February 6, 2023
By: Evan Polaski, Investor Relations Managing Director
Evan Polaski:
Hi, I’m Evan Polaski, managing director of Investor Relations with Ashcroft Capital, and back with us today is Scott Lebenhart, Ashcroft Capital’s chief investment officer. Today, we really want to touch on a Q4 recap and a Q1 outlook for our past and future acquisitions. We’ll jump right into it. Thank you for joining us today, Scott.
Scott Lebenhart:
Thanks for having me, Evan.
Evan Polaski:
Very grateful to have your time and share some of your insights with our investors. Why don’t we start with Q4 and look back at what we bought, how many deals we had underwritten throughout, and what the acquisition pipeline looked like?
Scott Lebenhart:
Absolutely. Given the volatility in the market, the pipeline significantly decreased from where we were in Q4 2021. That was a robust period. We closed seven deals in the fourth quarter of 2021. In 2022, during the fourth quarter, we closed two deals that we’re extremely excited about. These were deals that we targeted specifically. We closed on Halston Paces Crossing in November. This deal is in Atlanta. It was a loan assumption deal with a fixed interest rate at 3.25%. It was over 200 basis points lower than current rates. We were already familiar with the submarket, because it was the fourth property that we had purchased in Gwinnett County in Atlanta. We were excited to get that one done.
Then, we closed Midtown 501 right before the holidays. That deal is in Chapel Hill. It is in an A++ location, with very minimal deferred maintenance, a light value add strategy, and tons of operational upside. It’s a deal that was owned by a group that we have worked with several times in the past. We have bought several deals from them before, so we knew how they operate and how we could improve the value from the get-go. So, those are two fantastic deals that we were able to get our hands on and make sense of. We found a meeting of the minds at the right price—or what we believed to be the right price—but, overall, the acquisition market was much slower. We underwrote about 50 deals in Q4. That’s about 50% of the deals that crossed our desk. And, of deals that we were actually pursuing, we only submitted seven LOIs in the fourth quarter—and that’s dating back to when we would submit seven LOIs in a week based on some of the heavy volume that we saw over the past couple of years. Things are definitely slowing down in the market, but we’re still able to find the right deals and sellers who are willing to sell at today’s pricing.
Evan Polaski:
Looking back at Q4, not only the deals that we acquired but even the deals that we were underwriting LOIs issued, how were we finding those deals? Were those mostly off-market? Was there a balance of off-market and on-market? What efforts were we making on that front?
Scott Lebenhart:
It was a balance, and at the end of the day, we always say real estate is a relationship business. We try to position ourselves to be the group that people want to work with and want to sell their deals to. That really came to fruition in the fourth quarter when our reputation and level of trust helped us get the deals done. Paces Crossing was a true off-market deal that we were able to get a look at from a seller who we knew wanted to sell out of certain deals in their portfolio. They bought the deal in 2018 and refinanced out of it in 2021—or, refinanced out their equity in 2021—which gave us the ability to assume a 2021 loan with a lot of interest only remaining. We were able to convince them to sell at a price that made sense for us just because they were looking to. They didn’t know where the world was going, and they said, “We’re done with this one, and we’ll move on.”
Midtown 501 was a deal that was marketed. However, we had bought two other deals previously from the seller. We knew them well. We were able to negotiate with them directly. Given the level of comfort that they had with us, they wanted to close before the end of the year. We wanted to close before the end of the year to allow investors to benefit from certain potential tax advantages. We were able to get the seller comfortable with moving forward with us at a discounted price compared to the other groups.
We’re continuing to have conversations with groups that we know and are trying to price some deals away from them. We‘re doing an intense amount of research right now. We did a lot of research back in Q4 wherein we targeted quality deals at specific locations. We have our databases in which we’re able to search when deals were purchased and what type of loan structures they have. Those are the deals for which we’re approaching sellers and saying, “Hey, we know you bought this in 2018. You have your debt maturing next year, et cetera, et cetera.” For the people who bought then, even though the market is in some turmoil right now, they’re still making money on their deals and perhaps incentivizing them to negotiate and decide that we’re the right buyers for it, that we will make it nice and smooth. Right now, we’re doing a lot of targeted approaches on our deals to drum up deals off-market.
Evan Polaski:
In terms of the actual deals themselves, you talked about targeting a much more specific type of deal through research. Are there changes in the general focus of the type of risk profiles or anything along those lines that we’re looking at today, kind of like Q4 starting to blend into future looks or looking for it relative to the end of 2021 or early 2022?
Scott Lebenhart:
I’d say it’s more of a narrowed focus where certain quality deals make a lot of sense right now versus others. Loan assumptions make a lot of sense because it takes one of the most uncertain and volatile components out of the deal by having an in-place loan that you can assume. Right now, lighter value-add deals make a lot of sense with limited deferred maintenance. Historically, [at] the beginning of 2022 and beyond, there was plentiful debt out there that was willing to fund future CapEx projects. Right now, we’re able to be selective and lean on some of our relationship lenders for loans like that. But if you’re going with an agency loan or some type of fixed-rate product, the cost of those deferred maintenance items and the cost of the renovation, that’s coming out of equity, which is obviously more expensive than debt. This is why people put debt on their property. This is straining the ability to project some decent returns on certain deals.
Deals that are in great shape are targeted more. We are not looking for super heavy lifts right now. We’ve made a lot of great acquisitions in the past that are heavy lifts, but right now the environment is not conducive to that. We’re also really focused on the potential of a recession in 2023. We’re looking at recession resistant locations with highly ranked school systems, great access, and diverse employment drivers in the area. So that’s another factor that we’re focused on at the moment.
Evan Polaski:
With everything we mentioned in terms of how we’re sourcing deals, the types of deals that we were focusing on both Q4 and forward, how do we see that continuing to evolve, or what areas are we focusing on more heavily given the information we’ve received over the last three months?
Scott Lebenhart:
I think that in Q1 we will continue to be extremely selective on the deals that we’re targeting from an acquisition projection. Unfortunately, we still expect limited transactions to occur in the first half of 2023. We’re going to continue to be disciplined and make sure we’re buying the right deals at the right price. And a lot of that goes into what I was talking about in Q4, how we’re targeting specific deals in specific locations. That’s going to be where we continue to focus. We will also continue to have conversations with the groups and the potential sellers out there that we’ve worked with in the past in order to try to pry some deals away from them later in the year toward the second half of 2023. We do expect there to be more transactions.
We expect there to be some deals that happen in Q1, which helps create data points and the bid/ask spread becomes a little narrower. Hopefully, there will be some more stabilized stabilization in the debt markets. The belief is that by midyear the rate increases will come to a halt and even potentially by the end of the year start to decrease. So there should be more clarity on that front.
We also believe toward the end of this year, there’ll be some more distress in the market. We’re going to see sellers that have debt maturities coming up and have rate cap purchase obligations to fulfill and cash flow being drained from properties based on higher-than-expected debt service. We expect those deals to start to come out in the second half of the year. Right now, it’s a lot of positioning with the groups that we believe will have those opportunities for us throughout the year and staying true and making sure we’re buying safe, conservative deals in strong locations.
Evan Polaski:
How are we then making sure that we’re not in a similar pinch if rates don’t drop like they’re anticipated to in the next few years? How are we adjusting our financing structure and overall deal structure accordingly?
Scott Lebenhart:
A lot of that is being proactive with our existing deals. We’re being extremely proactive. We’re having conversations with lenders today. I actually just double-checked a couple weeks ago to confirm that there were no loans maturing in 2023, and this was triple-checked the other day to make sure we didn’t miss anything. We have no loans maturing this year, which is fantastic. We have no reasons that we need to sell deals. May we want to sell a couple of deals this year? Absolutely. But those are probably deals where we have already been able to implement our value-add strategy. So it’s not going to be a deal that we bought six months ago that we’re looking to sell out of this year, but we are having conversations with lenders in terms of future rate cap obligations that we have.
We are extremely focused, as always, on operations and making sure that our expenses are in line with where they should be and not running up. We are focused on maintaining extremely strong occupancy on the construction side. We are still seeing plenty of demand for our renovated product, renovated units, and our properties that we’re repositioning in the market. As we’re getting into a recession, there’s usually a sense of some sort of flight to quality. People with higher average incomes, like the markets that we’ve been buying, tend to live in those quality locations, perhaps at a slight discount to where they would’ve been at a stronger economic time. So again, we’re focused on these strong submarkets a lot right now.
Evan Polaski:
I appreciate all of your input, and I’ll leave it to you if you have any other closing remarks that you’d like to add before we part ways.
Scott Lebenhart:
It has been an interesting year. As you know, I think the world has a lot of sorting out post-COVID-19. Hopefully, supply chain issues figure themselves out. Inflation seems to be starting to get under control and trending in the right direction. Last year was a tale of two halves, where the first half was all rosy and the second half was, “I have no idea what’s happening.” We saw that after COVID-19 in 2020, [there was] a ton of uncertainty, obviously for different reasons, but we relied on our relationships in the summer of 2020. We closed three deals at the end of 2020 that we were able to tie up throughout all that uncertainty. Those deals were potentially some of the better deals that we’ve done. Ultimately, they were deals that we were able to buy from groups that knew us, felt comfortable selling to us, and knew that we would execute and close. We expect now to be similar to that period of time, where people are going to want to de-risk themselves during the sales process as well. We’re looking to put ourselves in a strong position.
So the beginning of 2023 continued with uncertainty. Hopefully, we will have some more clarity by the end of 2023. We’re excited to see what the year has in store for us. We’re awaiting some more surprises, so we’ll say.
Evan Polaski:
I think over the last three years, 2020 through 2022, uncertainty is the only certainty. I appreciate all your time and insights and, as always, am grateful to you for sharing your thoughts with us.
Scott Lebenhart:
Great. I appreciate you having me. 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.
