“We’re in the final innings of this cycle” is a refrain we’ve heard time and time again this year when describing the economy. And we at Wildhorn agree, this has been the longest bull market in modern history. During the last 9 years real estate prices have exploded and cap rates have compressed–it’s been an incredible time to be a real estate investor.
These conversations have only intensified over the last 45 days as the stock market has started to waver and decline. Naturally our investors are evaluating their positions, liquidity and plans for the coming year. As we sit and evaluate where things are, and look ahead to our plans in 2019, we wanted to share why we will continue to be net buyers, and what is so attractive about our value-addValue-add is a strategy where an investor or property owner seeks to increase the value of a property by making significant improvements or changes to it. The goal is to enhance the property's appeal, functionality, and income-generating potential, which can lead to higher rental income, increased property valuation, and improved overall performance. View Definition business plan.
First, a little caveat. Investors are always asking us what our growth plans are. How many deals we are going to do, and when the next deal is coming. We always answer the same way–we don’t know. The next deal could be 2 weeks away, or 6 months away. It depends on what we see, and when. It also means we don’t have a hard goal in mind of how many deals we have to do. We want the ability to execute on around 4 deals a year. To us, that means we have the operations and teams in place to support those deals, and the equity to close on them. In the past 13 months we’ve closed on 5 deals (including our most recent here), but we don’t have a mandate or any sort of outside pressure to try and repeat that velocity, forcing us into bad deals.
When we look at our strategy, we are guided by two principles on the acquisition side:
Buy in core MSA’s that are experiencing sustainable growth Big cities are growing–specifically the big cities in Texas where we operate. We want to own assets in places people want to live. And within those cities we want to be in quality, in-fill locations. There are many groups we know chasing deals in small, tertiary markets as they look for yield. That gives us pause as the economy slows–how diverse are those markets? How will they grow in a downturn?
An acquisition must have value-add potential Simply put, we want to be able to force appreciationThe increase in the value of a property over time, usually due to factors such as market demand, economic growth, infrastructure improvements, and inflation. View Definition, and create value for our investors. We’ve talked about some of those value-add strategies in the past, and we’re not always going to be able to execute all of them. But there has to be a story and a clear path for how we can improve on the asset and/or the operations.
This strategy provides us with a higher chance of making strong returns as well as gives our team guard rails to focus our efforts. Drilling one level deeper, this strategy is bolstered by a number of factors that differentiate Multi-Family from broader market cycles. These factors include:
Limited Volatility
Compared to investments in equities, the real estate we buy is a hard asset. It’s not going anywhere overnight, and there is inherent value in the land, the building itself, and the operational income it produces. As the stock market becomes more and more volatile, it’s nice not to be subject to those big swings and watching our values swing day after day.
Compared to investments in equities, the real estate we buy is a hard asset. It’s not going anywhere overnight, and there is inherent value in the land, the building itself, and the operational income it produces. As the stock market becomes more and more volatile, it’s nice not to be subject to those big swings and watching our values swing day after day.
Capital Preservation
There is capital preservation–even in the worst of times. We’re not trying to pick on stocks specifically, but anytime you could conceivably lose all of your investment in a single day, we have a hard time putting our money behind that. We believe that by investing in apartments, you are eliminating the lion share of that risk. For all of our deals we perform a sensitivity analysis during our due diligence, and on average our assets are going to be cash flowThe money that is left over each month or year from the property's income after paying for operating costs, mortgage, taxes, and other expenses. Positive cash flow occurs when the income exceeds the expenses, while negative cash flow indicates that the property's expenses are higher than the income it generates. View Definition neutral at an occupancy of below 80%. That means that if we had a sustainable period of time where occupancy was below 80%, investor capital, and the asset itself would remain intact. In 2009, the worst recession of our lifetime, the average occupancy in both Austin and San Antonio was about 87%–and that lasted no more than 18 months. Pretty comforting numbers that compel us to keep buying.
There is capital preservation–even in the worst of times. We’re not trying to pick on stocks specifically, but anytime you could conceivably lose all of your investment in a single day, we have a hard time putting our money behind that. We believe that by investing in apartments, you are eliminating the lion share of that risk. For all of our deals we perform a sensitivity analysis during our due diligence, and on average our assets are going to be cash flowThe money that is left over each month or year from the property's income after paying for operating costs, mortgage, taxes, and other expenses. Positive cash flow occurs when the income exceeds the expenses, while negative cash flow indicates that the property's expenses are higher than the income it generates. View Definition neutral at an occupancy of below 80%. That means that if we had a sustainable period of time where occupancy was below 80%, investor capital, and the asset itself would remain intact. In 2009, the worst recession of our lifetime, the average occupancy in both Austin and San Antonio was about 87%–and that lasted no more than 18 months. Pretty comforting numbers that compel us to keep buying.
Flexible Hold Periods
5-7 year hold periods can weather economic downturns. Between 1854 and 2009, there were 33 defined business cycles. In those cycles, the average time of a downturn/recession was less than 18 months. Given that our deals average 5-7 year anticipated hold periods, these investments are able to operate through any downturn, and wait for an opportune time to exit when the economy is in a bright spot.
5-7 year hold periods can weather economic downturns. Between 1854 and 2009, there were 33 defined business cycles. In those cycles, the average time of a downturn/recession was less than 18 months. Given that our deals average 5-7 year anticipated hold periods, these investments are able to operate through any downturn, and wait for an opportune time to exit when the economy is in a bright spot.
Rent Doesn’t Fluctuate with Home Prices
What goes up when the stock market is in decline, wages are stagnant and single family home values are plummeting? Rental rates. When looking at the last 25 years of average U.S. Home Price Index (blue line) you’ll see some exciting highs and absolutely depressing lows. Look at how rental rates (red line) have changed over that same period of time. Growth is constant in an upward direction. If you’re able to cash flow on a mutli-family property day 1 and you manage the operation’s costs, you should be able to continue to generate a growing profit year over year.
What goes up when the stock market is in decline, wages are stagnant and single family home values are plummeting? Rental rates. When looking at the last 25 years of average U.S. Home Price Index (blue line) you’ll see some exciting highs and absolutely depressing lows. Look at how rental rates (red line) have changed over that same period of time. Growth is constant in an upward direction. If you’re able to cash flow on a mutli-family property day 1 and you manage the operation’s costs, you should be able to continue to generate a growing profit year over year.
Source: https://fred.stlouisfed.org/
If you can’t tell by now, there are many reasons we like the multifamily investment space, and think it makes for a strong investment, no matter the economic cycle. It obviously takes a lot of patience and effort to find deals that meet our criteria, but we remain committed to turning over every stone and working hard every single day to bring those opportunities, and provide them with good, risk-adjusted returns as we enter a time of economic uncertainty.
Bring it on 2019.
Written by Andrew Campbell
Andrew Campbell is a native Austinite and Managing Partner at Wildhorn. He is a real estate entrepreneur who first broke into the business in 2008 as a passive investor. In 2010 he transitioned into active investing and management of a personal portfolio that grew to 76 units across Austin and San Antonio. He earned his stripes building and managing his personal portfolio before founding Wildhorn Capital and focusing on larger multifamily buildings. At Wildhorn, he is focused on Acquisitions and maintaining Investor Relations, utilizing his marketing and communications background to build long-term relationships.
