It’s Frothy Seas and Full Sail Ahead!

Full Sail Ahead!

Happy Tuesday! Hope it’s going well so far.  Not a short week unfortunately – but that’s more time to get stuff done!  Come on, the economy needs you!  With nearly double the folks on unemployment (still) versus pre- COVID, the IRS needs some help! 

CONSERVATIVE VS. FOMO

All humor aside – we were outbid again on a phenomenal asset – Santa Fe Ranch in Dallas, TX (feel free to look it up).  It fits perfectly into our wheelhouse on every angle so we were prepared to push hard to get it.  My initial underwriting put us at $70MM – in line with the guidance we were receiving.  After some further research, we felt comfortable pushing to $72MM, maybe even $73MM if we had to.  Not bad to have a few million to play with if need be.  Our lender even mentioned we could still get 70% LTV at $75MM.  While our returns began to take a hit at that point, it settled out in the 8% COC and 13% IRR.  While that may seem a little low, you have to remember that we’re talking a home run asset in a home run market so you’re going to have to give a little with the expectation that the team and the market will allow you to outperform in the long run.  Long story short the word on the street says this deal went north of $77MM before the dust settled.  WOW! 

With yet another crazy price in the books, I go back to double check my data.  Am I being too conservative, am I missing opportunities with too much of a rearview mirror?  I don’t think so.  I think our pricing was spot on and takes into account the upside in the market.  On the flip side, I also don’t think that 4-5% returns are market either (which is what the deal would have penciled at $77MM). 

TRACKING THE MARKET

I’ve been tracking the market pretty closely the past few months given all the money that’s flooded into our space and have made a couple interesting observations.  

1. Beginning in March of this year, rental rates literally took off on a tear.  We’ve been seeing healthy rental rate increases across the board for the past decade, but something happened in March to really amp that trajectory significantly.  Traditionally leasing season gets underway in a serious manner around that time for southern states, but usually doesn’t get its stride until May or June up north.  However, this trajectory was pretty consistent across all of our markets regardless of geographic location – and it’s not a small deviation, it’s massive!
2. The spreads and rates for debt have gone to yet another record low level.  Bridge debt, the more risky debt for value-add deals, which even a month ago was 4.5%, is now in the low 3% range.  Lenders are practically climbing over themselves to sign up multifamily debt.  While occupancy, rental rates, and collections continue to make new highs as the economy improves, I suppose it’s not too hard to understand some of the enthusiasm.  This is interesting, though, considering we’re about to, hopefully, see an expiration to the eviction moratorium and potentially millions of evictions from people who have chosen not to pay rent for the past months (or year).  Maybe the market has already priced in this potential downside?

THE DFW MARKET

In the DFW market, the average effective rent growth was 1.9% for the quarter.  Yes, that’s the quarter, not the year.  While Class A and B took the lion’s share of that rent growth, that’s still an amazing statistic.  Lease concessions drove much of that increase as properties phased out previous leasing concessions that were no longer needed as demand came roaring back.  We’ve seen the same in our properties as rental rates and collections reach all-time highs.  With new construction moderated by the inflationary situation for raw materials, this continues to bode well for stabilized assets. 

All this to say, it is somewhat understandable why some buyers are throwing caution to the wind just to get their hands on a deal – especially in Dallas.  And while it can be frustrating and the old FOMO (fear of missing out) can set in, I have to remind myself that this is a long game and these are times when it’s easy to make mistakes.  We’ll continue to push forward and do the best we can to adjust our expectations (within reason) to the current market conditions, but don’t expect us to throw caution to the wind just to put another notch on the deal belt! 

In the meantime, we’re working on several deals in the Southeast and Midwest that are penciling quite well so I look forward to keeping you posted on those outcomes as we search for that elusive “good deal” in a sea of froth.