September 7, 2023

We haven’t done a deal in over a year. Here’s why.

It’s been over a year since we made our last value-added apartment investment in Southern California, a three-asset portfolio in Azusa totaling $40 million and 116 units.

It ain’t for lack of trying though.

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We’ve looked at hundreds of opportunities over the past year and passed on each one. None met our investment criteria (we are very picky buyers). Most importantly, sellers still have their heads in the clouds, looking in the rearview mirror at yesterday’s prices. Refusing to accept the new reality of higher capital costs and heightened economic uncertainty. In short, sellers’ asking prices are way off from our bids.

We’re not the only ones sitting on the sidelines

We’ve been buying and managing investment real estate for 30 years, primarily with institutional partners. We know that institutional capital looks to real estate as one of many investment alternatives to generate attractive yields and preserve invested capital. Our strategies resonate with our investors because we target properties that provide an essential need… namely, affordable workforce housing in high barrier markets.

For the past year, we’ve been scouring the multifamily rental market in search of value-added opportunities that will generate appropriately priced returns against the backdrop of today’s higher interest rates and uncertain macroeconomic landscape. You know what we’ve found after looking at nearly 200 opportunities to date?… virtually nothing!

The pickings are so slim today that, while my team continues to evaluate new deals, I think a higher and better use of my time is working on my cabin near Tahoe or visiting my son who recently moved to Bali. Yes, the younger folks on my team are out there diligently kicking the tires for new deals. And yes, they’re getting really frustrated, because they haven’t been through a market cycle like this before.

I keep reminding them that we haven’t seen a spike in interest rates and inflation this big since the early 1980’s, when I first started my career. Back then, it took years for the real estate markets to adjust to the new reality. Same thing happened after the 2008-09 Global Financial Crisis. Today is no different. It will take many months, if not years, for growing debt pressures and other impacts of higher interest rates to ripple through the market and be reflected in lower asset pricing and higher transaction volume. It’s been no surprise that deal volume in the SoCal apartment market over the past year is about a quarter of what it was in 2021.

So, we continue to sit on the sidelines (the cabin is done and Bali is beautiful, by the way).

So, why not expand our horizons?

Ok, so if we can’t find the right deals in our sweet spot (SoCal workforce rental housing), why not look at other product types or go out of state?

Well, I am glad you asked. We’ve done that plenty times before, investing in nearly $2 billion of real estate across the U.S. since 1995. In short, no product type or U.S. market has ever come close to the consistent returns our SoCal Class B/C apartment strategy has generated for our investors over the past 30 years.

Here’s a link to a recent article summarizing our “Top 5 List” of reasons why SoCal workforce rental housing will continue to outperform other U.S. markets and strategies over the next 2-3 years. To cut to the punchline, SoCal apartments offer a unique combination of: (1) cycle resilient demand, (2) limited supply-side risk, (3) irreplaceable assets with a huge cost advantage, (4) little institutional competition, and (5) abundant value-added opportunities. The result is an asymmetrical risk-reward proposition… attractive upside potential with unparalleled downside protection… that you simply cannot find in any other U.S. market or product type.

Our bottom line

Here’s how we look at the current situation…

We could lower our return requirements and/or expand our market and product focus. We’ve done that in the past, with good success.

But that’s not where we want to put our money today – or our investors’ capital. After more than 30 years in the trenches, we’ve seen plenty of market cycles. So, we know that sellers can’t ignore market fundamentals indefinitely. Eventually, loans will mature, and owners will face refinancing shortfalls in today’s high interest rate environment. Many will be forced to sell.

At times like these, patience and discipline will pay off for astute real estate investors who keep their powder dry. When the markets do turn in our favor, we will be ready to pounce.

In the meantime, I intend to personally use this market-imposed respite to do something productive: work my golf handicap solidly down into the single digits. However, I remain confident that, sometime very soon, I will be buried in closing new deals and the golf course will be a fond but fading memory.

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