U.S. real estate – no more “low hanging fruit”

The U.S. real estate market is once again attracting investor interest and there is an abundance of mortgage money available to buyers. Investors in the commercial and multi-family housing sectors appear confident the market recovery is real and sustainable. As a result, prices for these types of properties have been rising.

The multi-family sector (i.e. apartment buildings) has been one of the strongest performers for many reasons – not the least of which is that since the financial crisis many Americans have abandoned the dream of home ownership.

We have been investing in the U.S. multi-family space since 2011 and our clients now have interests in apartment buildings in Texas, Georgia, Florida and Tennessee. Our goal was to build a diversified portfolio of properties that would capture an attractive yield and a meaningful capital gain. The capital gain would be the result of both a recovering real estate market and strong growth in rents. Our experience to date has been very positive and if anything, the market has recovered more quickly than we anticipated.

Venterra Realty, a specialty real estate investment company investing in multi-family residential communities in the southern United States, has been an important partner for Newport Private Wealth in this program.

John Foresi, CEO, co-founder and director of Venterra, was in our office recently to provide an investment update. He reviewed the changes in the U.S. real estate market in the five years following the financial crisis of 2008.

In his view, the market was frozen in 2009-2010. There was little activity – mortgage money was scarce and buyers and sellers were paralyzed by the dramatic price declines. For many, it was a game of survival and there were few buyers with money and conviction. Venterra had both.

By 2011, the market had stabilized and bargain hunters had returned. But only the “best-financed” buyers were in the game as mortgage money remained very scarce. The majority of U.S. lenders were reducing their balance sheets and most doors were shut for new borrowers. For well-financed buyers like Venterra, the 2011-12 period was, according to John, akin to “shooting fish in a barrel.”  In retrospect, he wished that they had been more aggressive, but hindsight is 20/20 and our view is that it is better to be conservatively opportunistic than take on too much risk.

By 2013, investors of all kinds were back looking for yield and the supply of mortgage money had improved dramatically. The result? “Cap rates” for multi-family projects fell to 5.75% from 6.75%. While this may not seem like much, it means that prices increased 18%! (Note: commercial real estate is valued using a “capitalization rate” i.e. “cap rate”. The lower the cap rate, the higher the price.)

In John’s view, there is now little left in the way of “low hanging fruit” in the multi-family sector. He reminded us that it is more essential than ever to “buy well, use moderate leverage and be prepared to wait it out if needed.”

He also reminded us that Venterra has a number of meaningful competitive advantages. They have an unblemished record as a reliable buyer that can close quickly. Quite often, they have bought buildings after the winning bidder failed to close. They are also able to assume existing mortgages. Mortgage lenders are very reluctant to transfer mortgages to new buyers. As a result, an existing mortgage is often viewed as a “negative” and it eliminates many potential buyers from the bidding process; an advantage for well-capitalized buyers like Venterra.

Finally, there continues to be “underperforming” properties for sale due to absentee ownership or deferred maintenance. In these cases, Venterra’s strategy is twofold. They believe that their operational expertise will improve occupancy and rental rates. In addition, they have the ability to raise enough money to upgrade the property. If successful, the result is increased annual income and a higher sale price in 5 to 6 years.

Westover Oaks, San Antonio, TX, acquired Dec. 2012

Overall, John remains confident that he and his team can continue to secure attractive opportunities for us to consider and invest in for our clients. Success will be less about falling cap rates and more about value-added strategies to increase the net income from each property.

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