are likely to remain reasonably stable going forward, or, at least not go down much more.

While strong urban and transportation influenced location will continue the urban village trends, the rather amazing expansion in the supply of multi-family units within I-495 has many landlords and potential landlords wondering where good quality tenants will come from. Expect vacancy creep up.

On the other hand, there are many MFRE markets – outlying ones to the west of the Boston core – that show a much different risk profile. There, where economies are still destabilized, population growth trends negative, and housing tends to be well-used, buyers are more concerned with the certainty of cash flow rather than with wild appreciation.

Many investors in those tertiary markets are faced with finding good quality tenants. Margins are slimmer there and after paying Real Estate Taxes, needed repairs, and the Bank Loan. Tenants not paying or paying only some rent crimps cash flow. Management has to work harder.

The problem of landlords in outlying markets is not just vacancy but collections. There is nothing worse than space that is occupied but not producing rent. Appraisers take note.

With the concerns about tenant quality and general economic conditions, these outlying markets show much higher capitalization rates commensurate with risk. Appraisers and lenders should pay attention to the higher risk profiles of these outlying markets and not be misled by comparison with the much lower cap rates prevalent in core markets.

It’s not time to sound alarms but a warning bell may be in order. While the imminent meltdown of MFRE is not before us, manage expectations about the future wisely.

William Pastuszek, Jr., MAI, SRA, MRA is the principal of Shepherd Associates, Newton Center, Mass.