TruAmerica Multifamily’s Bob Hart took an important lesson from the 2008–2009 recession that he’s beginning to apply in this frothy market. 

“The lesson is, ‘Don’t buy on pro forma only,’ ” Hart says. 

Hart says TruAmerica underwrites “fairly conservatively,” looking at growth rates of 3% to 4% for primarily Class B buys. 

“You need to be going in with some kind of a spread that’s not a pie in the sky so that if things come to a grinding halt, you’re not left holding the bag,” Hart says.

The good news is, so far in this cycle he doesn’t see people betting on pro forma growth as they underwrite deals. “They want durable cash flow out of the gate,” Hart says. “I think you have to maintain discipline.”

Starwood Capital Group’s Christopher Graham says today’s low rates provide his company with some cover. “The beauty about apartment investing for us right now is that the cash flow is good enough that we only have to assume inflationary-type growth throughout our hold period,” he says. “Contrast that to 2005 and 2006. Then, apartments had a similar cap rate but much higher interest rates [on debt financing of apartments].”

If rates do go up, however, aggressive buyers will find themselves faced with some decisions.

“People will use variable-rate financing and interest-rate caps to make deals work,” Hart says. “Deals are going to get done, but I think durability of cash flow will be a challenge in a higher–interest-rate environment.”

Even if the worst-case scenario occurs—pricing deteriorates—deals will still get done. In fact, that’s a scenario some people are hoping for.

“Lots of guys like me are hoping that pricing resets in a meaningful way,” says Robert Lee, president and COO of Los Angeles–based JRK Property Holdings. “But I don’t think pricing resets drastically in the near term. If it does, a lot of people will come off the sidelines and be back in the market.”