Finding Your Path

A Few Musings from the Front Lines

By Lorne Polger, Senior Managing Director

Lorne Polger

The Apartment Sector’s Insulation from The Cold of Winter

We’ve got some headwinds cooking. The overall economy is, depending on which economist you are following, either (i) in a recession; (ii) heading into a recession; (iii) gliding to a soft landing or (iv) floundering about with no clear signals on where it will land.

Interest rates have soared this year. The November 2 Fed rate hike brought the Fed funds rate up to almost 4%, from a low of near zero in March. The consensus estimate for peak Fed Funds rate is 4.50% to 4.75% in 2023. Some experts predict the rate could hit 5% in 2023 before trending down. And finally, inflation is still spiraling. You see it daily on your trips to the grocery store and gas station. You also see it more broadly in higher prices for building materials, airline fares, electricity and rent.

That said, recession doesn’t necessarily result in doom in the apartment sector. Among the major commercial real estate food groups, multifamily remains a shining light. While there are some clouds on the horizon, and we expect a moderate pricing correction ahead, we also expect that several elements will continue to work in favor of rental housing, especially workforce housing.

Historically, for-sale housing affordability and multifamily vacancy rates have correlated. In the early 2000s, looser mortgage credit (remember those fog-a-mirror loans?) spurred an increase in home ownership, while affordability held steady. Multifamily vacancies rose during that time. The situation reversed in the early 2010s after the Great Financial Crisis when housing became more affordable, but fewer buyers were able to qualify for a mortgage. Amid this dynamic, multifamily vacancies declined, and rents increased. Today, as mortgage rates spiral, the pool of creditworthy homebuyers has shrunk. Reduced affordability in for-sale housing will likely bolster multifamily demand, providing a counterweight to the challenges multifamily investors face from a weakening economy and a significant amount of new construction that has brought more apartment supply over the last few years.

As an affordability example, mortgage rates are set at approximately 3% above the Fed Funds rate. Earlier this year when the Fed Funds rate was near 0% and mortgage rates were near 3%, a buyer on a $2,500 budget could afford a $600,000 home. At a 6% mortgage rate, the same buyer could only afford a $420,000 home. At an 8% rate, that same buyer’s budget is capped at $340,000. What a massive difference. There aren’t too many homes for sale at those prices, at least in the markets that Pathfinder invests in. Those renters will continue to rent.

Consider also that we are going to see a significant reduction in apartment construction ahead. The rising costs of land, materials, labor, and interest rates are not working in the favor of developers. On top of that, banks have started to pull back from construction lending and we believe that process will accelerate. I attended a conference a few weeks back where several construction lenders mentioned to me that they were “pencils down” on new construction loans for the near future. If you are a lender, why take that sort of risk at this point in the cycle?

Another factor driving rental housing is that people may not need an office to work from or a brick-and-mortar retailer to buy from, but they still need a place to sleep. And if their pay is cut or their costs increase, they still have options to ratchet down their housing expense. Bottom line, we believe strongly that it remains better to invest in the Class B apartment space than the Class A space, where rents are much higher.

We believe that apartments will continue to offer a strong hedge against inflation. If you’re operating in resilient markets (avoiding those with excess concentrations in tourism or economic drivers that are fickle, like capital goods manufacturing), have strong asset and property management teams and good lender relationships, multifamily investing should continue to offer solid risk-adjusted returns during turbulent times.

Fun Times for the Mega Banks

Speaking of lender relationships, we do most of our work with business banks and community banks. Admittedly, I’m also a customer at a couple of the megabanks, where I keep some personal checking accounts (primarily because I’ve been too lazy to close them and move the monies over to my primary banks). How these megabanks stay in business is a mystery to me.

I’ve been a customer at one California megabank for almost 30 years. Their branch in La Jolla sits at a primary, high rent intersection, and is 5,000 square feet. I walked in on a recent Tuesday around noon. There were three employees there, all pretty much twiddling their thumbs.  I was the only customer in the place, and you could have fired a cannon off without hitting anyone. Can’t even imagine how their profits from that branch tie into their rents.

Similar experience with another megabank. I am the trustee of a trust account held there and wanted to transfer the account from San Diego to Denver, where the trust beneficiary lives. I walked into the Denver branch on a beautiful Thursday afternoon. Everyone must have been out hiking that day; nary another customer to be found. I walked up to the nicely dressed teller and she asked if I had an appointment. “An appointment?” I replied as I looked around searching for signs of human life. “No, but I’m already a proud customer here at megabank!”

I explained what I needed to do (transfer an account within their system so that it would be domiciled in Denver). Her vacant stare did not give me great confidence. After a minute or two of fumbling around, she brought over the branch manager, who appeared to be somewhere in his early 20’s and wore a suit more befitting a Cannes red carpet than a Denver bank. “I’m sorry sir, but we can’t do that. You’ll need to close that account and open a new one. And we only do that by appointment, so you’ll need to book one online at and come back and see us then!” Alrighty. I’ve since closed that account and moved it to a community bank in Denver where a banker answers the phone and provides customer service…without an appointment.

The Joys of Business Travel

We’ve been back on the road for a while now at Pathfinder, touring our properties, meeting with brokers and attending conferences. That has also meant time in the skies. In a similar vein to the megabank experiences, customer service seems lost on the airlines. Delayed flights, smaller seats, rude flight attendants, and lost baggage are now the routine. My experience on a recent trip to D.C. suggested that the flight attendants were significantly more concerned about pushing the credit card application on you then they were in making sure your pre-made $17 “snack box” was delivered to the correct seat. And notwithstanding the fact that my weight has remained within a 5-pound range for the last ten years, I’m wondering why I can barely squeeze into a coach seat while knocking my seatmate’s elbow off their perch every time I hit the return button on my laptop. Moreover, why did my credit card need to be “pre-approved” before I got on the flight to order a snack? Really? After I just spent $800 on a coach seat with 2” of legroom?  Thank goodness I am only 5’7”.  Cannot imagine being a six-footer and cramming into one of those.

Thanksgiving Message

It is the time of season to give thanks, and we have plenty to give. To our investors, our service providers, the brokers and other professionals we work with. To our amazing staff, many of whom have been with us now for over a decade. And to our families and friends, who form the most meaningful parts of our lives. Enjoy the holidays and we look forward to seeing you in 2023.

Lorne Polger is Senior Managing Director of Pathfinder Partners. Prior to co-founding Pathfinder in 2006, Lorne was a partner with a leading San Diego law firm, where he headed the Real Estate, Land Use and Environmental Law group. He can be reached at

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