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Forward and Backward

December 2022 Insight

There are few Insight readers that have experienced anything like the economic and investing climate of the past year. This sort of turbulence hasn’t been witnessed in a very long time. Yes, 2008 was a wild ride, but it was completely different in cause and experience. Shoot, even in comparison to the early 1980’s when Volcker won the last battle with inflation, the interest rate increases of the past 10 months were unprecedented in scope (especially when the reversal of quantitative easing (QE) is taken into account). Additionally, when Volcker did his magic there was not a major war in progress (the Cold War not withstanding).

The impacts of the Fed’s actions are only just starting to make their way into the economy and real asset valuations. Many real estate companies (including Altus) are expecting opportunity in distressed assets, but the truth of the matter is, no one knows what the future holds. Substantial distressed asset funds were raised in 2020 at the outbreak of COVID which never ended up getting deployed because the expected distress never manifested itself. This time sure feels different though, with the impact to asset valuation not coming from economic influence, but rather because of the vastly increased cost of owning the assets (or, for non-levered investments, the relative change in opportunity cost).

While interest rate increases could have been expected as we entered 2022, I don’t know of anyone that forecasted the speed and scope of the changes. Looking backwards, and to no one’s surprise, the year ended up playing out very differently than we expected. In some ways we wouldn’t have preferred, but in other ways that we didn’t dare to hope for.

This past year reiterated my thankfulness for our board of directors and our investors, especially those more seasoned that have experienced cycles, and specifically inflationary cycles. I have spent a considerable amount of time picking their combined brains (along with anyone else who will humor me). They can’t foresee the future any better than anyone else, but that historical context is so helpful in trying to understand the possible outcomes. It is not feasible to prepare for potential outcome, but by understanding the possibilities, and maybe being able to apply some level of probability to those possibilities, we can try and prepare the business to take advantage of the greatest amount of those probabilities.

I am also thankful for the financing philosophy that Altus has followed for the past several years of locking in long term assumable financing wherever possible, and almost always including amortization. The siren sound of the lower rate, shorter term, interest only loans captured many within the industry, and at times was tempting to us as we tried to compete for projects and investors. But now, as we look at our portfolio, we are in such a great place that fighting off those temptations, and almost assuredly slowing the growth of our company, was well worth it. Not only does our financing provide years of stability into the future, but the assumable loans have become assets even in their own right. We continue to receive considerable interest from buyers. Some are carpet bombing looking for distressed sales. Those we try to quickly weed out. But there are others that are serious in their interest and willing to pay a premium for the ability to assume loans. While price changes within the market can only be quantified in hindsight, we feel like market prices in multifamily have dropped around 20% from their peak. Even when we stick to providing pricing guidance based on pre-March valuations, which were already pushing the very bounds of the market, buyer interest continues. If I had to wager, I would guess that because of financing on our properties, our prices have only fallen around 5%, which is substantially less than the market at large.

That isn’t to say that we haven’t been impacted. We were/are working on several active construction projects, ranging from pre-construction (submitted for building permits) to TIs being completed for tenant occupancy. Some of those projects are still moving forward, but others…it may be difficult to make the numbers work due to the increased interest costs and the expected, but still largely unknown, reduction in backend value. We said many times in early 2022 and in 2021 that things weren’t bad, they were just complicated. The complicated portion is still absolutely true, but complicated can be solved. There may well be some pre-construction projects that don’t get off the ground, at least in the short term. That obviously impacts investors in those projects (though that preliminary investment is relatively minimal). But it also impacts Altus’s operating revenue since Altus generally doesn’t get paid until certain milestones are achieved.

While all our active projects are impacted, thankfully several of them are able to proceed despite the difficulties, and still look to be profitable for our investors. Specifically, industrial projects in Texas continue to move forward with strong tenant interest, our build-for-rent duplex project in NW Arkansas still pencils well, and most impactfully for Altus as an organization, the industrial project in South Carolina continues to push forward full steam ahead. Taking into account an allocation of the project between us and our operating partners on that project, it is still three times larger than anything we have done in the past (though less so from some of the other projects currently in progress). Market pricing not with-standing, Altus remains highly bullish on the individual project fundamentals for the properties under construction and even in pre-construction. Economic drivers for the property uses remain strong; it is only the impact of the interest rates, and to a lesser degree construction costs, that are causing the project viability issues.

I also feel lucky about the timing of the property sales we completed this past year. Altus doesn’t often sell property, but when a buyer is willing to pay far more than what we would ever purchase that same property for (taking transaction costs into account), it can be hard to say no. We were able to sell four separate properties in Q1 of 2022, at the very highest point of the market. Sometimes it is better to be lucky than good.

Politically, and I am not telling anyone anything they don’t already know, things are a mess. While the Federal Reserve is trying to tighten fiscal conditions to fight inflation, the federal and many state governments, are making monetary policy moves that are highly inflationary, even as recently as this past week when the President signed a huge $1.7 TRILLION (yes, with a “T”) spending bill into law. We have an ex-president who has lost his mind, and along with his disciples thinks that contesting the legality of every close election is a good thing for democracy. Meanwhile the ruling party has voted someone into the highest post in House that is also an election denier. At both the state and federal level there is a severe lack of policy consistency, increasing the difficulty of playing by the rules and further acerbating the two-track system for companies that can more easily absorb the cost of government compliance and have the resources to figure out how to benefit from government largesse. I can’t figure out if this sort of policy inconsistency is a tail or head wind for Altus. We are a large enough company that some of the costs aren’t as impactful as they are to smaller companies (though certainly more impactful than they are to larger players in the space). We are sophisticated enough that we are able to structure projects so that our investors can benefit from various government largesse, but certainly not as sophisticated or well-connected as other companies that have specific staff focused on working with various governments to win government contracts or public-private partnerships.

What I know without a doubt, a huge win for Altus over the past year has been the ongoing growth of our team, both in terms of additional committed team members and the growth of existing team members. I am incredibly thankful for the team that we have, and specifically the commitment each member of the team has to self-improvement, and in turn, the ongoing improvement and growth of Altus. As we look forward to the year ahead, and what I strongly believe may include some rough sailing, our team is well prepared to both deal with the turbulence and take advantage of the associated opportunities.

I find it interesting that so many of us use the turning of the year to look backwards over the past twelve months and forward to the coming twelve months. Other than it being on the calendar, what is so special about a twelve-month period of time? This is especially true in our business. The Camp Hall industrial project in South Carolina was in process for over 18 months before the debt and equity was finalized this month, and now it has another 12 months of construction and leasing to follow. Almost none of our projects run full cycle within a calendar (or fiscal) year. Shoot, we often work on projects for many months, regularly crossing the turning of the calendar, prior to closing on the purchase of a property. We certainly can’t measure the success of our investments or our business over the course of a year.

But twelve months is what we have, so we use it, but with the awareness that it is nothing more than a  human created arbitrary period of time. The successes of the last twelve months don’t ensure success into the future. There are certainly areas where we wished things would have gone differently or that we could have done better, but that doesn’t mean we didn’t experience success and won’t experience success in the future. Investing, especially in real estate, shouldn’t be measured year by year, but rather across time with an end objective in mind. Investing, like business, is not a sprint, and the runner that leaves the marathon starting line the fastest rarely ends up crossing the finish line first. The marathon winners are those that can continue the pace and grow stronger as the race continues.

Happy Investing.

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 fjinks@altusequity.com.