New Construction Starts Down Spell OPPORTUNITY

Apr 2023
An aerial view of a building with palm trees.

Hope all is well and trust you had a nice weekend! I’m writing you from the hospital – not the usual locale – as we wait for little Lidia Grace to arrive. We’ve been very appreciative of the many prayers and thoughts. Thank you so much! Healthwise both mommy and baby have gotten to a really good spot so we are extremely thankful for that. That being said, I figured I better get this written before things get really crazy!

I promised I would circle back and talk about my thoughts on the reserve currency this week but I’ll have ask for a rain check because I want to share some very timely and interesting news regarding the development space and why I continue to feel we are in a unique opportunity right now. But before we get to that… some exciting news with regard to our team.

Building The Team

On the hiring front, we capped off last week with some really exciting news. After months of interviews and a lot of hard work by everyone involved, we’re thrilled to have an accepted offer for our Southeast RVP role. I didn’t think it would take this long but am also glad we took our time to find the right person for such a critical role. I continue to be reminded of the importance of having alignment when it comes to company culture and vision. The synergies of working with a like-minded team are truly amazing.

After adding 14 properties last year, 2023 has been the perfect year to take a step back and build our “bench” as we tackle the economic headwinds and prepare for continued growth ahead. My learning curve on the hiring front has been a steep one but worth every bit of investment. I can see why many folks stop at a certain point in their growth – growing requires incredible perseverance. Identifying and managing a top-tier team takes unwavering determination when you want to build a company culture based on trust and integrity. It kind of reminds me of any relationship where we all bring our baggage to the table – and it requires nurture and vision to bring out the best!

At this point, we have completed our operational leadership team with four extremely high-level folks each with 20-30 years of multifamily experience who will drive and direct the operations team. Each one has had national experience working for large, small, and mid-size operators. Each has extensive renovation and value-add experience. Each has hired/mentored dozens if not hundreds of employees. It’s going to be exciting to see this dream team go to work.

New Starts Continue Down – Spelling Opportunity

As you know I’ve been watching new construction starts pretty carefully for the past 6-9 months because I’ve sensed an opportunity in the development space. The question I’ve been asking myself is “What’s the reason behind this pullback?” While it may seem obvious, I think there are a couple of nuances that bear discussing in addition to the more obvious reasons.

To me, the obvious reason is a general feeling of uncertainty about our economic future. There’s a trickle-down effect from the Fed rate hikes as we all realize the goal of these rate hikes is to stall the growth in the economy that’s causing the outsized inflation. Makes sense. And when people feel less certain about the future, they invest less and hoard more. Also makes sense. Kind of. But what if Warren Buffet was right? Be greedy when others are fearful.

The banking crisis has prompted many folks to opine on the potential massive effects on real estate if lending were to freeze up. This is what we saw in 2008 and, no doubt, it was a bad situation. When liquidity dries up, lending stops. And when lending stops, prices go down because no one can trade their assets without a steep discount. Bad scenario.

So how does that apply to today? And how does it apply to development deals, in particular? Most folks agree that if there were a banking crisis, the smaller banks would be the ones affected – or maybe we should say ARE the ones being affected. In most of my conversations with local and regional banks, there’s a general pullback in real estate lending – it is getting very difficult to get financing for development deals. Here’s where it gets interesting for both stabilized deals and development deals.

First, most of the lending for stabilized deals is done by Fannie/Freddie (government-backed agencies) and CMBS (commercial mortgage-backed securities) lenders. That market could be affected by the CMBS lenders getting into trouble but with Fannie/Freddie having a large portion of the market, is unlikely to fall apart. These lending groups generally do not lend for development deals. Bottom line, we don’t see a reason for a severe drop in liquidity for stabilized multifamily deals.

Second, on the development side of things, most development deals are funded at the bank level. Local, regional (and even national) banks are the ones generally in the best position to understand the local market, the local operators, and take the necessary risk to lend on development deals. With the current banking environment where it is today, those lenders have pulled way back and it’s incredibly difficult to find capital for development deals. Thus, new construction starts continue to plummet! Folks, that’s a massive opportunity.

What we’re seeing with the drop in new construction starts means that in 12-18 months when there is a lack of inventory in the market, we’ll be in a prime position to lease up quickly, achieve better-than-expected rents, and refinance our properties sooner. We also know that on a macro level, we’re still close to two million units short in the overall market. And right now, even with rates where they are today, you can get fixed 10-year debt at 5.5% (assuming you’re agency qualified) so modeling an exit at those numbers seems pretty conservative given that most likely our debt cost in 24 months will be lower than it is today.

Don’t worry, we’re still going to continue with the value-add opportunities as they re-surface but I think this is a pretty exciting window of opportunity as we build the development side of the portfolio. Even though it’s a 2-3 year wait, the COC at 15-20% on a Class A asset in a prime market is pretty awesome. I’m all about portfolio diversification and this will give us a good amount of exposure at the higher end of the credit quality scale.