Altus Insight: June, 2017

The Altus Insight
Market news, commentary and relevant topics for today’s alternative asset investor

Date: June 30, 2017
FR: Forrest Jinks
RE: To much good stuff (opportunity)

In a month where there is plenty to talk about (debt ceiling, the wild bond market, demographics, and even, gulp, immigration), Altus is also up past our elbows trying to get an eleven property portfolio in Norman, Oklahoma purchased. Several of the properties in the portfolio are smaller than our normal purchases, but each one still requires all the same steps as larger properties. This takes man-hours, lots of them. Due to the hours we are putting into that effort I didn’t have the time this month to do the research needed for a more traditional Altus Insight. Instead, below is a compilation of questions, with answers, we have received from potential investors in the Norman deal.

For those of you who are not familiar with this opportunity, below are the highlights.  Please contact us to receive a marketing package if you are interested in more detailed information.

  • Eleven properties, same seller, all in the same small area
  • One larger property (163 units) is being paired with two smaller properties, and being syndicated for investors
  • The remaining properties are being purchased by various individual investors, mostly using 1031 proceeds, in partnership with Altus Equity. This totals an additional 121 units.
  • The properties will be repositioned and resold or refinanced to permanent financing

Questions:

1.Why Norman, Oklahoma?

Altus believes that the most important aspect of underwriting an opportunity is the specific asset(s). However, all other things being equal, we want to make investments in areas that we view as “Emerging Markets”. Generally speaking we define Emerging Markets as areas that have strong population growth, job growth and household formation. Additionally, we want to invest in areas that have business and landlord- friendly governments. Norman scores well in all those criteria. As an example, the population has grown 8% in the past 6 years. This growth rate of 1.3% per year compares to only 0.7% in California and .8% in the USA at large.

2.How was this opportunity identified?

Nearly all of Altus’s investments are opportunities that are specifically brought to us by people in our network. In this particular case, two brokers with whom we have a high level of trust made us aware of the situation and introduced us to the seller. We met with the seller multiple times over several months and finally were able to come to terms that worked for both us and the seller.

3.How did Altus determine which properties were to be syndicated versus allocated to direct investment?

The original plan was to include all the properties in the syndication, but as we worked through the details we realized it was going to be far too complicated to do so. The largest property was an easy choice for the syndication, since it is so similar to other projects we have done and been successful with, such as Rockwell Plaza and Sunset Ridge. The other two properties were added to the syndication because of the 11 properties they made the most sense to resell as soon as possible. We believe there are likely to be tax benefits tied to the resale of these two properties, and those tax benefits would not be available to investors if these properties were structured as a direct investment. The remaining properties work well for investors looking to invest 1031 funds but not in large enough amounts to normally be able to partner with Altus.

4.How was the price allocated between properties?

The total purchase price of $12,600,000 was divided by the number of doors and then adjusted slightly so the Charleston Apartments, which is the large property being syndicated, was assigned a lower per door purchase price than the smaller properties by roughly 5%. This adjustment was made because larger properties are in general less expensive per door than similarly conditioned smaller properties, and because the large property has more deferred maintenance. However, due to the location, amenities, and architecture we believe the large property upside is more easily quantifiable.

5.What are the risks in this investment?

Good question. All investments have risk and this one is no different.

i.Before the purchase is consummated, investors are risking time reviewing and analyzing this information. If for some reason the purchase doesn’t occur, that time is lost. Altus Equity is likewise risking (considerable) time, and is also risking the upfront cost of due diligence, earnest deposits, financing deposits, travel, etc. So far, Altus has approximately $300,000 at risk if, for some reason, the financing doesn’t come through, or the seller cancels the transaction.

ii.The ownership risks are as follows:

  1. Our construction budget may be incorrect. While always a concern, we do have considerable experience in construction cost for repositioning apartments. Additionally, this risk is bounded by whatever the dollar amount is over the budget overrun.
  2. We may have incorrectly forecasted the post-repositioning Net Operating Income. This is a major focus of our due diligence into any such investment opportunity. Forecasting the future is difficult. To help mitigate this risk, our “Plan” forecast uses lower rental rates than the comparable properties we surveyed. We also use a higher vacancy rate than the current market rates. In fact, the bank doing the financing for this project mentioned that their own underwriting used higher rental rates and lower vacancy rates than we used in our forecast. This is the first time in my career that I have ever had a bank tell me their underwriting was more aggressive than the underwriting of the borrower.
  3. Interest rate risks.  This risk has less likelihood of being an issue, but would have a larger impact if it did indeed become an issue. The greatest mitigation we have against this risk is the time the project takes until we are able to refinance. The shorter the time frame, the less interest rates can adjust. Once we refinance, we will then have a longer-term fixed-rate loan that will not be affected by changes in the interest rate market until years into the future.
  4. Tornados: Everyone asks about this one because Oklahoma is well known for tornados. Having a tornado touch down on a property is a major event that creates a difficult and unfortunate situation, but counter-intuitively, tornados rarely create monetary harm for the property owners. Insurance on properties in Oklahoma includes tornado insurance, and we have the ability of getting the work done less expensively than what the insurance company would pay to have that work done. The insurance policy also includes a provision for loss of rents, so even while the damage is being repaired, income continues to be collected.

6.What is Altus’s skin in the game?

This particular deal is a little different than most. There are 11 total properties and only three are included in the syndication (as explained above). Of the remaining 8 properties, four are being purchased by members of Altus, three via 1031 funds, and the fourth by an Altus team member who doesn’t yet fit the accreditation requirements to be able to invest in the syndication. This total investment is close to $1MM. Additionally, Altus has invested substantial time and money in working through this project, which is now entering its sixth month of negotiation and research, and has an additional couple hundred thousand dollars at risk. The deal structure itself provides for a preferred return with no asset management fees, meaning Altus only makes money if the investors are first making money. The cost associated with being the asset manager though this type of project is substantial and is fully at risk if we are not successful in creating profit for the investors.

7.What is the deal with the road in front of the property (Lindsey Ave) being all torn up?

The City of Norman has invested substantial money to upgrade the I-35 off ramp at Lindsey Ave, and then Lindsey Ave itself between the Interstate and the University of Oklahoma campus. Lindsey is one of only two east-west corridors between the campus and the Interstate, and the construction, or more specifically, the rather severe impact the construction has had on traffic, has been difficult on the businesses along Lindsey. This has also negatively impacted the Charleston Apartments. This is all good news, however. The public works are scheduled to be done in October, which will provide a nice, new, street-front for the Charleston property, and the increased traffic on this corridor will correspond with the improvements to the property and act as free marketing for the lease up.

8.What else should an investor know?

Despite the plan to sell the two smaller properties included in the syndication, Altus has a long-term focus in our investment strategy. We want to own good properties in good areas. We believe Charleston fits this criteria. Additionally, a long term investment strategy reduces risks associated with future changes in the interest rate environment. While investors in this syndication have the absolute right to exit after five years, we hope investors view their investment in this opportunity as a long-term cash-flow investment.

Happy Investing.

Forrest Jinks