The method to buy below replacement cost is a tried-and-true investment strategy among real estate investors that allows them to capitalize on short-term fluctuations in the market in order to lock in long-term value.
Grant Russell, director of investments at AvalonBay Communities Inc., said that multifamily investors today are in a “golden window” because they can acquire a Class A property for less than what it costs to develop the same community from the ground-up, all things being held equal.
“Deals are trading for higher than yesterday’s costs and below today’s costs; these are win-win transactions,” added Russell. “If a developer capitalized the deal a few years ago then they’re selling for a profit, and the buyer is able to acquire these deals for below today’s costs.”
These win-win deals are becoming few and far between in today’s environment of elevated interest rates. While buyers are seeking strong yields in their investments, sellers are seeking profitability, and the middle ground has become narrower as those two motivations don’t overlap as often, especially compared to 24 to 36 months ago when interest rates were at historic lows.
“In 2021-2022, properties were trading like commodities to some extent — they were two-year holds at high leverage,” said Eli Chester, senior director of investments at Blaze Capital Partners. “Those days are gone.”
Chester and Russell were speakers on the investment panel at InterFace Multifamily Carolinas, an annual conference held on May 22 at the Hilton Charlotte Uptown hotel by InterFace Conference Group and Southeast Real Estate Business. Andrea Howard, regional managing director of investment sales at Northmarq, moderated the discussion.
Negative leverage, leasing activity
A major theme of the investment panel was the reality of negative leverage. In order to transact, many buyers have had to accept that their capitalization rate will fall below the interest rate on acquisition financing.
“Negative leverage has been on everyone’s mind, and it’s been really difficult to access deals that are positive leverage on day one,” said Davis Finnen, senior director of investments at Greystar. “Those deals are the diamonds in the rough, the needles in the haystack.”
Chester said that the prospect of negative leverage is a “constant deal killer” with institutional equity partners. He mentioned Blaze Capital had an equity partner on Lector 85, a Class A midrise apartment community located in the Ybor City neighborhood in Tampa, Florida. Blaze purchased the property after the seller took it to market but failed to achieve target pricing.
“It’s the first deal [our equity partner] has done in the past three years,” said Chester. “We were able to hit a return target for them and they were comfortable with the negative leverage up front. But I would say that’s a little bit of a unicorn in the space today.”
The main reason why investors are willing to take on negative leverage at all in the short-term is that they are confident in the multifamily market’s long-term health. Several panelists mentioned that they’ve experienced strong leasing activity at their communities, especially those in high-growth markets in the Sun Belt, though it’s not a given as in previous years.
Finnen said that leasing momentum is the first topic that investment committees ask about when discussing potential acquisitions. And at this point in time, he said only a few of the top markets in Florida and the Carolinas are seeing positive leasing activity in terms of total absorption and lease renewals, thus taking on lease-up risk has become more commonplace for recent acquisitions.
“We recognize that there’s going to be some negative leasing momentum in the first year and maybe a little bit in the second year,” said Finnen. “Greystar has a lease-up portfolio that is signing 20 to 25 leases a month. The supply is going to be absorbed and we’re going to have an opportunity to lease in a better environment pretty early on into our hold.”
Finnen added that when underwriting its pro-formas for acquisitions, Greystar is calculating a “rent snapback” as early as year two, which is a bet on the sophistication and execution of the property’s operations team to improve both occupancy and rental rates.
Moderator Andrea Howard began the panel discussion with a statement on the health of the multifamily market for investors. She said that buyers are increasingly taking on negative leverage and other operational headwinds in order to continue investing in the multifamily sector.
She estimated that because of Northmarq’s growing pipeline of broker opinions of value (BOVs) and the competitive nature for assets that do come to market, a return to a frothy investment market could come sooner than many realize.
“There is tremendous capital waiting on the sidelines,” said Howard. “A return to normal from a transaction volume standpoint could happen in the next six months, maybe even sooner.”
Alternative plays
The panel didn’t just discuss traditional market-rate investment, as the breadth of knowledge and experience among the panelists covered other alternative investment strategies. One of the panelists was Caci Cambruzzi Jaeger, a partner at Ascent Multifamily Group, an affordable housing arm within Charlotte-based Ascent Real Estate Partners.
Jaeger said that the firm has purchased four communities and sold another in the past 18 months. One such deal was Charlotte Woods, a 266-unit community off Woodlawn Road in Charlotte. The company acquired the property in September 2023 in partnership with Housing Impact Fund II, a $16 million investment vehicle backed by PNC Bank and other investors that features a social impact component.
As part of the acquisition, Ascent Multifamily placed a long-term deed restriction on the asset so that units remained affordable to households earning 30 to 80 percent of the area median income (AMI).
“The current environment has actually been favorable for us,” said Jaeger. “We’re able to have a lower cost of capital with our affordable fund that we’re deploying. That enables us to compete well with the former value-add buyers that are looking for that double-digit return.”
Another bright spot in the multifamily continuum that the panel discussed is active adult. The property category, which falls into the sweet spot between market-rate multifamily and independent living for seniors, has become a darling in the investment community as occupancy and rent growth remain positive.
“Institutional equity is very interested in active adult,” said Chester of Blaze Capital. “That’s largely driven by the fundamentals. We can point to our portfolio where we’re getting 75 percent retention and 70 percent renewal growth.”
Blaze Capital purchased a pair of active adult communities in metro Atlanta in late 2022 — Hardy Springs in Dallas and Annabelle on Main in Duluth — and Chester said the firm has another community in lease-up in the Carolinas.
Chester added that the active adult category is not without its challenges, and because of the limited supply it’s “thinly traded” and consolidated within a few entrenched firms, though there are opportunities among newer deliveries for buyers willing to take on lease-up risk.
Russell said that AvalonBay has also been thinking outside of just market-rate acquisitions lately. The company has been actively investing in development deals with third parties.
“A lot of lenders aren’t lending as high into the [capital] stack as they used to, so that presents some opportunity to participate in some third-party deals by helping bridge those gaps,” said Russell.
— John Nelson