In response to last month’s Insight I received several requests for more detailed explanation about the purchases Altus is working on, and why we think they are good opportunities; especially taking into account how those opportunities play into the current economic uncertainties. This seems like a worthy discussion in light of such opportunities. As investors we can’t really sit on our hands and do nothing, but at the same time this isn’t 2009 or 2010 when the investment world was on deep discount as measured by almost any metric.
Any analysis of our current opportunities needs to be understood through the lens of our investment guidelines. At a very high level those guidelines are as follows:
- Lots of tenants/customers so the loss of any one tenant/customer is not catastrophic to the investment. These tenants don’t necessarily already have to be in place at the time of purchase but there must be a clear and reasonable path to obtaining them, preferably even in times of economic duress.
- Find locations (markets, neighborhoods, etc.) that have immediate product need and/or are poised for long term growth. We also look for locations that appear to have solid footing to handle an economic correction.
- Making investment purchases at prices below replacement costs provides a natural buffer to market rent and price corrections, but only assuming financial projects don’t assume rents on par with new construction competition.
- Multiple exit strategies help mitigate changes within a market while also providing optionality…
- Long term debt, long term investment horizons, and investing for cashflow go a long way in mitigating economic risk, assuming there are no tenants that will have a catastrophic impact on the investment by leaving and assuming there debt coverage ratio is such that some downward pressure in rents can be absorbed and the property still be cash flow positive.
- Use investment structures and or tax advantages to improve investor returns whenever possible.
- Sometimes opportunities will present themselves that are outside the above guidelines and may be profitable enough to pursue anyway. That pursuit just needs to be done in the conscious awareness that the investment is being made outside the base guidelines.
Each of the projects on which we are currently working to procure fit the above criteria as outlined below:
Skyline Apartments – Chico, California: This project is a 100% shovel ready apartment building in a market with dire need of multi-family housing.
Guideline #1 – Lots of tenants: As multi-family housing there are lots of tenants.
Guideline #2 – Location with product need or growing market: As many will know Chico is located not far from the devastation of last fall’s Camp Fire centered in Paradise, Ca. Like many areas of California, even before the fire Chico has low residential rental vacancy. With the impact of so many lost homes in the MSA, vacancy is now effectively zero. This project was underwritten and moving forward prior to the fire so any fire related bump in rents will be a bonus to the project, but such bumps aren’t assumed in the financial projections.
Guideline #3 – Invest below replacement cost: We have structured a deal with a local experienced builder in which they are acquiring an option to purchase the property post completion. They will also be deferring all general contracting profit to the completion of construction so it can reduce their option strike price. This puts our cost/exposure below the replacement cost.
Guideline #4 – Multiple exit strategies: The agreed upon option strike price is well, well below the current market value for the stabilized property and includes a predefined rate of return on the investment in this project. If for some reason the builder is not able to exercise their option we will retain ownership of the property and we and our investors will profit nicely.
Guideline #5 – Long term debt, strong debt coverage ratios: While we will be using bridge/construction financing for the project, the loan will have a clause allowing it to roll over to permanent financing. Additionally, because of the equity built into the project the coverage ratio can handle a large increase in interest rates and maintain profitability.
Guideline #6 – Use tax advantages when possible: Lastly, while investment in this opportunity effectively acts as a loan to the project, we are able to structure in such a way that the returns will be treated as long term capital gains, boosting the after-tax returns for the project
Taken in its entirety this is one of my favorite opportunities that we have come across in quite some time. The returns will not be as high as some of our other projects have produced or are projected to be, but they are predefined with substantial downside protection compared to standard real estate equity investments. Additionally, unlike most of Altus’s opportunities, this is shorter term in nature – 18 – 30 months, potentially unlocking different buckets of investment dollars that would be used for the longer-term cash flow investments.
Industrial Warehouse and Distribution – Tupelo, MS: This property is an existing 300,000 square foot industrial building that is 100% leased with strong tenants (including a national tenant). Additionally, there is considerable demand in the market place for this type of space. This property is in a QOZ and has additional land for building expansion to allow for QOZ qualification.
Guideline #1 – Lots of tenants: This is currently a multi-tenant building. Additional tenants will be added to the rent roll as the future expansion is leased up.
Guideline #2 – Location with product need or growing market: For the past couple years our market research has often pointed us back to a swath of the country starting in the Carolinas and then running west through the north part of the gulf states (and Tennessee), through Arkansas and then out to Oklahoma and Texas. Cost of living, business friendly environments and warmer winters are driving population and job growth throughout the region. Tupelo is within that larger region and is one of the top ten micropolitans in the country. With a broad manufacturing base and a skilled blue-collar population, companies (like Toyota) are moving to Tupelo. There simply isn’t enough industrial real estate product to handle the demand.
Guideline #3 – Invest below replacement cost: We are purchasing the existing building at roughly $20/ft, well below the market replacement cost. This price includes the additional land. The new construction will obviously be built at replacement cost, but the total cost of the project will still be well below replacement cost on a per foot basis.
Guideline #4 – Multiple exit strategies: As a QOZ project the intent is to own the property for the required ten years past in service to qualify for the QOZ benefits. This negates any short-term exit strategies. However, after the ten-year term individual parcels will be able to be sold together, separately or held for continued cash flow.
Guideline #5 – Long term debt, strong debt coverage ratios: Our debt structure has not yet been determined for this project, but with us purchasing an in place 9 cap rate we are well positioned for a great coverage ratio.
Guideline #6 – Use tax advantages when possible: The 2017 tax code created Qualified Opportunity Zones which provide huge tax benefits for investors able to take advantage of them. This investment stands on its own, but the opportunity zone treatment makes it that much sweeter.
Altus was one of the first real estate sponsors to kick off an opportunity zone project when we started the Art House Project last fall and we are big believers in the QOZ benefits, but ONLY when the investment would otherwise stand on its own. We also love cash flow. We have very specifically been looking for opportunities that have existing cash flow but still have the upside opportunity needed for the project to be QOZ eligible. After turning over lots and lots of rocks within our target regions/markets we are excited to have found this one. For those unfamiliar with QOZ benefits, a summary can be found here.
Agricultural Land for Orchard Development, Artois, CA: This is an off-market 870 acre tract uncovered by a local orchardist we have been trying to partner with. It has been used for hay production and sheep pasture. It is located in a prime almond orchard area.
Guideline #1 – Lots of buyers: Almonds are a commodity with lots of buyers and end users spread across the globe.
Guideline #2 – Location with product need or growing market: Almond consumption continues to grow, especially in parts of Asia. Additionally, due to water constraints a considerable amount of existing orchards in the San Juaquin valley are in danger of being replaced. There is voracious appetite among existing orchard owners to purchase additional acreage.
Guideline #3 – Investment below replacement cost: A large part of the cost of an orchard is the land, which we have in contract well below current market prices. However, land prices are volatile so we can’t truly say this alone provides us an investment below replacement costs since land prices could change in the future. We are also partnering with the orchardist so will be able to get the orchard developed for below market prices in exchange for his equity in the project moving forward.
Guideline #4 – Multiple exit strategies: Like with the apartment project outlined below, we already have a buyer lined up for planted orchard. That buyer will have considerable non refundable earnest money in escrow prior to our purchase of the property, minimizing the chance they won’t move forward with the purchase. Long term ownership of the orchard is far more lucrative than selling after development, but because there is no cash flow for the first four years of the investment we didn’t believe our investor base would be interested in such a scenario.
Guideline #5 – Long term debt, strong debt coverage ratios: Unfortunately, fixed rate debt is unavailable during the orchard development process. This is in a large part mitigated by already having a buyer in place on the back end. Further, only 50% of the total project cost are to be borrowed, greatly increasing the coverage ratio while allowing for crop size and price volatility.
Guideline #6 – Use tax advantages when possible: Because of the in-place buyer, and again like the apartment complex above, an investment in this project is much like debt with a predefined return. Like the apartment complex investment, the returns can be treated as long term capital gains.
There is a strong likelihood we will end up passing this project to another real estate sponsor. This is not at all due to the investment dynamics of the opportunity itself, which we think are excellent. Rather Altus already has a lot on its place with the first two opportunities. Additionally, we feel our investor base is currently more comfortable with the real estate product types of the first two investments so are more likely to want to pursue those opportunities.
It is interesting how investment opportunities become available. As we did last year, we can go for months without really turning up anything of interest, and then we can uncover multiple great opportunities all at once. We know that so long as we are disciplined through the slow times that we will have opportunities again and are glad to be back in such a time period now. Even more so, we are especially glad that we have opportunities we can feel comfortable with in the current economic environment of uncertainty.
About the Author: Forrest Jinks is CEO of Altus Equity Group Inc and a licensed real estate broker. Forrest has decades of experience as principal in a variety of alternative investment segments including real estate (residential rehab, in-fill development, multi-family, office and retail), debt, and small business start-up (online marketing and site retail). He can be reached at firstname.lastname@example.org.