September 1, 2023
By: Evan Polaski, Investor Relations Managing Director
To learn more or schedule a time to talk to Evan, visit https://ashcroftcapital.com/evan/
Evan Polaski:
Hi, I’m Evan Polaski, managing director of investor relations with Ashcroft Capital. Today, I’m back with Scott Lebenhart, our chief investment officer. Scott, why don’t you give us a quick intro of yourselves for our new viewers?
Scott Lebenhart:
Great. Hey, Evan. Scott Lebenhart. I’m the chief investment officer here at Ashcroft. I’ve been working at Ashcroft since 2018. Prior to that, I was at a private equity company called DRA Advisors for over 11 years. And here at Ashcroft, I’ve bought over 14,000 units and over $2 billion worth of assets. And, as Evan knows, and the return viewers know, Evan and I like to get together on a quarterly basis and talk through what we’re seeing in the market.
Evan Polaski:
Yeah, I appreciate that. And let’s jump right in. So looking back to Q2, how has the market continued to evolve since it hit the brakes toward the end of 2022?
Scott Lebenhart:
Yeah. I mean, In my opinion, and based on what I’ve been seeing, Q2 was fairly similar to Q1. It’s been really slow, especially on the transaction front. Continued uncertainty around the Fed and what they’re going to do with interest rates has really halted everything right now. It’s really halted lenders, the buyers willing to execute, and sellers do not necessarily know what market pricing is. In Q2, the CPI measurements, unemployment numbers, employment indicators, and other economic indicators sent a lot of mixed signals. And so people couldn’t guess and say, “Hey, what’s the Fed going to do next? When are they going to start to pause their increases? When are they going to stabilize? When are they going to start to come down?”
And with interest rates remaining high and no real insight as to when those rates are going to start to come down, it’s just continued to be a stalemate through the second quarter. There were a minimal number of deals that went under contract or were awarded, we did see a handful of those actually fall out of contract and come back to market, or the seller decided to hold, just given all the volatility on the capital market side. So it was good to see some deals at the end of Q1 get under contract and get awarded. But in this market, we continue to track those deals, and unfortunately some of them did not go through. So Q2 was a lot of the same at the beginning of the year, and just not a lot.
Evan Polaski:
Yeah. And we’re seeing that obviously in our transaction volume. But speaking specifically to Ashcroft, how many deals did we see come across our desk that we ultimately underwrote? And then, of those, how many LOIs did we submit?
Scott Lebenhart:
Yeah, I mean, so I looked back at our numbers. We looked at about 125 deals that came across our desk, but in terms of what we actually underwrote, that number was closer to 60 deals. So 50% or so of the deals that we came across us, we actually spent time putting pen to paper on. Two reasons for that percentage, where it’s typically much higher.We’re being highly selective. If it’s not in the market or the submarket that we want to be in, or if it’s not the quality of the asset that we’re looking for right now, no need to spend our time on it.
And then, secondly, is if the price on the property is unreasonable, and we know that the seller really has no driving motivation to sell, we’re interested in spending time on deals that the seller is more likely to transact than not. So you get a pie in the sky price on some deals, and you just push it aside and say, “Hey, I’ll wait until the seller gets a little more realistic to look at it.”
Evan Polaski:
Yeah, a deal that’s worth buying. But we just know, from all of our experience that their whisper price or official asking price is just too far off to even waste time plugging numbers into a spreadsheet.
Scott Lebenhart:
Exactly.
Evan Polaski:
And then did we actually submit any LOIs for those 60 that we were underwriting?
Scott Lebenhart:
Yeah. So we submitted LOIs on around 12 deals over the past quarter, and a lot of those deals were more on the off-market transactions. We spent a lot of time trying to drum up deals off-market in nature, but some of those LOIs we spent more discovery on, “Hey, seller, here’s our price.” Then, getting the feedback, and sellers saying, “Oh no, I’m looking for 20% higher than that,” or something on it. But we still wanted to show that we are active, and we are looking for deals. We did get two fantastic deals under contract through the relationships that we have in the market, but it’s been really tough to mitigate that bid–ask spread that’s out there right now.
Evan Polaski:
Yeah. And just as a reminder, for one of those deals that you just mentioned, by the time this actually comes out and our viewers are watching this, we’ll likely have closed it. So one closed in August, and then the others are coming toward the tail end of August as well. So I appreciate that. It sounds like what you said—more of the same as it is felt broadly in the economy as well. But now, as we’re fast forwarding to the next three months, six months, probably even to Q1 of ‘24, where do you see that market heading since we’ve been flat? Is it continuing to tighten? Is it going to start loosening? What are your thoughts?
Scott Lebenhart:
So I am starting to be a little more optimistic, and part of that is based on the debt market. I’m starting to see signs of us beginning to come out of this period of the cycle where virtually nothing gets done. We’re seeing lenders starting to become more aggressive, and we’re also seeing more money pursuing making loans. With interest rates so high, we’re seeing groups looking to issue debt, as opposed to invest in equity into deals, based on where the treasuries and interest rates are right now, some of these mega-billion dollar funds are saying, “Hey, I could get my risk-adjusted return by issuing debt at 7 or 8% as opposed to actually owning the real estate of the deal.
And so we’ve been seeing a large amount of groups create funds targeting debt and creating preferred equity positions as part of it. And I view this as a good part of the cycle, as money starts to funnel back into the space. And as we see more lenders come into the market and create this liquidity, I believe we’re going to start to see spreads coming down. Competition is always good for the market. In our capitalist society, people want to win deals, and they start to be willing to pay more, or in a lender’s case, reduce their spread on it. And I do believe that this will help to narrow some of that gap that we were talking about in Q1 and Q2 between the bid–ask spread between buyers and sellers.
So don’t get me wrong. I’m not saying that it’s going to be a flip of a switch and happen overnight, but this is the first sign where we’re out looking for refinances, new acquisition financing, and we’re seeing a lot more lenders come to the table. And a handful of them are willing to be a lot more aggressive in order to get the deal done. So we’re starting to see a break, which I’m excited about.
Evan Polaski:
Yeah, and as we’ve discussed in the past, the lenders have to price-in their own risk. I won’t say inflating, but they’re adjusting their rates to account for their own risk, and then we would have to do the same on our risk. That’s where the big bid–ask spread is coming because we’re hitting it on both sides.
Scott Lebenhart:
Right.
Evan Polaski:
So a big chunk of that is thelender starts to narrow their risk or their thoughts on risk, and there’s more demand out there. Then clearly that starts to ease up one side of the equation on the pricing that we’re ultimately looking at. We’re hopefully starting to see a slight relaxation in the market coming down the road, how’s your team evolving? I know we focus a lot on specific assets, a lot of outreach. Does that remain the same? Is it continuing to shift?
Scott Lebenhart:
Yeah, it continues to modify slightly based on what we’re seeing in the market. As I mentioned about Q2, the majority of deals that we spent the most time on were the off-market deals. We’ve now transitioned to where we monitor the market deals. It’s a good indication if those deals do actually trade, where people are willing to pay, and buyers are willing to sell. It’s something we are always going to pay attention to. If the right deal comes along and we have the right relationship with the seller, and it’s in the right market, absolutely, we will pursue those. But we view most of the opportunities right now through an off-market approach. We’re doing a tremendous amount of research on potential opportunities. We’re trying to find the right deals, meaning we’re looking at very specific submarkets, specific vintages, specific demand drivers, specific average household incomes, and we’re really taking a targeted approach.
Not to give away our secret sauce, but we are conducting targeted research on deals that we believe sellers would be willing to transact on; if they bought them five years ago, pre-pandemic, we believe, based on our research, that they have debt coming due within the next year or two—or perhaps even shorter term—or it’s invested in a fund that’s likely going to be into its liquidation mode shortly. So we’re doing a good amount of research behind the assets themselves. We’re finding the assets first; then we’re finding reasons why someone may be looking to sell in the near term. And that’s how we’re really targeting our deals. And given that, we all know, and I speak about this all the time, how real estate is a relationship business; we’re really utilizing our relationships with that in order to gain knowledge about properties that may be coming to market soon or are willing to sell soon and working to drum up deals that way. So we are heavily researching and trying to find a diamond in the rough right now.
Evan Polaski:
OK, yeah. And that sounds like it might be the only way. Because as you noted, you saw 125 deals come across your desk. I know some of those are on-market, and some of those are off-market. I’m sure, back in ‘21 (and I know I didn’t ask you to pull these numbers), you probably saw that in a month of just on-market deals.
Scott Lebenhart:
It could have been a week or something.
Evan Polaski:
Yeah.
Scott Lebenhart:
Some weeks were crazy.
Evan Polaski:
Yeah, so you’ve got to find them somehow. But the big topic that I’ve been hearing lately in my conversations, in my team’s conversations, is what’s happening with this mortgage doom coming, as all these short-term loans that were taken out in ‘20 and ‘21 start to come due. Do you foresee a lot of distressed deals coming down the pipe in the near future?
Scott Lebenhart:
So, I’ll admit, earlier in the year, and you probably have me on record saying it, so I’ll admit it, I was not expecting much distress to hit the market, as much as everyone was expecting, because I believe, when we’re doing this conversation that we’d be talking about interest rates starting to come down at that point and help to alleviate some of the pressures on certain deals with debt maturities, or rate cap issues, or just a light at the end of the tunnel for some of these. That has not happened. And so I will be the first to admit that I do believe that I was wrong and that there is more distress coming than I originally thought. That being said, I do not expect a flood of distress to hit the market all at once. I think these are deals that are going to trickle out over time. And I believe they’re also going to be extremely relationship driven in terms of who gets what deal.
I think lenders as a whole are not interested in taking deals back, being owners of deals, and therefore having to sell them. I think, even based on our direct conversations with certain lenders, they’re going to be willing to work with good borrowers; by “good borrowers,” I mean those working to execute a business plan. Perhaps they’re unable to buy an interest rate cap required because of liquidity issues or something like that, where the asset itself is doing fine, but because of the capital markets, there’s some level of distress with it.
If lenders do ultimately take deals back and foreclose on a deal or force a sale, at that point, the lender’s going to be driving that sale and selecting the buyer on it. I think they’re going to be . . . . Because we saw this back in 2009, 2010, as lenders were trying to get rid of some of their loans that they had on their books, they would sell to groups that they worked with—groups that are institutional in nature and have strong balance sheets that they have a high certainty to close. They’re not looking to lend this to the highest bidder out there. They’re looking for someone who’s going to ultimately transact on it and perhaps even structure a deal where that lender will stay in the deal with the new borrower and try to find a way to recoup some of their losses if there were any.
And we’ve also discussed the amount of money moving onto the debt side. There’s a lot of preferred lenders out there looking to help bridge the gap on some of these deals. There are groups raising money purely for rescue capital on these deals. And so there will be deals that are distressed and do get forced to market and that lenders do foreclose on. But again, I think we’ve already seen it in the market with some of these larger institutions that are well capitalized. So they’ve gone ahead and said, “Hey, my floating rates are extraordinary right now. I got millions of dollars of rate cap purchases.” We’ve seen them go and refinance with the agencies. They would go and take 20, 30, $50 million on a portfolio and pay down the debt in equity in order to just readjust their capital stack to market conditions. So again, there’s going to be the outliers where there is distress coming to the market. But as a whole, I’m really not seeing the flood.
But what we’re doing is we’re not waiting around for the deals to be distressed to hit the market and come to the market. Through our research, like we just discussed, we’re targeting deals that may perhaps be in a distressed situation, as opposed to ultimately being a distressed deal. And what we’re doing is having conversations with those owners and trying to come up with a creative solution for them, where maybe we step in and buy part of the deal, fresh equity into the deal, take over the management, take over the control of the deal, and leave that owner in for some type of upside if we’re able to wait this out. But everyone’s in the sense right now where fundamentals in multifamily are still relatively strong. The distress is caused by the capital markets and the majority of situations, not at the performance of the properties. And so an owner’s first instinct is going to be find a way to kick the can down the road. And I tend to think that that’s going to be more predominantly in the market than a tremendous number of distressed deals.
Evan Polaski:
Yeah. No, and I think that aligns with things that I’ve seen personally. As you said, there’s rescue capital; there’s a lot of capital waiting in the wings; and, even thinking back to my experience in 2009, it’s what deals got reworked? Were they the ones where there was actually an opportunity to see a light at the end of the tunnel, versus a bad operator with the bad deal, where it’s just like, “We just need to take this and get it off our books as fast as possible”? So with that, I personally align with you, but I appreciate those insights.
Scott Lebenhart:
And I’d also say, thankfully or hopefully everyone listening is in the multifamily space or industrial space. But from our conversations with the lenders, their main concern are the office assets right now. Those are the ones where, unfortunately, they are going to have to take back, where there will be foreclosures on lender-controlled deals. They do not want to take multifamily assets back right now. They view them as cash-flowing assets that perform well and that are distressed because of the capital market. So every time we bring up multifamily to an investor as a potential issue, they say, “We’re not worried about multifamily right now. We’re focused on our office loans.”
Evan Polaski:
Yeah, yeah. Everybody needs a place to live, so the core level of the business plan is pretty well insulated in that regard. Well I really appreciate all your time, Scott. As always, it’s great to hear your insights this quarter, and we certainly look forward to doing this again next quarter.
Scott Lebenhart:
Hopefully, we’ll be talking about more deals next time.
Evan Polaski:
As long as they’re the right deals, yes.
Scott Lebenhart:
Exactly. Exactly.
Evan Polaski:
I appreciate all you do for us and appreciate your time. Thanks so much.
Scott Lebenhart:
Thanks, Evan.
If you would like to learn more about investing in multifamily assets, visit https://info.ashcroftcapital.com/fund, or schedule a call with our Investor Relations Team at investorrelations@ashcroftcapital.com.
