April 20, 2023
By: Ben Nelson, Investor Relations Regional Manager
In recent conversations with accredited investors, I’ve found that few asset classes feel like comfortable landing places for capital in today’s environment. It seems that every list of pros can be outweighed by a longer list of cons that stall investor decision-making. For many, the choice is simple: move to cash and stay on the sidelines until the climate improves.
However, because cash appears to be a prudent choice, if you’re looking for the stability and protection of a major bank, you may be forced to forego yield entirely. For example, most large institutional banks currently offer 0.02%–0.05% on savings accounts.[1][2] I’ll refrain from any further cash-bashing rant to focus on a topic we love at Ashcroft: multifamily real estate. Like any other asset class in the past 12 months, multifamily has had its share of ups and downs. Here are three factors that make us cautious in this environment and three that keep us confident.
Reasons for Caution
Inflation and rising costs: From the data released on April 12, 2023, the current consumer price index (CPI) measures 5.00% over the past 12 months.[3] These monthly CPI data represent a wide range of consumer goods and services and are primary indicators of the inflationary or deflationary forces at work in the broader economy. This is the ninth consecutive month that the CPI has fallen, which is a good sign for consumers feeling the pinch. Unfortunately, inflation is still at uncomfortably elevated levels, and sovereign measures to fight inflation can take months, if not years, before they are fully realized. Ashcroft’s proven value-add strategy requires a substantial commitment to construction materials and labor. Although Ashcroft is able to reduce costs and maximize efficiency through Birchstone Residential, our vertically integrated property management and construction company, construction costs are separate from and can be up to double the CPI inflation rate.[4] We are being extremely cautious when deploying capital to our construction projects in this environment to maximize investor return.
Tighter lending requirements: If recent history is any guide, when banks start failing and governments rush to backstop depositors, stricter lending regulations are sure to follow. Sometimes it can take years for these policies to go into effect, but you can bet that they are coming. Real estate markets operate on credit, and tighter requirements usually restrict deal flow, weaken property economics, and slow the movement of capital required for growth. This can come in the form of larger down payments for new acquisitions, increased insurance requirements, and forcing buyers to hold higher levels of cash reserves. Often these policies will force sellers to market assets at attractive valuations for buyers, which can be advantageous for a syndicator like Ashcroft Capital.
Market timing: One of my favorite quotes has always been “No plan survives first contact with the enemy.” The ability to adapt and find opportunities ultimately leads to long-term success. In 2022 and 2023 the timing of market forces beyond our control has been concerning. As the US Federal Reserve led the fight against inflation by raising interest rates at its most aggressive levels in the past 40 years, every syndicator was notified that their original plan had made contact with the enemy of progress. Franklin D. Roosevelt said, “A smooth sea never made a skilled sailor,” and I believe this statement will apply to the multifamily space in the coming years. A skilled syndicator will be able to capitalize on opportunities brought on by market conditions and use every tool at their disposal to navigate the turbulence for their investors.
Reasons for Confidence
Supply/demand imbalance: There is a housing shortage in the US. Anna Bahney of CNN recently stated that, from 2012 to 2022, the gap between new households formed and new homes constructed, including multifamily units, is a shortage of 2 million.[5] When consumer demand is up, and supply is down, economics 101 tells us prices will increase until that supply is met or demand falls. Even more revealing is that 95% of new housing construction in the first three quarters of 2022 was intended for rentals, not purchases.[6] New multifamily construction is often the most expensive rental option, so your average renter will typically look toward more affordable housing in renovated but slightly older properties. This plays into Ashcroft’s core strategy and why value-add properties will continue to maintain high occupancy rates and drive net operating income growth.
A nationwide shift to renting: If we look in the rearview mirror going back 24 months, we see a dramatic shift in US home affordability. According to data from the Federal Reserve of St. Louis, in March 2021 the average 30-year fixed-rate mortgage was 3.18%, and the average home sales price was $418,600. As of April 6 the average 30-year fixed-rate mortgage is 6.24%, and at the end of the last quarter of 2022 the average US home sales price was $535,800. [7][8] To summarize, mortgage rates rose 96%, and home prices rose 28% in roughly a two-year period. Moreover, homeowners with existing low-rate mortgages are largely unwilling to sell their homes and add to the already low housing inventory. This combination has priced out thousands of would-be home buyers and has propelled the necessity of affordable multifamily housing. Rents have risen along with rising interest rates, but the affordability gap between homeownership and renting has widened dramatically.
The great migration: Inflation-adjusted wages were reported down again for March of 2023, marking the 24th consecutive monthly decrease.
But financial pressure isn’t the only factor causing people to move and later rent in more affordable cities. Rising crime, growing homeless populations, heavy taxes, subpar education, and stubborn home prices are also factors. Perhaps the greatest is the growth of the remote workforce in the US, making tens of thousands reevaluate where they can afford the highest quality of life for their families. Derek Thompson of The Atlantic wrote, “But for millions of white-collar workers, something important has changed: They don’t work ‘in’ cities anymore. They work on the internet. The city is just where they go for fun.”[9] Ashcroft’s core strategy is to acquire multifamily properties in healthy and growing submarkets, and this continued nationwide migration makes us even more confident in our long-term strategy.
Why Ashcroft and AVAF3?
This may not be the most favorable time for a multifamily syndicator, but it’s not all negative. The sector’s fundamentals remain strong, and there will be opportunities for the skilled and prepared. Our value-add process has repeatedly been proven to work, and although construction materials can be cost-prohibitive, we hedged against potential rising prices by prepurchasing our materials and safely storing them in our centralized Dallas warehouse.
Ashcroft Capital will always be conservative in its projections, and we’ve gone to great lengths to incorporate market softening and rising cap rates into our AVAF3 model. In fact, we’re assuming year-over-year rent growth of 5% in year one and only 3% each year thereafter, which is much less than the commonly used 10 bps per year an asset is held. We have also lowered the loan-to-value percentage from our historical average of roughly 75% to 65% on Midtown 501, our first asset in AVAF3, to reduce interest expenses. Our all-in interest rate on Midtown 501 is 5.75%, with three-year rate caps in place. We also can refinance this property without any prepayment penalties should rates begin to fall.
Most important, we feel great about our target markets and the assets we buy. Areas like Raleigh, Jacksonville, Tampa, Orlando, Atlanta, and Dallas–Fort Worth are buzzing with strong economies and growing populations. People need an affordable place to live and are choosing to rent in safer areas where they can maximize their income and quality of life. We believe this will play into our hands and drive returns for years to come.
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.
Sources:
- “Consumer Deposit Rates, RATES IN EFFECT AS OF: Friday, April 7, 2023.” Chase Bank, N.A., 7 April 2023, https://www.chase.com/content/dam/chase-ux/ratesheets/pdfs/rdny1.pdf. Accessed April 10, 2023.
- “Deposit Interest Rates & Annual Percentage Yields (APYs), Northeast Texas Consumer & Business Online Rates.” Bank of America, N.A., 10 April 2023, https://media.bac-assets.com/DigitalDeposit_TX_TX_Northeast.pdf?cacheBuster=2980. Accessed 10 April 2023.
- Wallace, Alicia. “US inflation falls to lowest level since May 2021.” CNN Business, 11 April 2023, https://www.cnn.com/2023/04/12/economy/cpi-inflation-march/index.html. Accessed 11 April 2023.
- Zerenski, Ed. “Construction Inflation 2023.” CONSTRUCTION ANALYTICS, ECONOMICS BEHIND THE HEADLINES, 20 December 2022, https://edzarenski.com/2022/12/20/construction-inflation-2023/#:~:text=Long%2Dterm%20construction%20cost%20inflation,change%20in%20contractors%2Fsupplier%20margins. Accessed 10 April 2023.
- Bahney, Anna. “The US housing market is short 6.5 million homes.” CNN Business, 8 March 2023, https://edition.cnn.com/2023/03/08/homes/housing-shortage/index.html. Accessed 11 April 2023.
- Idib.
- “30-Year Fixed Rate Mortgage Average in the United States.” FRED, ECONOMIC DATA | ST. LOUIS FED, 6 April 2023, https://fred.stlouisfed.org/series/MORTGAGE30US. Accessed 11 April 2023.
- “Average Sales Price of Houses Sold for the United States.” FRED, ECONOMIC DATA | ST. LOUIS FED, 26 January 2023, https://fred.stlouisfed.org/series/ASPUS. Accessed 11 April 2023.
- Thompson, Derek. “Why Americans Are Leaving Downtowns in Droves.” The Atlantic, 25 April 2022, https://www.theatlantic.com/newsletters/archive/2022/04/metro-areas-shrinking-population-loss/629665. Access 11 April 20223.
